UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File No. 001-33050

REALTY FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

Maryland

30-0314655

(State or other jurisdiction

incorporation or organization)

(I.R.S. Employer of

Identification No.)

185 Asylum Street, 31^st Floor, Hartford, CT 06103

(Address of principal executive offices - zip code)

(860) 275-6200

(Registrant’s telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, $.01 Par Value		Over-the-Counter Bulletin Board

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) 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 ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a small reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of March 12, 2009, there were 30,936,533 shares of the Registrant’s common stock outstanding. The aggregate market value of common stock held by non-affiliates of the registrant at June 30, 2008, was $101,421,864. The aggregate market value was calculated by using the price at which our common stock was last sold, which was $3.44 per share on June 30, 2008.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for the 2009 Annual Stockholders’ Meeting which are expected to be filed within 120 days after the close of the Registrant’s fiscal year are incorporated by reference into Part III of this Annual Report on Form 10-K.

REALTY FINANCE CORPORATION

INDEX


		PAGE
PART I

1.	Business	1

1A.	Risk Factors	12

1B.	Unresolved Staff Comments	30

2.	Properties	30

3.	Legal Proceedings	31

4.	Submission of Matters to a Vote of Security Holders	31

PART II

5.	Market for Registrant’s Common Equity and Related Stockholders Matters and Issuer Purchases of Equity Securities	32

6.	Selected Financial Data	34

7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36

7A.	Quantitative and Qualitative Disclosures about Market Risk	51

8.	Financial Statements and Supplemental Data	53

9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	86

9A.	Controls and Procedures	86

9B.	Other Information	86

PART III

10.	Directors, Executive Officers of the Registrant and Corporate Governance	87

11.	Executive Compensation	87

12.	Security Ownership of Certain Beneficial Owners and Management and Related Stock Matters	87

13.	Certain Relationships and Related Transactions, and Director Independence	87

14.	Principal Accountant Fees and Services	87

PART IV

15.	Exhibits and Financial Statement Schedules	88

	SIGNATURES

PART I

ITEM 1.

BUSINESS

General

Realty Finance Corporation, formerly known as CBRE Realty Finance, Inc., was organized in Maryland on May 10, 2005, as a commercial real estate specialty finance company focused on originating and acquiring whole loans, bridge loans, subordinate interests in whole loans, or B Notes, commercial mortgage-backed securities, or CMBS, and mezzanine loans, primarily in the United States. Unless the context requires otherwise, all references to “we,” “our,” and “us” in this annual report mean Realty Finance Corporation, a Maryland corporation, our wholly-owned and majority-owned subsidiaries and our ownership in joint venture assets and real estate projects. As of December 31, 2008, we also own interests in seven joint venture assets, two of which are consolidated in the consolidated financial statements. We commenced operations on June 9, 2005. We are a holding company and conduct our business through wholly-owned or majority-owned subsidiaries.

Historically, we have been externally managed and advised by CBRE Realty Finance Management, LLC, our Manager, an indirect subsidiary of CB Richard Ellis Group, Inc., or CBRE, and a direct subsidiary of CBRE Melody & Company, or CBRE|Melody. As of December 31, 2008, CBRE|Melody also owned an approximately 4.5% interest in the outstanding shares of our common stock. In addition, certain of our executive officers and directors owned an approximately 2.5% interest in the outstanding shares of our common stock. The management agreement expired by its terms on December 31, 2008. The expiration of the management agreement ended our affiliation with CBRE and its affiliates. As a result, subsequent to December 31, 2008, we have internalized the operations historically performed by our Manager into our company through the direct hiring of the employees previously employed by our Manager and replacing other functions previously performed or facilitated by CBRE|Melody, such as payroll and other back office functions, and obtaining standalone insurance coverage. As a result of the termination of the management agreement, we will no longer pay any management fees. However, such fees will generally be replaced by costs that had historically been absorbed by our Manager, primarily compensation and benefit costs. No fees were paid by us in connection with the expiration of the management agreement.

On November 4, 2008, the 30 trading-day average market capitalization of our common stock fell below $25 million, resulting in the permanent delisting of our common stock from the New York Stock Exchange, or NYSE. Our common stock has since been traded through normal brokerage channels on the OTC Bulletin Board, or the OTCBB. The OTCBB is an electronic, regulated quotation service that displays real-time quotes, last-sale prices, and volume information for over-the-counter equity securities issued by companies that are subject to periodic filing requirements with the Securities and Exchange Commission, or the SEC, or other regulatory authority.

On December 8, 2008, the NYSE filed a Form 25 with the SEC to delist our common stock from trading on the NYSE and to deregister our common stock under the Securities and Exchange Act of 1934, as amended, or the Exchange Act, which became effective on March 9, 2009. Given that we have fewer than 300 holders of record of our common stock, we will voluntarily choose to become a non-reporting company, which would suspend our obligation to file periodic reports with the SEC pursuant to the Exchange Act. Our board of directors has elected to file Form 15 with the SEC on or around March 16, 2009 to effectuate this change. Eliminating our requirement to make further SEC filings will permit us to reduce expenses associated with compliance efforts as well as listing fees, professional fees, insurance and other administrative costs. Currently, we do not believe the benefits of being a periodic reporting company and continuing to make SEC filings justify these significant costs. Upon the filing of the Form 15, we will no longer be obligated to file periodic reports with the SEC, including Forms 10-K, 10-Q and 8-K. As a result, management anticipates that our shares of common stock will not be eligible to be traded on the OTCBB and will instead be traded solely on the Pink OTC Markets, or the Pink Sheets. However, we can make no assurances that any broker will make a market in our common stock. The Pink Sheets is a centralized quotation service that collects and publishes market maker quotes in real time, primarily through its web site, http://www.pinksheets.com. We intend to continue to release unaudited quarterly earnings reports and audited annual financial statements by posting on our website as well as on the OTC Disclosure and News Service.

We have elected to qualify to be taxed as a real estate investment trust, or REIT, for U. S. federal income tax purposes commencing with our taxable year ended December 31, 2005. As a REIT, we generally will not be subject to U. S. federal income tax on that portion of income that is distributed to stockholders if at least 90% of the our REIT taxable income is distributed to our stockholders. We conduct our operations so as to not be regulated as an investment company under the Investment Company Act of 1940, as amended, or the 1940 Act. We also conduct business through our wholly-owned taxable REIT subsidiary, or TRS, RFC TRS, Inc.

In July 2007, when concerns over the sub-prime residential markets began impacting liquidity and valuations in the commercial real estate market, we suspended new investment activity due to the uncertainty about our ability to secure short-term financing under repurchase agreements and long-term financing through the use of collateralized debt obligations, or CDOs. Although we do not have any direct sub-prime exposure or direct exposure to the single family mortgage market, the factors described above have resulted in substantially reduced mortgage loan originations and securitizations, and caused more generalized credit market dislocations and a significant contraction in available credit. As a result, most financial industry participants, including commercial real estate lenders and investors, continue to find it difficult to obtain cost-effective debt capital to finance new investment activity or to refinance maturing debt.

During 2008 and into 2009, the global capital markets continued to experience tremendous volatility and a wide-ranging lack of liquidity. The impact of the global credit crisis on our sector has been acute. Transaction volume has declined significantly, credit spreads for all forms of mortgage debt have reached all-time highs, issuance levels of commercial mortgage backed securities, or CMBS, have ground to a halt, and other forms of financing from the debt markets have been dramatically curtailed. Financial institutions still hold significant inventories of unsold loans and CMBS, creating a further overhang on the markets. The continuing dislocation in the debt capital markets, coupled with a slowdown in the U.S. economy, has already reduced property valuations and is impacting real estate fundamentals. These developments can and have impacted the performance of our existing portfolio of assets. Furthermore, the volatility in the capital markets has caused stress to all financial institutions and, our business is dependent upon these counterparties for, among other things, financing and interest rate derivatives. As we await the credit and capital markets to improve and stabilize, our primary focus has been securing our liquidity by paying down and terminating outstanding short-term repurchase agreements and managing our existing portfolio of assets to minimize credit risks where possible. The current credit and capital market environment remains unstable and we continue to review and analyze the impact on potential avenues of liquidity. We expect credit and capital market conditions to continue to be challenging throughout 2009 and into 2010.

During 2008, we undertook a process of evaluating strategic and operational initiatives assisted by our financial advisor, Goldman Sachs & Co., or Goldman Sachs. Based on the continued decline in the capital and credit markets which has had a severe adverse impact on our valuations and our ability to obtain financing, management concluded that a sale of our company, merger or other business combination, capital investment or other strategic alternatives at the present time was either not available or was not in the best interest of stockholders. We will continue to explore and evaluate future opportunities as they present themselves, however, our primary focus will remain on maximizing the value of our current $1.2 billion investment portfolio and non-recourse long-term financing in place through our two CDOs. As a result of the rapidly changing and evolving markets that continue to create challenges in our industry and in the general economy, we are experiencing the following: (i) no loan originations or other investment activity, (ii) lower operating margins due to lack of scale, (iii) reduced access to capital, if at all, and if such capital is available at significantly increased costs, (iv) an increase in non-performing loans and watch list assets, (v) reduced operating cash flows due to breach of CDO covenants and reduced asset base, and (vi) reduced cash available for distribution to stockholders, particularly as our portfolio is reduced by scheduled maturities, prepayments and non-performing loans. Our $1.2 billion investment portfolio has decreased by approximately 26% from December 31, 2007 based on these factors. On December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to increase our liquidity and maintain our financial flexibility.

- 1 -

and net of repayments and sales of partial interests in loans and CMBS, with a weighted average spread to 30-day LIBOR of 311 basis points for our floating rate investments and a weighted average yield of 7.12% for our fixed rate investments. Our portfolio is comprised solely of commercial real estate debt and equity investments with no sub-prime exposure. We have long-term financing in place through our first CDO issuance, which provides approximately $508.5 million of financing with an average cost of 30-day LIBOR plus 50.6 basis points and our second CDO issuance which provides $853.2 million of financing with an average cost of 90-day LIBOR plus 40.6 basis points. Our CDOs contain reinvestment periods of five years during which we can use the proceeds of loan repayments to fund new investments. As of December 31, 2008, we had approximately 2.3 years and 3.3 years remaining in our reinvestment period for our first and second CDO, respectively. Reinvestment is not permitted during periods that we are not in compliance with our CDO covenants.

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund loans and other investments, pay dividends, fund debt service and for other general corporate purposes. On December 31, 2008, we had approximately $23.1 million of unrestricted cash and cash equivalents. We have long-term financing for 100% of our encumbered portfolio in place through our existing CDOs and mortgage loans. Our primary sources of funds for short-term liquidity requirements, including working capital, distributions, if any, debt service and additional investments, if any, consist of (i) cash flow from operations; (ii) proceeds from our existing CDOs; (iii) proceeds from principal and interest payments on our unencumbered investments; (iv) proceeds from potential loan and asset sales; and, to a lesser extent; (v) new financings or additional securitization or CDO offerings and (vi) proceeds from additional common or preferred equity offerings. We believe these sources of funds will be sufficient to meet out short-term liquidity requirements.

Due to continued market turbulence, we do not anticipate having the ability in the near term to access equity capital through the public or private markets or debt capital through warehouse lines, new CDO issuances, or new trust preferred issuances. We continue to explore equity and other capital raising options as well as other strategic alternatives as they present themselves; however, in the event we are not able to successfully secure financing, we will rely on existing cash on hand, cash flows from operations, principal payments on our investments, and proceeds from asset and loan sales, if any, to satisfy these requirements. If we (i) are unable to renew, replace or expand our sources of financing, (ii) are unable to execute asset and loan sales in a timely manner or to receive anticipated proceeds therefrom or (iii) fully utilize available cash, it may have an adverse effect on our business, results of operations and ability to make distributions to our stockholders.

Our current and future borrowings may require us, among other restrictive covenants, to keep uninvested cash on hand, to maintain a certain portion of our assets free from liens and to secure such borrowings with our assets. These conditions could limit our ability to do further borrowings. If we are unable to make required payments under such borrowings, breach any representation or warranty in any loan document or violate any covenant contained in a loan document, our lenders may accelerate the maturity of our debt or require us to pledge more collateral. If we are unable to pay off our borrowings in such a situation, (i) we may need to prematurely sell the assets securing such debt, (ii) the lenders could accelerate the debt and foreclose on our assets that are pledged as collateral to such lenders, (iii) such lenders could force us into bankruptcy, (iv) such lenders could force us to take other actions to protect the value of their collateral and (v) our other debt financings could become immediately due and payable. Any such event would have a material adverse effect on our liquidity, the value of our common stock and the ability to make distributions to our stockholders.

The majority of our investments are pledged as collateral for our CDO bonds and the income generated from these investments is used to fund interest obligations of our CDO bonds and the remaining income, if any, is retained by us. Our CDO bonds contain interest coverage and asset overcollateralization covenants that must be met in order for us to receive such payments. If we fail our interest coverage or asset overcollateralization covenants in either of our CDOs, all cash flows from the CDO (including interest on the bonds we own, distributions on our common and preferred equity and our subordinated management fee) would be diverted to repay principal and interest on the outstanding CDO bonds and we would not receive any residual payments until the CDO was back in compliance with such tests. We were in compliance with all such covenants as of December 31, 2008. In the event of a breach of our CDO covenants that we could not cure in the near term, we would be required to fund interest on trust preferred securities and other expenses (including compensation expenses) through (i) cash on hand, (ii) income from any CDO not in default, (iii) sale of unencumbered assets or (iv) accessing debt or equity capital markets, if available. We have the ability to cure defaults, which would resume normal payments to us, by purchasing non-performing loans out of our CDOs. However, we may not have sufficient liquidity available to do so at such time. In some cases, collateral may be continuing to pay interest but may be considered a defaulted interest for the purpose of the covenant calculations, such as our CMBS in our 2006 CDO, or CDO I, which are considered defaulted interests for the purpose of covenant calculation if any rating agency downgrade occurs. To the extent noncompliance continues for an extended period of time, our ability to continue as a going concern may be jeopardized. At December 31 2008, our most restrictive covenants on our CDOs had an interest coverage ratio of 2.21x and 1.22x for CDO I and our 2007 CDO, CDO II, respectively, compared to minimum requirements of 1.21x and 1.09x. At December 31, 2008, our most restrictive covenants on our CDOs had an asset overcollateralization ratio of 1.15x and 1.10x for CDO I and CDO II, respectively, compared to minimum requirements of 1.12x and 1.10x. If we experience an additional $15 million or $500,000 in reductions of collateral in CDO I or CDO II, respectively, due to further investment losses or other factors, we will fail the overcollateralization test for the respective CDO.

On February 25, 2009, we were notified by the CDO I trustee that we failed the overcollateralization test for CDO I on the February 25, 2009 payment date and, as a result, future net cash flows from CDO I, including approximately $488,000 due on the February 25, 2009 payment date, will be diverted to pay down principal of senior bond holders rather than being paid to us until such time the covenant is back in compliance, if ever. As of February 27, 2009, CDO II was in compliance with the overcollateralization test, however, if an additional $0.5 million in defaults occur, CDO II will also breach the overcollateralization covenant. Management believes it is likely that CDO II will fail the overcollateralization test at some point in 2009, which will result in the cash flows of CDO II (including interest on the bonds we own, distributions on our common and preferred equity and our subordinated management fee) being diverted to pay down principal of senior bond holders, eliminating residual cash inflows paid to us. With both CDOs out of compliance with overcollateralization covenants, we will have minimal incoming cash flows from our primary business and there is no assurance when or if we will be able to regain compliance with these covenants. As discussed further in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related-Party Transactions,” the breach of the overcollateralization covenant in either CDO provides MBIA Insurance Corporation, or MBIA, the controlling class of CDO II bondholders, the ability to terminate the existing collateral management agreement, as amended, and to remove us as the collateral manager of CDO II. We have incurred significant losses since our inception and may incur additional losses in the future as we continue to navigate the difficult issues in the credit and real estate markets. With minimal incoming cash flows, management’s plans to fulfill short-term capital requirements include (i) use of $23.1 million of cash on hand as of December 31, 2008 to fund operating expenses, (ii) senior collateral management fees, (iii) reduction in administrative costs, as a result of becoming a non-reporting company, (iv) reduction in employee headcount, and (v) sale of our unencumbered 1515 Market Street LLC joint venture interest, if possible under current market conditions. We believe these sources of funds will be sufficient to meet our liquidity requirements for at least the next 12 months. We continue to seek and explore partnerships and new business opportunities; however, there is no assurance that such partnerships or business opportunities will be available on favorable terms or at all.

- 2 -

As of December 31, 2008, our investment portfolio of approximately $1.2 billion in assets, including origination costs and fees, and net of repayments, sales of partial interests in loans, and loan loss reserves and charge offs, consisted of the following:


							Weighted Average
Security Description	Carrying Value			Number of Investments	Percent of Total Investments		Coupon		Yield to Maturity		LTV
	(In thousands)
Whole loans⁽¹⁾	$	843,934		38	61.3	%	5.28	%	5.09	%	72	%
B Notes		218,427		11	15.9	%	5.42	%	5.76	%	52	%
Mezzanine loans		247,437		12	18.0	%	6.36	%	6.38	%	53	%
CMBS		54,620		67	4.0	%	4.76	%	7.20	%	—
Joint venture investments⁽²⁾		11,231		7	0.8	%	—		—		—

Total investments	$	1,375,649		135	100.0	%
Loan loss reserve		(141,065	)

Total investments, net	$	1,234,584

⁽¹⁾	Includes originated whole loans, acquired whole loans and bridge loans.

⁽²⁾	Includes our equity investment in two limited liability companies which are deemed to be VIEs and which we consolidate in our financial statements because we are deemed to be the primary beneficiary of these VIEs under FIN 46R.

The following chart illustrates the structure and ownership of our company during the year ended December 31, 2008 and the management relationship between our Manager and us. The management agreement expired by its terms on December 31, 2008.

LOGO

⁽¹⁾	Excludes shares of common stock beneficially owned by Mr. Ray Wirta, chairman of our board of directors.

⁽²⁾	The remainder is owned in the aggregate by our CEO and certain other employees of CBRE\|Melody

Our Business Strategy

Historically, our business strategy has been to generate a diversified portfolio of commercial real estate investments and leverage these investments to produce attractive total returns to our stockholders. As we continue to assess the impact of the credit and capital markets on our long-term business strategy, we have been focused on actively managing our existing investment portfolio. We have not entered into a new investment since July 2007. As of December 31, 2008, the net carrying value of our investments was approximately $1.2 billion, including origination costs and fees and net of repayments and sales of partial interests in loans and CMBS, with a weighted average spread to 30-day LIBOR of 311 basis points for our floating rate investments and a weighted average yield of 7.12% for our fixed rate investments. Our portfolio is comprised solely of commercial real estate debt and equity investments with no sub-prime exposure. We have long-term financing in place through our first CDO issuance, which provides approximately $508.5 million of financing with an average cost of 30-day LIBOR plus 50.6 basis points and our second CDO issuance, which provides $853.2 million of financing with an average cost of 90-day LIBOR plus 40.6 basis points. Our CDOs contain reinvestment periods of five years during which we can use the proceeds of loan repayments to fund new investments. As of December 31, 2008, we had approximately 2.3 years and 3.3 years remaining in our reinvestment period for our first and second CDO, respectively.

The ability to manage our credit and real estate risks is a critical component of our success. We actively manage our portfolio by using our management team’s expertise in understanding the risk characteristics of an investment and, wherever possible, proactively managing the credit risk of investments in our portfolio. We generate income principally from the spread between the yields on our assets and the cost of our borrowing and hedging activities. Future distributions and capital appreciation are not guaranteed.

During 2008, we undertook a process of evaluating strategic and operational initiatives assisted by Goldman Sachs. Based on the continued decline in the capital and credit markets which has had a severe adverse impact on our valuations and our ability to obtain financing, management concluded that a sale of our company, merger or other business combination, capital investment or other strategic alternatives at the present time was either not available or was not in the best interest of stockholders. We will continue to explore and evaluate future opportunities as they present themselves, however, our primary focus will remain on maximizing the value of our current $1.2 billion investment portfolio and non-recourse long-term financing in place through our two CDOs. As a result of the rapidly changing and evolving markets that continue to create challenges in our industry and in the general economy, we are experiencing the following: (i) no loan originations or other investment activity, (ii) lower operating margins due to lack of scale, (iii) reduced access to capital, if at all, and if such capital is available at significantly increased costs, (iv) an increase in non-performing loans and watch list assets, (v) reduced operating cash flows due to breach of CDO covenants and a reduced asset base and (vi) reduced cash available for distribution to stockholders, particularly as our portfolio is reduced by scheduled maturities, prepayments and non-performing loans. Our $1.2 billion investment portfolio has decreased by approximately 26% from December 31, 2007 based on these factors. On December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to increase our liquidity and maintain our financial flexibility.

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Our Financing Strategy

General Policies. Our financing strategy historically focused on the use of match-funded financing structures. This means that we seek to match the maturities and/or repricing schedules of our financial obligations with those of our investments to minimize the risk that we have to refinance our liabilities prior to the maturities of our assets and to reduce the impact of changing interest rates on earnings. As of December 31, 2008, 100% of our encumbered portfolio was match-funded. Over the long-term, we intend to finance the acquisition of our investments primarily by borrowing against or leveraging our existing portfolio and using the proceeds to acquire additional investments; however, given current credit and capital market conditions, such financing is currently unavailable to us. We may, if available, from time to time utilize proceeds from equity and/or debt offerings or other forms of debt financing. Our leverage policy permits us to leverage up to 80% of the total value of our assets. Our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our indebtedness policy at anytime. As of December 31, 2008, 98% of our assets by carrying value are levered. We use leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.

Warehouse Facilities. Over the long-term, we seek to use short-term financing, in the form of warehouse facilities. Warehouse lines are typically collateralized loans made to borrowers who invest in securities and loans that in turn pledge the resulting securities and loans to the warehouse lender. As of December 31, 2008, we did not have a facility in place that allowed for additional short-term borrowings. As a result on the continued dislocation in the capital and credit markets, it is unlikely that any form of warehouse facilities will be available to us in the near-term.

Collateralized Debt Obligations. We intend to use long-term financing, in the form of securitization structures, particularly CDOs, as well as other match-funded financing structures, if available. We believe CDO financing structures are an appropriate financing vehicle for our targeted real estate asset classes because they will enable us to obtain long-term match-funded cost of funds and minimize the risk that we have to refinance our liabilities prior to the maturities of our investments while giving us the flexibility to manage credit risk and, subject to certain limitations, to take advantage of profit opportunities. As of December 31, 2008, we had issued two CDO transactions totaling approximately $1.4 billion, which provide attractive long-term financing. As a result on the continued dislocation in the capital and credit markets, there have been virtually no new CDO issuances and we are unable to predict when the market will return, to what degree underwriting standards will change and whether or not we will have access to such markets.

Term Debt. We may explore term financing from bank lenders that is secured by commercial real estate loans, securities or properties. We anticipate using secured leverage to enhance returns on investments. However, there is no assurance that such financing will be available.

Preferred Equity. We may explore financing from preferred equity. We anticipate using any preferred equity proceeds to preserve our liquidity and enhance returns on investments. However, there is no assurance that such financing will be available.

Our Investment Portfolio

Our investments target the following asset classes:

•

Whole loans;

•

Subordinated interests in first mortgage real estate loans, or B Notes;

•

Mezzanine loans related to commercial real estate that is senior to the borrower’s equity position but subordinated to other third-party financing; and

•

Commercial mortgage-backed securities, or CMBS.

As of December 31, 2008, our investment portfolio (excluding our direct real estate assets) of approximately $1.2 billion in assets, including origination costs and fees, and net of repayments, sales of partial interests in loans, and loan loss reserves and charge offs consisted of the following:


							Weighted Average
Security Description	Carrying Value			Number of Investments	Percent of Total Investments		Coupon		Yield to Maturity		LTV
	(In thousands)
Whole loans⁽¹⁾	$	843,934		38	61.3	%	5.28	%	5.09	%	72	%
B Notes		218,427		11	15.9	%	5.42	%	5.76	%	52	%
Mezzanine loans		247,437		12	18.0	%	6.36	%	6.38	%	53	%
CMBS		54,620		67	4.0	%	4.76	%	7.20	%	—
Joint venture investments⁽²⁾		11,231		7	0.8	%	—		—		—

Total investments	$	1,375,649		135	100.0	%
Loan loss reserve		(141,065	)

Total investments, net	$	1,234,584

⁽¹⁾	Includes originated whole loans, acquired whole loans and bridge loans.

⁽²⁾

Includes our equity investment in two limited liability companies which are deemed to be variable interest entities, or VIEs, which we consolidate in our audited financial statements because we are deemed to be the primary beneficiary of these VIEs under Financial Accounting Standards Board Interpretation No. 46R, or FIN 46R.

Our investment guidelines require us to maintain a geographically diverse portfolio of assets. Our investment focus is on opportunities in North America. Our board of directors may change these guidelines or investment focus at any time without the approval of our stockholders. As of December 31, 2008, our investment portfolio (excluding our direct real estate assets) consisted of assets primarily located in four regions of the U.S., as defined by the National Council of Real Estate Investment Fiduciaries, or NCREIF, with approximately 29% of our investments located in the East, approximately 10% in the South, approximately 48% in the West and approximately 7% in the Midwest. The remaining 6% of our investments were located throughout the U.S. and Aruba.

The following is a more detailed description of each of our target asset classes:

Whole Loans. Commercial mortgage loans, or whole loans, are structured to either permit us to retain the entire loan, or to sell or securitize the lower yielding senior portions of the loans and retain the higher yielding subordinate investment or to contribute the entire loan to our CDOs. Typically, borrowers of these loans are institutions and well-capitalized real estate operating companies and investors. These loans are secured by commercial real estate assets in a variety of industries with a variety of characteristics. We expect to originate both fixed and floating rate loans and we expect to hold these investments to maturity. Our primary focus initially is commercial properties in the office, retail, hotel, industrial and apartment sectors.

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Historically, we have also acquired seasoned loans in the secondary market secured by single assets and portfolios of performing and sub-performing loans originated by third-party lenders such as banks, life insurance companies and other owners. These loans are secured by commercial properties throughout the U.S.

If we anticipate selling the senior portion of our commercial mortgage loans, we would seek to fund the purchase of the loan either through, or jointly with, our TRS. In instances where we originate or purchase the commercial mortgage loans jointly with our TRS, we will retain the subordinate portion for our own account and our TRS will seek to sell the senior portion. If we purchase the commercial mortgage loans through our TRS, the TRS will sell the subordinate piece of the loan to us at fair market value determined based on arms length dealing, and the TRS will seek to sell the senior piece to third parties. Our TRS will be subject to corporate income tax on any taxable gain recognized by it on the sale of loans to us or to third parties and on its other taxable income. If we anticipate holding a commercial mortgage loan for our own account, we will generally seek to fund the purchase of the loan without funding by our TRS. We and our TRS intend to use warehouse facilities, if available, to provide short-term funding for our third-party loan purchases.

Subject to maintaining our qualification as a REIT, we historically have also offered bridge loans to borrowers who are seeking short-term capital (that is, less than five years) to be used in the acquisition, construction or redevelopment of a property. Typically, the borrower has identified a property in a favorable market that it believes to be poorly managed or undervalued. Bridge financing enables the borrower to secure short-term financing while improving the property and avoid burdening it with restrictive long-term debt. The bridge loans we originate will be predominantly secured by first mortgage liens on the property and we expect to hold these investments to maturity. We believe our bridge loans will lead to additional financing opportunities in the future, as bridge facilities are often a first-step toward permanent financing or a sale.

As of December 31, 2008, we had invested $843.9 million on a carrying value basis, or 61% of our total investments in whole loans. None of the whole loans we made investments in were in default at the time of purchase. However, we may in the future invest in whole loans or seasoned loans that may be in default. As of December 31, 2008, two whole loan investments with an aggregate carrying value of $57.5 million were on our watch list and one whole loan and two bridge loans totaling $20.6 million were non-performing, which are described further in Item 7 “Management’s Discussion and Analysis of Financial Condition— Risk Management” of this report.

Subordinate Interests in Whole Loans (B Notes). Historically, we have purchased from third parties and have retained, and in the future may retain, from whole loans we originated and securitized or sold, subordinate interests referred to as B Notes. B Notes are loans secured by a first mortgage and subordinated to a senior interest, referred to as an A Note. The subordination of a B Note is generally evidenced by a co-lender or participation agreement between the holders of the related A Note and the B Note. In some instances, the B Note lender may require a security interest in the stock or partnership interests of the borrower as part of the transaction. B Note lenders have the same obligations, collateral and borrower as the A Note lender, but typically are subordinated in recovery upon a default. B Notes share certain credit characteristics with second mortgages, in that both are subject to the greater credit risk with respect to the underlying mortgage collateral than the corresponding first mortgage or A Note. If we originate first mortgage loans, we may divide them, securitizing or selling the A Note and keeping the B Note for investment. In instances where we divide a first mortgage loan, we will fund the origination of the loan either through or jointly with our TRS. If we originate the first mortgage loan jointly with our TRS, we will retain the B Note for investment and our TRS will sell the A Note. If we originate the first mortgage loans through our TRS, the TRS will sell the B Note to us for investment at fair market value determined based on arms length dealing, and the TRS will sell the A Note to a third party. We may also pay our TRS a fee for the origination services provided by it for the B Notes we acquire for our loan portfolio. Any fee we pay to our TRS for loan origination will be market-based and consistent with fees that would be earned with the origination of mortgage loans on behalf of third parties. Our TRS will be subject to corporate income tax on any taxable gain recognized by it on the sale of B Notes or A Notes to us or to third parties and on its other taxable income.

When we acquire and/or originate B Notes, we may earn income on the investment, in addition to the interest payable on the B Note, in the form of fees charged to the borrower under that note or by receiving principal payments in excess of the discounted price (below par value) we paid to acquire the note. When we originate a B Note out of a whole loan and then sell the A Note through our TRS, we will have to allocate the basis in the whole loan to the two (or more) components to reflect the fair market value of the new instruments.

Our TRS may realize a profit on the sale if the allocated value is below the sale price. Our TRS will be subject to corporate income tax on any taxable gain recognized by it on such sales as well as its other taxable income.

Our ownership of a B Note with controlling class rights may, in the event the financing fails to perform according to its terms, cause us to elect to pursue our remedies as owner of the B Note, which may include foreclosure on, or modification of, the note. In some cases the owner of the A Note may be able to foreclose or modify the note against our wishes as holder of the B Note. As a result, our economic and business interests may diverge from the interests of the holders of the A Note. These divergent interests among the holders of each investment may result in conflicts of interest. We expect to hold B Notes to their maturity. We generally structure or acquire B Notes with unilateral foreclosure rights on the underlying mortgage.

As of December 31, 2008, we had invested $218.4 million on a carrying value basis, or 16% of our total investments in B Notes. As of December 31, 2008, one B-Note with a loan balance of $42.8 million is non-performing, which is described further in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Management” of this report.

Mezzanine Financing. Historically, we have invested in mezzanine loans that are senior to the borrower’s common and preferred equity in, and subordinate to a first mortgage loan on, a property. These loans are secured by pledges of ownership interests, in whole or in part, in entities that directly or indirectly own the real property.

Mezzanine loans may have elements of both debt and equity instruments, offering the fixed returns in the form of interest payments and principal payments associated with senior debt, while providing lenders an opportunity to participate in the capital appreciation of a borrower, if any, through an equity interest. Due to their higher risk profile, and often less restrictive covenants, as compared to senior loans, mezzanine loans generally earn a higher return than senior secured loans. Mezzanine loans also may include a “put” feature, which permits the holder to sell its equity interest back to the borrower at a price determined through an agreed upon formula.

We historically have structured our mezzanine loans so that we receive a stated fixed or variable interest rate on the loan. In addition, at times we may also receive a percentage of gross revenues and a percentage of the increase in the fair market value of the property securing the loan, payable upon maturity, refinancing or sale of the property. Our mezzanine loans also generally have prepayment lockouts, penalties, minimum profit hurdles and other mechanisms to protect and enhance returns in the event of premature repayment. Mezzanine loans have maturities that match the maturity of the related mortgage loan but may have shorter or longer terms. We expect to hold these investments to maturity. We expect to hold certain of our mezzanine investments in our TRS.

As of December 31, 2008, we had invested $247.4 million on a carrying value basis, or 18% of our total investments in mezzanine financing. As of December 31, 2008, one mezzanine investment with a loan balance of $18.0 million was on our watch list and two mezzanine loans aggregating $65.0 million are non-performing, which is described further in Item 7 “Management’s Discussion and Analysis of Financial Condition— Risk Management” of this report.

Commercial Mortgage-Backed Securities. Historically, we have acquired CMBS that are created when commercial loans are pooled and securitized. These securities may or may not be rated investment grade by rating agencies. We expect a majority of our CMBS investments to be rated by at least one nationally-recognized rating agency, and to consist of securities that are part of a capital structure or securitization where the rights of such class to receive principal and interest are subordinated to senior classes but senior to the rights of lower rated classes of securities. We intend to invest in CMBS that will yield high current interest income and where we consider the return of principal to be likely.

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CMBS are generally pass-through certificates that represent beneficial ownership interests in common law trusts whose assets consist of defined portfolios of one or more commercial mortgage loans. CMBS are secured by or evidenced by ownership interests in a single commercial mortgage loan or a pool of mortgage loans secured by commercial properties. They are typically issued in multiple tranches whereby the more senior classes are entitled to priority distributions from the trust’s income to make specified interest and principal payments on such tranches. Losses and other shortfalls from expected amounts to be received on the mortgage pool are borne by the most subordinate classes, which receive payments only after the more senior classes have received all principal and/or interest to which they are entitled.

The yields on CMBS depend on the timely payment of interest and principal due on the underlying mortgage loans and defaults by the borrowers on such loans may ultimately result in deficiencies and defaults on the CMBS. In the event of a default, the trustee for the benefit of the holders of CMBS has recourse only to the underlying pool of mortgage loans and, if a loan is in default, to the mortgaged property securing such mortgage loan. After the trustee has exercised all of the rights of a lender under a defaulted mortgage loan and the related mortgaged property has been liquidated, no further remedy will be available. However, holders of relatively senior classes of CMBS will be protected to a certain degree by the structural features of the securitization transaction within which such CMBS were issued, such as the subordination of the relatively more junior classes of the CMBS. Historically, we have invested in investment grade and subordinate classes of CMBS, including BBB-rated, BB-rated, B-rated and non-rated classes. We expect to hold CMBS securities to maturity.

As of December 31, 2008, we had invested $54.6 million on a carrying value basis, or 4% of our total investments in CMBS. During the year ended December 31, 2008, 11 of our 67 CMBS investments were downgraded and one was upgraded by nationally recognized statistical rating agencies, such as Standard and Poor’s Rating Service and Fitch Ratings and Moody’s Investors Services, Inc. Throughout 2008 and 2009, the CMBS market has experienced significant declines in value and significantly lower trading volumes.

Joint Venture Investments. In 2007, we elected to discontinue seeking new joint venture investments in favor of focusing on our core whole loan, B-notes, Mezzanine and CMBS investments. We continue to actively manage our existing joint venture portfolio. Our joint venture investment holdings involve the development, redevelopment or re-tenanting of all or a portion of the real estate assets in the retail, office, industrial and multifamily sectors. These investments were expected to initially provide a low current dividend or yield, or no current dividend or yield, on our invested equity compared to the dividend or yield that is projected upon stabilization of the underlying real estate assets. Therefore, these assets are likely to have a dilutive effect on our cash flows and results of operations.

As of December 31, 2008, we had invested approximately $77.9 million in joint venture investments which, after recognition of depreciation, operating losses and impairments, have a carrying value of $11.2 million, or 1% of our total investments. Included in this total is our equity investment in two limited liability companies that are deemed to be VIEs that we consolidate in our audited financial statements because we are deemed to be the primary beneficiary of these VIEs under FIN 46R.

Other Real Estate-Related Investments. We also may make investments in other types of commercial real estate assets. These may include acquisitions of real property, net leased property, distressed and stressed debt securities, RMBS, CDOs and equity and debt issued by REITs, other real estate companies or repurchase of our own CDO bonds that are outstanding. We have authority to issue our common stock or other equity or debt securities in exchange for property. Subject to gross income and asset tests necessary for REIT qualification, we may also invest in securities of other REITs, or other entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities.

Some of these investments may be equity interests in properties with no stated maturity or redemption date, or long-term leasehold interests with expiration dates as long as 40 years beyond the date of our investment. We expect that we would hold these investments for between several months and up to ten years, depending upon the risk profile of the investment and our investment rationale. The timing of our sale of these investments, or of their repayment, is frequently tied to certain events involving the underlying property, such as new tenants or superior financing.

Sourcing Potential Investment Opportunities

We recognize that investing in our targeted asset classes can be very competitive under normal market conditions, and that we compete with many mortgage REITs, other specialty finance companies, private equity and other discretionary funds and other lenders for profitable investment opportunities. Given this potentially competitive environment, when and if we are actively make new investments, it is important for us to have access to the broadest supply of new investment and finance opportunities, which we refer to as our gross origination flow, so that we can be highly selective in those opportunities that we decide to pursue. Our management team’s deep experience in all aspects of real estate lending, investment, capital markets and management provides us with a valuable origination system. Over the years, our management team has developed extensive relationships with borrowers, sellers of whole loans, various financial institutions and other financial intermediaries throughout the U.S. These relationships provide us with a broad range of investment and finance opportunities, including seasoned loans, purchased securities and private equity. The depth and diversity of these relationships will provide us with investment and finance opportunities across all major product types and markets. As we continue to monitor the credit and capital markets, to the extent we are able to start making new investments, we will seek to leverage our experience and relationships to create new sourcing opportunities and partnerships.

Our Investment Process

While we are not currently making any new investments, our process for evaluating potential investment opportunities employs an active five-step investment process consisting of:

Information Research. We continuously monitor the property, credit and capital markets to adjust our investment strategy seeking to optimize the performance of our portfolio. We believe we have strong research capabilities through access to market data supplied by third party services. Some of the key elements we generally focus on are:

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fundamental supply and demand characteristics of markets;

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performance characteristics of all property types;

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overall capital flows;

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macro-economic trends and local market;

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demographic trends;

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quotes on various structures and products;

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market makers and leaders;

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default rates;

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cap rates; and

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sales information.

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Once we identify our target markets and borrowers/partners in those markets, we conduct a second level of research including: detailed information on the borrower/partner, leasing and sales comparables by product type in each market, recent financing quotes and market specific capital flows. This approach allows us to focus on investment opportunities that are best for us and fall within our investment guidelines. All potential investments that fall within our investment guidelines are reviewed by our investment committee, prior to the decision to pursue such an investment, for overall compatibility with our investment portfolio.

Screening and Pursuit of Potential Transactions. When we have identified a potential transaction, we analyze it to determine if the particular investment meets our stated objectives. We review the potential investment to determine its risk/return profile and how it would fit within our overall portfolio. Our goal is to quickly determine if we should pursue a potential investment. To make the determination at this stage requires a comprehensive review of the materials provided by the borrower concerning itself and its assets, quick analysis of the market in which the investment is located and our own modeling of the property’s projected financial performance.

When we identify an investment opportunity that warrants continued review and resources, we will prepare a written summary of the transaction for the investment committee. The purpose of the brief is to introduce the opportunity to the investment committee and seek its initial guidance. The brief will include review of the following elements:

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the borrower’s reputation, credit and payment performance;

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an initial review of the asset, including market analysis, property valuation, risk assessment and physical examination;

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consideration of environmental, structural and zoning factors;

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the proposed transaction structure;

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initial financial modeling; and

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initial REIT and 1940 Act compliance.

We believe that this approach allows us to be responsive to prospective borrowers, clients and partners while enabling us to stay focused on which potential investments will best help us accomplish our goals. Once the investment committee agrees to place the prospective investment, we will then begin a more detailed and thorough underwriting and due diligence.

Thorough Underwriting and Due Diligence. Following the decision to pursue an investment, each potential transaction, whether a single asset or a portfolio of assets, is subject to a review of the underlying real estate collateral, the borrower and the associated debt/equity structure. We conduct a rigorous and disciplined review approach that allows us to determine whether a prospective investment can achieve our targeted returns. From a real estate perspective, the due diligence includes, but is not limited to:

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conducting a thorough analysis, regardless of the recourse nature of a loan, of the borrower’s investment history, reputation, credit history, investment focus and expertise;

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making site visits to assess the economic viability of the collateral including tenant and overall property viability;

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reviewing submarket supply and demand and existing and planned competitive properties;

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reviewing local submarket rental and sales comparables;

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reviewing issuer and third party valuations and appraisals of the property, if applicable, and the LTV ratio with respect to the collateral;

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performing in-depth legal, accounting, environmental, zoning, structural analyses of the property and borrower;

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reviewing the level and stability of cash flow from the underlying collateral to service the mortgage debt;

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analyzing the availability of capital for refinancing by the borrower if the loan does not fully amortize;

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reviewing loan documents to determine the lender’s rights, including personal guarantees, additional collateral, default covenants and other remedies as well as the lender’s rights under any intercreditor agreements; and

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making appropriate modifications to reflect the underlying collateral and borrower credit risk, including requiring letters of credit or other liquid instruments to ensure timely payments and loan to value ratios appropriate for the yield.

Additionally, all investments are considered in the context of their risk and yield profile, reviewing such factors as match-funding and hedging efficiency and overall concentration considerations, such as investment size, product type, tenants, borrower, sector, floating vs. fixed rates and maturity. Our focus is on risk management and understanding the impact of any investment on our investment portfolio prior to closing.

As a result of this extensive real estate review, a cash flow forecast for each collateral property is prepared, and a valuation is assigned. The performance of the respective investment is then forecasted to derive the projected return. Sensitivity analyses are performed in consideration of differing levels of the property’s cash flow, loan losses, variances in the timing of loan payoffs or prepayments, loan extension scenarios and changing interest rates. In all cases, we consider the potential impact on the risk profile of our investment portfolio and the impact on cash flow after we implement financing at the company level, whether in the form of a CDO or some other debt instrument.

Upon completion of due diligence, we consider the impact of any material findings on the transaction’s risk profile. Once final due diligence is substantially complete, the investment professionals prepare and submit a final investment committee brief to the investment committee.

Investment Committee Approval. The investment committee will review the final investment committee brief and decide to approve or decline the investment. Should the investment be approved, we will move to close the investment or financing with the assistance of legal, accounting, tax and other specialists appropriate for that particular investment.

All transactions are reported to our board of directors. When we make new investments, our investment committee consults with our board of directors and the executive committee of our board of directors to understand and take advantage of the latest available market information and trends. The majority vote (which must include the affirmative vote of our chief executive officer) of all members of our investment committee is required to approve all investments and dispositions, including investments and dispositions of up to $25 million (except for (i) investments and dispositions having credit ratings of “A” or better by a major rating agency, such threshold will be up to $50 million and (ii) with respect to aggregate CMBS investments of up to $15 million having credit ratings of “B” or better and consistent with our operating guidelines, only two members of the investment committee must approve the investment; however, the majority vote of all members of our investment committee will be required to approve aggregate CMBS investments over $15 million). Separate approvals by our executive committee and our board of

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directors are not required under the following circumstances. Our executive committee, which consists of Messrs. Ray Wirta, our chairman, and Kenneth J. Witkin, our chief executive officer, president and a director, has the authority delegated by our board of directors to authorize transactions consistent with our investment guidelines and must approve, by a majority vote (which must include the affirmative vote of the independent director), investments and dispositions aggregating greater than $25 million and up to $50 million (except for investments and dispositions having credit ratings of “A” or better by a major rating agency, such threshold will be greater than $50 million and up to $75 million). A majority of the members of our board of directors must approve all investments and dispositions greater than such amounts identified above.

Closing. The closing process is extensive due to the documentation associated with all of our investment products. Non-CMBS closings are completed, to the extent possible, on our own standard documentation. Those documents are negotiated by us with the support of one of our executive vice presidents and outside counsel.

Asset Management and Servicing

With respect to managing the investments made by us (with the assistance of GEMSA Loan Services, L.P., or GEMSA, a joint venture between CBRE|Melody and GE Capital Real Estate) or a third party (as servicer where appropriate) seeks to address the following issues:

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Investment Monitoring. We actively monitor and manage our investments. Our asset managers have been trained to identify asset level risks early and to take measures to mitigate those concerns when possible. Our management team reviews our portfolio quarterly on a formal basis and more frequently, on an informal basis, to consider any “early watch list,” “watch list,” or “non-performing” assets and determine any appropriate actions and reserve strategies. Assets are managed aggressively through maturity.

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Cash Collections. When we originate a new loan, we evaluate whether it is appropriate to require a lock box agreement (or cash management account), based on certain criteria, such as the debt service coverage ratio, LTV ratio and quality of sponsorship. As determined appropriate, we will require the borrower to establish a cash management account at a commercial bank acceptable to us. Tenants will be required to deposit all rents, revenues and receipts with respect to the property into the cash management account. Generally, the debt service, loan escrows and reserves are paid from this account, and any balance remaining is remitted to the borrower.

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Collateral Valuation. We are responsible for determining the value of the collateral property, including an analysis of the condition of the property, existing tenant base, current information and comparable market rents, occupancy and sales. When appropriate, we also conduct an investigation of the borrower to identify other potential sources of recovery, including other non-real estate collateral and guarantees. Our Manager is also responsible for reviewing the collateral operating statements on an ongoing basis and within the market in order to accurately track asset value and its cash flow performance.

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Recovery Strategies. To the extent a default is realized with respect to an investment, we are responsible for recommending and implementing the appropriate recovery strategy in order to produce the highest present value recovery. Our management team’s real estate operating and distressed debt workout management experience put us in a strong position to manage problems that may arise. We may also utilize a special servicer, to manage, modify and resolve loans and other investments that fail to perform under the terms of the loan agreement, note, indenture, or other governing documents. Special servicers are most frequently employed in connection with whole loans, B Notes and first-loss classes of CMBS. For the years ended December 31, 2008, 2007 and 2006, we paid or had payable an aggregate of approximately $250,000, $251,000 and $82,000, respectively, in fees to GEMSA in its capacity as a special servicer to our company.

Our Operating Policies

Our Investment and Borrowing Guidelines. We have adopted general guidelines for our investments and borrowings to the effect that:

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no investment will be made that would cause us to fail to qualify as a REIT for U.S. federal income tax purposes;

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no investment will be made that would cause us to be regulated as an investment company under the 1940 Act;

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no more than 25% of our equity, determined as of the date of such investment, will be invested in any single asset;

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no more than 25% of our equity, determined as of the date of such investment, will be invested in any single borrower;

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our leverage will generally not exceed 80% of the value of our assets, in the aggregate;

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the majority vote (which must include the affirmative vote of our chief executive officer) of all members of our investment committee will be required to approve all investments and dispositions, including investments and dispositions of up to $25 million (except for (i) investments and dispositions having credit ratings of “A” or better by a major rating agency, such threshold will be up to $50 million and (ii) with respect to aggregate CMBS investments of up to $15 million having credit ratings of “B” or better and consistent with our operating guidelines, only two members of the investment committee must approve the investment; however, the majority vote of all members of our investment committee will be required to approve aggregate CMBS investments over $15 million); the majority vote (which must include the affirmative vote of the independent director) of our executive committee will be required to approve investments and dispositions aggregating greater than $25 million and up to $50 million (except for investments and dispositions having credit ratings of “A” or better by a major rating agency, such threshold will be greater than $50 million and up to $75 million); and a majority of our board of directors must approve all investments and dispositions greater than such amounts identified above; and

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we will maintain a portfolio of geographically diverse assets.

These investment guidelines may be changed by our board of directors without the approval of our stockholders.

In addition:

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we will monitor all multiple asset types, sector markets, and tranches to identify attractive total return investments;

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our asset allocation will be determined by market conditions and driven by exploitable market inefficiencies on either the asset or structuring side or both; and

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we will emphasize the following investment themes:

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high quality investments carefully screened and selected from our origination channels;

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disciplined asset selection and bottom-up underwriting;

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use of asset and liability structuring to lock-in attractive total returns and to minimize risk; and

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hands on asset management and exit strategy/realization monitoring.

Credit Risk Management. We are exposed to various levels of credit and special hazard risk depending on the nature of our underlying assets and the nature and level of credit enhancements supporting our assets. Historically, we have originated or purchased mortgage loans that meet minimum debt service coverage standards established by us. We review and monitor credit risk and other risks of loss associated with each investment. In addition, we seek to diversify our portfolio of assets to avoid undue geographic, issuer, industry and certain other types of concentrations. Our board of directors monitors the overall portfolio risk and reviews levels of provision for loss.

Interest Rate Risk Management. To the extent consistent with maintaining our qualification as a REIT, we follow an interest rate risk management policy intended to mitigate the negative effects of major interest rate changes. We minimize our interest rate risk from borrowings by attempting, if possible, to structure the key terms of our borrowings to generally correspond to the interest rate term of our assets.

Hedging Activities. We engage in hedging transactions to protect our investment portfolio from interest rate fluctuations and other changes in market conditions. These transactions may include interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, mortgage derivatives and other hedging instruments. These instruments may be used to hedge as much of the interest rate risk as we determine is in the best interest of our stockholders, given the cost of such hedges and the need to maintain our qualification as a REIT. We may from time to time enter into interest rate swap agreements to offset the potential adverse effects of rising interest rates under certain short-term repurchase agreements. We may elect to have us bear a level of interest rate risk that could otherwise be hedged when it believes, based on all relevant facts, that bearing such risk is advisable.

Disposition Policies. We evaluate our asset portfolio on a regular basis to determine if it continues to satisfy our investment criteria. Subject to certain restrictions applicable to REITs, we may cause us to sell our investments opportunistically and use the proceeds of any such sale for debt reduction, additional acquisitions or working capital purposes.

Equity Capital Policies. Subject to applicable law, our board of directors has the authority, without further stockholder approval, to issue additional authorized common stock and preferred stock or otherwise raise capital, including through the issuance of trust preferred securities or senior securities, in any manner and on the terms and for the consideration it deems appropriate, including in exchange for property. We may also raise funds through the retention of cash flow (subject to provisions in the Internal Revenue Code concerning distribution requirements and the taxability of undistributed REIT taxable income). In the event that our board of directors determines to raise additional equity capital, it has the authority, without stockholder approval, to issue additional common stock, preferred stock, trust preferred securities or other senior securities in any manner and on such terms and for such consideration as it deems appropriate, at any time. Our existing stockholders and potential investors will have no preemptive right to additional shares issued in any offering, and any offering might cause a dilution of investment. We may in the future issue common stock in connection with acquisitions.

We may, under certain circumstances, repurchase our common stock in the open market or through private transactions with our stockholders, if those purchases are approved by our board of directors. Our board of directors has no present intention of causing us to repurchase any shares, and any action would only be taken in conformity with applicable federal and state laws and the applicable requirements for qualifying as a REIT, for so long as our board of directors concludes that we should remain a REIT. We also have the authority to offer equity or debt securities in exchange for property.

Other Policies. We intend to operate in a manner that will not subject us to regulation under the 1940 Act. Subject to gross income and asset tests necessary for REIT qualification, we may invest in securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities. We may engage in the purchase and sale of investments. We also may make loans to third parties. We will not underwrite the securities of other issuers.

Future Revisions in Policies and Strategies. Our board of directors has approved the investment policies, the operating policies and other strategies of our company. Our board of directors has the power to modify or waive these policies and strategies without the consent of our stockholders to the extent that our board of directors (including a majority of our independent directors) determines that such modification or waiver is in our best interest and the best interest of our stockholders. Among other factors, developments in the market that either affect the policies and strategies mentioned herein or which change our assessment of the market may cause our board of directors to revise its policies and strategies.

Competition

Over the long-term, growth in our net income depends, in large part, on our ability to originate and acquire structured investments with spreads over our borrowing costs. In originating and acquiring these investments, we compete with other commercial mortgage REITs, specialty finance companies, savings and loan associations, banks, mortgage brokers, insurance companies, mutual funds, institutional investors, private investment funds, investment banking firms, other lenders, governmental bodies and other entities. In addition, there are numerous commercial REITs with asset acquisition objectives similar to ours, and others may be organized in the future. The effect of the existence of additional REITs may be to increase competition for the available supply of commercial real estate finance products suitable for purchase by us. Some of our anticipated competitors are significantly larger than us, have access to greater capital and other resources and may have other advantages over us.

Conflicts of Interest

We have not adopted a policy that expressly prohibits our directors, officers, security holders or affiliates from having a direct or indirect pecuniary interest in any investment to be acquired or disposed of by us or any of our subsidiaries or in any transaction to which we or any of our subsidiaries is a party or has an interest. Nor do we have a policy that expressly prohibits any such persons from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contain a conflict of interest policy that prohibits our directors, officers and employees from engaging in any transaction that involves an actual or apparent conflict of interest with us.

Our board of directors has adopted a policy that a majority of our board of directors will be independent directors, and that a majority of our independent directors must make any determinations on our behalf with respect to the relationships or transactions that present a conflict of interest for our directors or officers;

Management Agreement

Prior to the expiration of the management agreement on December 31, 2008, we had entered into a management agreement with our Manager that provided for the day-to-day management of our operations. The management agreement required our Manager to manage our business affairs in conformity with the policies and the investment guidelines that are approved and monitored by our board of directors. Our Manager’s role as manager was under the supervision and direction of our board of directors.

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Pursuant to the management agreement, our Manager was entitled to receive a base management fee, incentive compensation and reimbursement of certain expenses as described in the management agreement. The following table summarizes the fees and expenses payable to our Manager pursuant to the management agreement.


Fee		Summary Description
*Base Management Fee*		Payable monthly in arrears in an amount equal to 1/12^th of the sum of (i) 2.0% of the first $400 million of our gross stockholders’ equity (as defined in the management agreement), or equity, (ii) 1.75% of our equity in an amount in excess of $400 million and up to $800 million and (iii) 1.50% of our equity in excess of $800 million. Our Manager used the proceeds from its management fee in part to pay compensation to its officers and employees who, notwithstanding that certain of them also are our officers, received no cash compensation directly from us during the term of the management agreement.

*Incentive Fee*		Payable quarterly in an amount equal to the product of: • 25% of the dollar amount by which • our Funds From Operations (as defined in the management agreement) (after the base management fee and before incentive compensation) per share of our common stock for such quarter (based on the weighted average number of shares outstanding for such quarter) • exceeds an amount equal to • the weighted average of the price per share of our common stock in our June 2005 private offering, our October 2006 initial public offering, or IPO, and the prices per share of our common stock in any subsequent offering by us, in each case at the time of issuance thereof, multiplied by the greater of • 2.25% or • 0.75% plus one-fourth of the Ten Year Treasury Rate (as defined in the management agreement) for such quarter; • multiplied by the weighted average number of shares of our common stock outstanding during such quarter.

*Expenses*		Payable monthly in arrears to our Manager for all documented expenses incurred by our Manager on our behalf. The expenses include all operating and administrative expenses incurred by the employees of our Manager.

For the twelve months ended December 31, 2008, 2007 and the 2006, our Manager had earned base management fees of approximately $5.1 million, $7.7 million and $6.5 million, respectively. We did not accrue or pay any incentive fees through December 31, 2008.

The management agreement with our Manager expired by its terms on December 31, 2008. The expiration of the management agreement ends our affiliation with CBRE and affiliates of CBRE effective December 31, 2008. On December 15, 2008, we, our Manager and CBRE|Melody entered into a Termination (the “Termination Agreement”) of the Amended and Restated Management Agreement. In addition to terminating the Amended and Restated Management Agreement, dated April 29, 2008, and acknowledging certain survival provisions in the Amended Management Agreement, the parties to the Termination Agreement acknowledged and/or agreed, among other things, that (i) the termination of the Amended Management Agreement will be effective as of December 31, 2008, (ii) there will be no termination fee in connection with the Termination Agreement, (iii) the Manager will make payment to us for certain accrued bonuses, (iv) we will make a payment to the Manager of (x) the final installment of the base management fee earned or accrued by our Manager as of December 31, 2008, (y) the reimbursement of CBRE’s operating expenses, and (z) the reimbursement of certain 2008 personnel bonuses, each on or before February 15, 2009, and (v) we will hire all employees of the Manager effective January 1, 2009.

Our Distribution Policy

U.S. federal income tax law requires that a REIT distribute annually at least 90% of its net taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain.

In order to maintain our REIT qualification and to generally not be subject to U.S. federal income and excise tax, we intend to make distributions of all or substantially all of our net taxable income to holders of our common stock. On December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to maintain our financial flexibility. Any future distributions we make will be at the discretion of our board of directors and will depend upon, among other things, our actual results of operations. These results and our ability to pay distributions will be affected by various factors, including the net interest and other income from our portfolio, our operating expenses and any other expenditure.

To the extent that our cash available for distribution is less than 90% of our net taxable income, we may consider various funding sources to cover any such shortfall, including selling certain of our assets. Our distribution policy enables us to review the alternative funding sources available to us from time to time.

Exclusion From Regulation Under the 1940 Act

We conduct our operations so that we are not required to register as an investment company. Under Section 3(a)(1) of the 1940 Act, a company is not deemed to be an “investment company” if:

•

it neither is, nor holds itself out as being, engaged primarily, nor proposes to engage primarily, in the business of investing, reinvesting or trading in securities; or

•

it neither is engaged nor proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and does not own or propose to acquire “investment securities” having a value exceeding 40% of the value of its total assets on an unconsolidated basis, or the 40% Test. “Investment securities” excludes U.S. government securities and securities of majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.

Because we are a holding company that will conduct our businesses through wholly-owned or majority-owned subsidiaries, the securities we own that have been issued by our subsidiaries that are excepted from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis. This requirement limits the types of businesses in which we may engage through our subsidiaries.

RFC Holdings, LLC, our subsidiary that holds, through wholly-owned subsidiaries, substantially all of our real estate-related securities, intends to be exempt from 1940 Act regulation under either Section 3(c)(5)(C) and/or Section 3(c)(6) of the 1940 Act. With respect to this subsidiary, at least 55% of its portfolio (directly or

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indirectly through its wholly-owned subsidiaries) must consist of qualifying real estate assets (which, in general, must consist of whole mortgage loans and other liens on and interests in real estate, certain B Notes and CMBS with unilateral foreclosure rights on the underlying mortgages and certain whole pool CMBS) and at least another 25% of its portfolio must consist of qualifying real estate assets or other real estate-related assets.

Based on no-action letters issued by the Staff of the Securities and Exchange Commission, or the SEC Staff, we classify our investments in whole loans as qualifying real estate assets, as long as the loans are “fully secured” by an interest in real estate. That is, if the loan-to-value ratio of the loan at the time of purchase or origination is equal to or less than 100%, then we consider the loan a qualifying real estate asset. We do not consider loans with loan-to-value ratios at the time of purchase or origination in excess of 100% to be qualifying real estate assets that come within the 55% basket, but only real estate-related assets that come within the 25% basket. With respect to our investments in B Notes, based on an SEC staff no-action letter, a B Note is a qualifying real estate asset that comes within the 55% basket, or Qualifying B Notes, where, among other conditions, (i) we have approval rights in connection with any material decisions pertaining to the administration and servicing of the relevant mortgage loan and with respect to any material modification to the relevant loan agreements, and (ii) in the event that the relevant mortgage loan becomes non-performing, we have effective control over the remedies relating to the enforcement of the loan, including ultimate control of the foreclosure process by having the right to: (a) appoint the special servicer to manage the resolution of the loan, (b) advise, direct or approve the action of the special servicer, (c) terminate the special servicer at any time with or without cause, (d) cure the default so that the loan is no longer non-performing, and (e) purchase the A Note at par plus accrual interest, thereby acquiring the entire mortgage loan. We will treat certain mezzanine loans (Tier 1 mezzanine loans) as qualifying real estate assets where, among other conditions, we (i) exercise ongoing control over management of the underlying property, (ii) have the right to readily cure a default or purchase the mortgage loan in the event of a default on the mortgage loan, and (iii) have the right to foreclose on the collateral and through our ownership in the property-owning entity become the owner of the underlying property. We will treat our other mezzanine loans and our current CMBS investments as real estate-related assets that come within the 25% basket.

Our joint venture investments may constitute qualifying real estate assets if we have the right to approve certain major decisions affecting the joint venture. Our direct real estate assets will be qualifying real estate assets. The treatment of other investments as qualifying real estate assets and real estate-related assets is based on the characteristics of the underlying collateral and the particular type of loan including whether we have foreclosure rights with respect to those securities or loans that have underlying real estate collateral. Because RFC Holdings, LLC intends to rely on Section 3(c)(5)(C) and/or Section 3(c)(6) for its 1940 Act exemption, our investment therein will not constitute an “investment security” for purposes of the 40% Test. We believe that RFC TRS, Inc., our TRS, is exempted from 1940 Act regulation under Section 3(c)(7) of the 1940 Act. Therefore, our investment in our TRS will constitute an “investment security” for purposes of the 40% Test. Our CDO subsidiaries are each a QRS, that is expected to be exempted under the 1940 Act under Section 3(c)(5)(C). Additionally, we expect to form separate subsidiaries for each additional CDO or other securitizations we sponsor. We expect that each such subsidiary will rely on the exception provided by Section 3(c)(5)(C) or 3(c)(7) under the 1940 Act.

We have not received, nor have we sought, a no-action letter from the Securities and Exchange Commission, or the SEC, regarding how our investment strategy fits within the exclusions from regulation under the 1940 Act that we and our subsidiaries are using. To the extent that the SEC provides more specific guidance regarding the treatment of assets as qualifying real estate assets or real estate-related assets, we may be required to adjust our investment strategy accordingly. Any additional guidance from the SEC could provide additional flexibility to us, or it could further inhibit our ability to pursue the investment strategy we have chosen.

If we or our subsidiaries fail to maintain our exclusions or exemptions from the 1940 Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), and portfolio composition, including restrictions with respect to diversification and industry concentration and other matters. Compliance with the 1940 Act will, accordingly, limit our ability to make certain investments.

Our Formation and Structure

We were organized as a Maryland corporation in May 2005 and completed a private offering of our common stock in June 2005 in which we raised net proceeds of approximately $282.5 million. CBRE, through one of its affiliates, purchased from us 1,100,000 shares of our common stock in the private offering, representing 5.1% of our common stock on a fully-diluted basis as of December 31, 2005. Certain of our executive officers and directors and certain executive officers and directors of CBRE and CBRE|Melody purchased 964,101 shares of our common stock in that offering, representing 4.5% of our common stock on a fully-diluted basis as of December 31, 2005. Additionally, certain other employees of CBRE and CBRE|Melody purchased 732,114 shares of our common stock in that offering, representing 3.4% of our common stock on a fully-diluted basis as of December 31, 2005. Upon completion of our June 2005 private offering, we granted to our Manager, its employees and certain of its related persons 565,087 shares of restricted stock and options to purchase 813,600 shares of our common stock with an exercise price of $15.00 per share, representing 6.5% of our common stock on a fully-diluted basis as of December 31, 2005. Additionally, 34,913 shares of restricted stock and options to purchase 186,400 shares of our common stock were made available for issuance to our Manager or to employees or other related parties of our Manager as directed by our Manager. Upon completion of our June 2005 private offering, we granted to our directors 2,668 shares of restricted stock in the aggregate.

Prior to the expiration of the management agreement on December 31, 2008, our investment activities were managed by our Manager and, through it, by CBRE and CBRE|Melody. The Manager was also supervised by our investment committee and board of directors. Ray Wirta, vice chairman and director of CBRE and chairman of our Manager, is our chairman.

Staffing

Prior to the expiration of the management agreement on December 31, 2008, we were managed by our Manager pursuant to the management agreement between our Manager and us. Our Manager had 16 employees as of December 31, 2008 that were fully dedicated to the operations of our Manager. All of our executive officers were employees of our Manager as of December 31, 2008. On January 1, 2009 all employees of our Manager became our employees as part of the internalization.

Available Information

Our internet address is www.realtyfinancecorp.com. We make available, free of charge, on or through the “SEC Filings” section of our website, annual reports on Form 10-K, quarterly reports on Form 10-Q, 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, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Also posted on our website, and available in print upon request to our Investor Relations Department, are the charters of our Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee, and our Code of Business Conduct and Ethics, which governs our directors, officers and employees. Within the time period required by the Securities and Exchange Commission, we will post on our website any amendment to our Code of Business Conduct and Ethics and any waiver applicable to our senior financial officers, and our executive officers or directors. In addition, information concerning purchases and sales of our equity securities by our directors and Section 16 reporting officers is also posted on our website. You can also read and copy the materials we file with the Securities and Exchange Commission at its Public Reference Room at 100 F Street, NE, Washington, DC 20549 (1-800-SEC-0330). The Securities and Exchange Commission maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding the issuers that file electronically with the Securities and Exchange Commission.

Our investor relations representative can be contacted by telephone: (860) 275-6200, or at our principal executive office, which is located at 185 Asylum Street, 31st Floor, Hartford, CT 06103, Attention: Investor Relations.

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ITEM 1A.

RISK FACTORS

An investment in our common stock involves a high degree of risk. Before making an investment decision, you should carefully consider the following risk factors, together with the other information contained in this Annual Report on Form 10-K. If any of the risks discussed in this Annual Report on Form 10-K occurs, our business, financial condition, liquidity, results of operations and ability to make distributions to our stockholders could be materially and adversely affected. If this were to happen, the price of our common stock could decline significantly and you could lose all or a part of your investment.

Risks Related To Our Business

Rating agency downgrades and impairment of certain of our loan investments have and may continue to adversely affect our cash flows.

The terms of our CDOs include certain overcollateralization and interest coverage tests, which are used primarily to determine whether and to what extent principal and interest paid on the debt securities and other assets that serve as collateral underlying the CDOs may be used to pay principal and interest on the various classes of notes payable issued by the CDOs. In the event these tests are not satisfied, interest and principal that would otherwise be payable on certain of the junior tranches of notes payable issued by the CDOs are instead redirected to pay principal on certain senior tranches of notes payable issued by the CDOs.

Certain overcollateralization coverage tests failed with respect to the February 2009 determination date for CDO I as a result of recent rating downgrades that have occurred since December 31, 2008 and certain loan loss reserves or impairments recognized in our portfolio. As a result, on the February 25, 2009 payment date, approximately $488,000 of cash from CDO I that otherwise would have been payable to us, (i) as the holder of certain junior tranches of notes payable and preferred shares issued by CDO I and (ii) in respect of the subordinate collateral management fees, were instead redirected to pay principal and interest on certain senior tranches of notes payable issued by CDO I, which are owned by third parties. We expect that such coverage tests will continue to fail for the foreseeable future.

The failures of the overcollateralization coverage tests under CDO I permit MBIA, as controlling class of CDO II bondholders, to terminate the existing collateral management agreement and to remove us as the collateral manager of CDO II. If that happens, we will lose the collateral management fees.

To date, rating agency downgrades or impairment of our loan investments have not affected the overcollateralization coverage tests applicable to CDO II. However, if an additional $0.5 million in defaults occur, CDO II will also breach its overcollateralization tests. Management believes that it is likely that CDO II will fail such test at some point in 2009, which will result in the cash flows of CDO II being diverted to pay principal and interest on the most senior tranches of notes payable issued by CDO II.

Apart from overcollateralization and interest coverage tests, the operative documents of the CDOs provide for certain events of default, occurrence of which would entitle a senior class or classes of notes payable to accelerate the notes payable of such CDO and, depending upon the circumstances, require a liquidation of the collateral under then-current market conditions, which could result in higher levels of losses on the collateral and the notes payable of such CDO than might otherwise occur.

Because we have not entered into any new investments since July 2007, almost all of our income in 2008 came from cash flows from our CDOs. Failures of the overcollateralization coverage tests would seriously curtail our liquidity and jeopardize our ability to support the CDOs and our other assets. While we had approximately $23.1 million of unrestricted cash and cash equivalent as of December 31, 2008, and believe we have sufficient cash to meet our liquidity requirements for the next 12 months, significant reduction in cash flows from our CDOs could force us to reduce staff and adversely impact our business operations.

Our CDOs would continue to generate taxable income for us despite the fact that if in the future we are not receiving cash distributions on our equity and subordinated note holdings from these CDOs. Should this occur, taxable income would continue to be recognized on each underlying investment in the relevant CDO. We would continue to be required to distribute 90% of our REIT taxable income (determined with regard to the dividends paid deduction and excluding net capital gain) from these transactions to continue to qualify as a REIT, despite the fact that we are not receiving cash distributions on our equity and subordinated note holdings from these CDOs.

There can be no assurance that the actions of the U.S. government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets, or market response to those actions, will achieve the intended effect, our business may not benefit from these actions and further government or market developments could adversely impact us.

Since mid-2007, and particularly during the second half of 2008, the financial services industry and securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all assets classes, including equities. The global markets have been characterized by substantially increased volatility and short-selling and an overall loss of investor confidence, initially in the financial institutions, but more recently in companies in a number of other industries and in the broader markets. The decline in asset values has caused increases in margin calls for investors, requirements that derivatives counterparties post additional collateral and redemptions by mutual and hedge fund investors, all of which have increased the downward pressure on asset values and outflows of client funds across the financial services industry. In addition, the increased redemptions and unavailability of credit have required hedge funds and others to rapidly reduce leverage, which has increased volatility and further contributed to the decline of asset values.

In response to the financial issues affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008, or the EESA, was signed into law on October 3, 2008. The EESA authorizes the U.S. Secretary of Treasury to create a Troubled Asset Relief Program, or TARP, to purchase from financial institutions up to $700 billion of residential or commercial mortgages and any securities, obligations, or other instruments that are based on, or related to, such mortgages, that in each case was originated or issued on or before March 14, 2008. EESA also provides for a program that would allow companies to insure their troubled assets. As of February 19, 2009, the U.S. Treasury had announced the establishment of the following programs under TARP: the Capital Purchase Program, or CPP, the Target Investment Program, or TIP, the Systematically Significant Failing Institutions Program, or SSFIP, the Asset Guarantee Program, or AGP, the Auto Industry Financing Program, or AIFP, and the Homeowner Affordability and Stability Plan, or HASP, which is partially financed by TARP.

In addition, the American Recovery and Reinvestment Act of 2009, or ARRA, was signed into law on February 17, 2009. ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health and education needs. ARRA also imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients.

These can be no assurance that the EESA, TARP or other programs will have a beneficial impact on the financial markets, including current extreme levels of volatility. To the extent the market does not respond favorably to these new initiatives or these new initiatives do not function as intended, our business may not receive the anticipated positive impact from the legislation. In addition, the U.S. Government, Federal Reserve and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. We cannot predict whether or when such actions may occur or what impact, if any, such actions could have on our business, results of operations and financial condition.

The continuing dislocation in the sub-prime mortgage sector and securitization markets, and the current weakness in the broader financial markets, could adversely affect us and our ability to fund our business, which could result in increases in our borrowing costs, reduction in our liquidity and reductions in the value of the investments in our portfolio.

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The continuing dislocation in the sub-prime mortgage sector and securitization markets, and the current weakness in the broader financial markets, could adversely affect our ability to enter into new repurchase agreements or obtain other forms of financing. Recent developments in the market for many types of mortgage products have resulted in reduced liquidity for these assets. Although this reduction in liquidity has been most acute with regard to sub-prime assets, there has been an overall reduction in liquidity across the credit spectrum of mortgage products. This could potentially limit our ability to finance our investments and operations, increase our financing costs and/or reduce our liquidity. If major market participants continue to fail and withdraw from the market, it could negatively impact the marketability of all fixed income securities, and this could reduce the value of the securities in our portfolio, thus reducing our net book value. Furthermore, if we are unable to obtain new financings, we could be forced to sell our investments at a time when prices are depressed. If this were to occur, it could prevent us from complying with the REIT asset and income tests necessary to fulfill our REIT qualification requirements or could cause us not to qualify for an exemption from the 1940 Act, and otherwise materially harm our results of operation, financial outlook and our ability to make distributions to our stockholders.

In addition, should we enter into any new repurchase agreements, the liquidity in our portfolio may also be adversely affected by possible margin calls under any such repurchase agreements. Repurchase agreements often allow the lender, to varying degrees, to determine a new market value of the collateral to reflect current market conditions. If the lender determines that the value of the collateral has decreased, it may initiate a margin call and require us to either post additional collateral to cover such decrease or repay a portion of the outstanding borrowing, subject to commercially reasonable business standards, on minimal notice as it has in the past. A significant increase in margin calls as a result of spread widening could harm our liquidity, results of operation, financial condition, business prospects, and our ability to make distributions to our stockholders. Additionally, in order to obtain cash to satisfy a margin call, we may be required to liquidate assets at a disadvantageous time, which could cause us to incur further losses and adversely affect our results of operations, financial condition, and may impair our ability to make distributions to our stockholders

We may not be able to access financing sources on favorable terms, or at all, which could adversely affect our ability to execute our business plan.

We have not entered into any new investments since July 2007. To the extent we are able to restart our lending activities, we intend to finance our assets over the long-term through a variety of means, including warehouse lines, repurchase agreements, credit facilities, issuance of CMBS, CDOs and other structured financings. Our ability to execute this strategy will depend on various conditions in the markets for financing in this manner which are beyond our control, including lack of liquidity and greater credit spreads. We cannot assure you that these markets will provide an efficient source of long-term financing for our assets. Currently, they do not. If our strategy is not viable, we will have to attempt to find alternative forms of long-term financing for our assets, as secured revolving credit facilities and repurchase facilities, if available, may not accommodate long-term financing. This could subject us to more recourse indebtedness and the risk that debt service on less efficient forms of financing would require a larger portion of our cash flows, thereby reducing cash available for distribution to stockholders, funds available for operations as well as for future business opportunities. Due to the current state of the credit and capital markets, we expect the availability of repurchase agreements, which we historically have used to finance loan originations that will ultimately be packaged in CDO offerings, will be limited throughout at least 2009.

Failure to procure adequate capital and funding would adversely affect our results and may, in turn, negatively affect the market price of shares of our common stock and our ability to distribute dividends.

We depend upon the availability of adequate funding and capital for our operations. As a REIT, we are required to distribute annually at least 90% of our net taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, to our stockholders and are therefore not able to retain significant amounts of our earnings for new investments. However, RFC TRS, Inc., our TRS, is able to retain (and likely will retain) earnings for investment in new capital, subject to the REIT requirements which place a limitation on the relative value of TRS stock and securities owned by a REIT. The failure to secure acceptable financing could reduce our taxable income, as our investments would no longer generate the same level of net interest income due to the lack of funding or increase in funding costs. A reduction in our net income would have an adverse effect on our liquidity and our ability to make distributions to our stockholders. We cannot assure you that any, or sufficient, funding or capital will be available to us in the future on terms that are acceptable to us. Therefore, in the event that we cannot obtain sufficient funding on acceptable terms, there may be a negative impact on the market price of our common stock and our ability to make distributions to stockholders.

Our reserves for loan losses may prove inadequate, which could have a material adverse effect on us.

We maintain and regularly evaluate financial reserves in accordance with generally accepted accounting principles, or GAAP. Our reserves reflect management’s judgment of the probability and severity of losses. We cannot be certain that our judgment will prove to be correct and that reserves will be adequate over time to reflect losses due to unanticipated adverse changes in the economy or events adversely affecting specific assets, borrowers, industries in which our borrowers operate or markets in which our borrowers or their properties are located. If our reserves for credit losses prove inadequate, we could suffer losses which would have a material adverse effect on our financial performance, the market price of our common stock and our ability to make distributions to our stockholders.

Higher loan loss reserves are expected if economic conditions do not improve.

If the decline in the U.S. economy does not stabilize and reverse in 2009, we will likely experience significant increases in loan loss reserves, potential defaults and asset impairment charges in 2009. Borrowers may also be less able to pay principal and interest on loans if the economy continues to weaken and they continue to experience financial stress. Declining real property values also would increase loan-to-value ratios on our loans and, therefore, weaken our collateral coverage and increase the likelihood of higher loan loss reserves. Any sustained period of increased defaults and foreclosures would adversely affect our interest income, financial condition, business prospects and our cash flows.

Loan loss reserves are particularly difficult to estimate in a turbulent economic environment.

Our loan loss reserves are evaluated on a quarterly basis. Our determination of loan loss reserves requires us to make certain estimates and judgments, which are particularly difficult to determine during a recession where commercial real estate credit has been nearly shut off and commercial real estate transactions have dramatically decreased. Our estimates and judgments are based on a number of factors, including projected cash flows from the collateral securing our commercial real estate loans, loan structure, including the availability of reserves and recourse guarantees, likelihood of repayment in full at the maturity of a loan, potential for a refinancing market coming back to commercial real estate in the future and expected market discount rates for varying property types. If our estimates and judgments are not correct, our results of operations and financial condition could be severely impacted.

Our financial condition and results of operation will depend on our ability to manage future growth effectively.

Our ability to achieve our investment objective depends on our ability to grow, which depends, in turn, on our management team and its ability to identify and invest in securities that meet our investment criteria as well as on our access to financing on acceptable terms. Our ability to grow is also dependent upon our ability to successfully hire, train, supervise and manage employees. We may not be able to manage growth effectively or to achieve growth at all. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition results of operations and ability to make distributions to stockholders.

We may experience reductions in portfolio income which would reduce our ability to make distributions over time.

We have not made a new investment since July 2007. Due to our status as a REIT, we are required to distribute at least 90% of our REIT taxable income to stockholders. We may experience declines in the size of the investment portfolio over time. A reduction in the size of our portfolio would also result in reduced income available for distribution and thereby lessen our ability to make distributions to our stockholders. On December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to maintain our financial flexibility.

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Our ability to retain and attract key personnel is critical to our success and our future growth.

Our success depends on our ability to retain our senior management and the other members of our management team and recruit additional qualified personnel. However, we may not succeed in retaining current personnel or recruiting additional personnel, as the market for qualified professionals in our industry is extremely competitive and costly. Members of our senior management possess substantial experience and expertise in investing, asset management and finance, and have significant relationships with our customers and other institutions which are the source of many of our investment opportunities. Therefore, if members of our management join competitors or form competing companies, it could result in the loss of investment opportunities, which could have a material adverse effect on our results of operations. Efforts to retain or attract professionals may result in significant additional expenses, which could adversely affect our business. However, the lack of liquidity could force us to reduce staff, which could negatively impact our business operations.

We may not be able to successfully complete securitization transactions.

In addition to issuing senior securities to raise capital as described above, we may in the future, to the extent consistent with REIT requirements, seek to securitize certain investments to generate cash for funding new investments, although we do not expect the markets for CDOs to be available in the near-term. This would involve creating a special-purpose vehicle, contributing a pool of our assets to the entity, and selling interests in the entity on a non-recourse basis to purchasers (who we would expect to be willing to accept a lower interest rate to invest in investment grade loan pools). We would retain all or a portion of the equity in the securitized pool of portfolio investments. When and if we are able to invest again, we expect we would initially finance our investments with relatively short-term credit facilities. We would use these short-term facilities to finance the acquisition of securities until a sufficient quantity of securities is accumulated, at which time we would attempt to refinance these facilities through a securitization, such as a CDO issuance, or other long-term financing, if available. As a result, we are subject to the risk that we may not be able to acquire, during the period that our short-term facilities are available, a sufficient amount of eligible securities to maximize the efficiency of a CDO issuance, if available. We also bear the risk that we may not be able to obtain short-term credit facilities or may not be able to renew any short-term credit facilities after they expire should we find it necessary to extend our short-term credit facilities to allow more time to seek and acquire the necessary eligible securities for a long-term financing. The inability to secure new short-term credit facilities may require us to seek more costly financing for our investments or to liquidate assets. In addition, conditions in the capital markets may make the issuance of a CDO impractical at all or when we do have a sufficient pool of collateral. The inability to securitize our portfolio would hurt our performance and ability to grow our business. At the same time, the securitization of our portfolio investments might expose us to losses, as the residual portfolio investments in which we do not sell interests will tend to be riskier and more likely to generate losses. For example, we are currently receiving no cash flow from our equity and subordinate debt interests and our subordinated management fees in CDO I because certain overcollateralization coverage tests have been triggered in such CDO.

We leverage our investments, which may adversely affect our return on our investments and may reduce cash available for distribution to our stockholders.

We leverage our investments through borrowings, generally through the use of warehouse facilities, bank credit facilities, repurchase agreements, secured loans, securitizations, including the issuance of CDOs, loans to entities in which we hold, directly or indirectly, interests in pools of assets, and other borrowings. Our charter contains no limitations on our use of leverage. As of December 31, 2008, our outstanding indebtedness with respect to leveraged investments was $1.4 billion, secured by 61 loans and 67 CMBS investments with an aggregate carrying value of approximately $1.2 billion, representing 87% of our assets by carrying value. At December 31, 2008, our leverage ratio was 6.8 times. The percentage of leverage varies depending on our ability to obtain credit facilities and the lender’s and rating agencies’ estimate of the stability of the investments’ cash flow. We intend to continue to use leverage to acquire all of our investments consistent with the policy described above, although our board of directors may alter this policy at any time. Our return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions increase the cost of our financing relative to the income that can be derived from the assets acquired. Our debt service payments will reduce cash flow available for distributions to stockholders. We may not be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to foreclosure or sale to satisfy the obligations. In addition, if a property or properties are mortgaged to secure payment of indebtedness and we are unable to meet required mortgage payments, the mortgage securing the property could be foreclosed upon by, or the property could be otherwise transferred to the mortgagee with a consequent loss of asset value and income to us and our stockholders. We leverage certain of our assets through warehouse agreements. A decrease in the value of these assets may lead to margin calls which we will have to satisfy. We may not have the funds available to satisfy any such margin calls and may have to sell assets at a time when we might not otherwise choose to do so.

Future credit facility providers, if any, may require us to maintain a certain amount of cash uninvested or set aside unlevered assets sufficient to maintain a specified liquidity position which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition and ability to make distributions could deteriorate rapidly.

We may change our operational policies without stockholder consent, which may adversely affect the market price of our common stock and our ability to make distributions to our stockholders.

Our board of directors determines our operational policies and may amend or revise our policies, including our policies with respect to our REIT qualification, acquisitions, growth, operations, indebtedness, capitalization, distributions and conflicts of interest or approve transactions that deviate from these policies, without a vote of, or notice to, our stockholders. In May 2007, we decided to no longer pursue equity real estate investments through joint ventures arrangements, and to instead concentrate solely on our core investment areas. Operational policy changes could adversely affect the market price of our common stock and our ability to make distributions to our stockholders.

We may change our investment strategy and asset allocation without stockholder consent, which may result in riskier investments.

We may change our investment strategy or asset allocation, including the percentage of assets that may be invested in each class, or in the case of securities, in a single issuer, at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described herein. A change in our investment strategy may increase our exposure to interest rate risk, default risk and real estate market fluctuations, all of which could adversely affect the market price of our common stock and our ability to make distributions to you. Furthermore, a change in our asset allocation could result in our making investments in instrument categories different from those described herein. In May 2007, we decided to no longer pursue equity real estate investments through joint ventures arrangements, and to instead concentrate solely on the fixed-income arena. Operational policy changes could adversely affect the market price of our common stock and our ability to make distributions to our stockholders.

Liquidity in the capital markets is essential to our businesses and future growth and we rely on external sources to finance significant portion of our operations. We have limited liquidity and we may be required to pursue certain measures in order to maintain or enhance liquidity.

Liquidity is essential to our business and our ability to grow and to fund existing obligations. Our liquidity may be impaired by an inability to access secured and/or unsecured debt markets, an inability to access funds from our subsidiaries, an inability to sell assets or redeem our investments, or unforeseen outflows of cash or collateral. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us, or even by the perception among market participants that we, or other market participants, are experiencing greater liquidity risk.

We depend on external financing to fund the growth of our business mainly because one of the requirements for the Internal Revenue Code for a REIT is that it distributes 90% of its taxable income to its shareholders, including taxable income where we do not receive corresponding cash. Our access to equity or debt financing

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depends on the willingness of third parties to make equity investments in us and provide us with corporate level debt. It also depends on conditions in the capital markets generally. Companies in the real estate industry, including us, are currently experiencing, and have at times historically experienced, limited availability of capital, and new capital sources may not be available on acceptable terms. Our ability to raise capital could be impaired if the capital markets have a negative perception of our long-term and short-term financial prospects or the prospects for mortgage REITs and the commercial real estate market generally. We cannot be certain that sufficient funding or capital will be available to us in the future on terms that are acceptable to us. If we cannot obtain sufficient funding on acceptable terms, we will not be able to grow our business, which would likely have a negative impact on the market price of our common stock and our ability to make distributions to our stockholders.

In addition, the liquidity in our portfolio may also be adversely affected by possible margin calls under any future repurchase agreements. Repurchase agreements generally allow the counterparties, to varying degrees, to determine a new market value of the collateral to reflect current market conditions. If such counterparties determine that the value of the collateral has decreased, it may initiate a margin call and require us to either post additional collateral to cover such decrease or repay a portion of the outstanding borrowing. A significant increase in margin calls as a result of spread widening could harm our liquidity, results of operation, financial condition, business prospects, and our ability to make distributions to our stockholders. Additionally, in order to obtain cash to satisfy a margin call, we may be required to liquidate assets at a disadvantageous time, which could cause us to incur further losses and adversely affect our results of operations, financial condition, and may impair our ability to maintain our current level of dividends.

It is difficult to predict when conditions in our business will improve. We expect that the adverse circumstances and trends in our business and securities will continue through at least the remainder of 2009, and will begin to improve thereafter only as the credit markets and overall economy improve. There can be no assurance as tow whether the credit markets and economy will improve in 2009, and even if they do improve, whether they will improve early enough in 2009 to impact our business and securities favorably in that same year. Continued disruption in the global credit markets or further deterioration in those markets may have a material adverse effect on our ability to repay or refinance our borrowings and our ability to grow our business.

Currently, we have limited liquidity. As of December 31, 2008, our cash balance was $23.1 million. We may be required to pursue certain measures in order to maintain or enhance our liquidity, including seeking the extension or replacement of our debt facilities, potentially selling assets at unfavorable prices and/or reducing our operating expenses. The CDOs are subject to structural inflexibility with little or no ability on our part as holders of junior notes payable and preferred shares in the CDOs to effect sales of assets held in the CDOs to raise capital for our liquidity needs. We cannot assure you that we will be successful in measures to improve our liquidity.

For information about our available sources of funds, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and the notes to the consolidated financial statements in this Annual Report on Form 10-K.

The recent downturn in the credit markets has increased the cost of borrowing and has made financing difficult to obtain, which has negatively impacted our business, and may have a material adverse effect on us.

During 2008, the sub prime residential lending and single family housing markets began to experience accelerating default rates, declining real estate values and increasing backlog of housing supply. The residential sector issues quickly spread more broadly into the asset-backed, corporate and other credit and equity markets. Since the sub prime meltdown, volatility and risk premiums in most credit and equity markets have increased dramatically while liquidity has decreased. These issues have continued throughout 2008 and into the beginning of fiscal 2009. Increasing concerns regarding the U.S. and world economic outlook, such as large asset write-downs at banks, rising oil prices, declining business and consumer confidence and increased unemployment, are compounding these issues and risk premiums in most capital markets remain near historical all-time highs. Although we do not have any direct sub prime exposure or direct exposure to the single family mortgage market, the factors described above have resulted in substantially reduced commercial mortgage loan originations and securitizations, and are precipitating more generalized credit market dislocations and a significant contraction in available credit. As a result, most financial industry participants, including commercial real estate lenders and investors, are finding it difficult to obtain cost-effective debt capital to finance new investment activity or to refinance maturing debt.

Due to these conditions, the commercial real estate finance market has experienced higher volatility and less liquidity despite continued relatively strong credit performance across the sector. Credit has become more expensive and difficult to obtain for the Company and its competitors. The cost of financing as well as overall market-demanded risk premiums in commercial lending have increased. Most lenders are imposing more stringent restrictions on the terms of credit and there is a general reduction in the amount of credit available in the markets in which we conduct business. The negative impact on the tightening of the credit markets, further declines in real estate values in the U.S. and continuing credit and liquidity concerns may have a material adverse effect on us. Additionally, there is no assurance that the increased financing costs, financing with increasingly restrictive terms or the increase in risk premiums that are demanded by investors will not have a material impact on our future profitability measures. However, we expect that a portion of the impact of increased capital costs will be offset by increased yields on newly-originated assets, particularly if assets in our existing commercial real estate CDOs are repaid.

Lenders may require us to enter into restrictive covenants relating to our operations.

When we obtain financing, lenders could impose restrictions on us that would affect our ability to incur additional debt, our capability to make distributions to stockholders and our flexibility to determine our operating policies. Loan documents we execute will contain negative covenants that may limit, among other things, our ability to repurchase stock, distribute more than a certain amount of our funds from operations, and employ leverage beyond certain amounts. For example, though we have legal title to our assets and have all of the risks and rewards of ownership, under a typical master repurchase agreement, the lender would have a security interest in certain assets as collateral for our obligation under the related borrowings. Accordingly, we would be prohibited, among other things, from taking any action which would directly or indirectly impair or adversely affect the lender’s security interest the underlying securities or loans, to transfer any interest in the underlying loans to any person other than the lender, to modify in any material respect or terminate any of our organizational documents or to create or permit any lien or encumbrance on the underlying securities or loans.

If we issue senior securities we will be exposed to additional restrictive covenants and limitations on our operative flexibility, which could adversely affect our ability to pay dividends.

If we decide and the markets allow us to issue senior securities in the future, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Holders of senior securities may be granted specific rights, including but not limited to: the right to hold a perfected security interest in certain of our assets, the right to accelerate payments due under the indenture, rights to restrict dividend payments, and rights to require approval to sell assets. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock. We, and indirectly our stockholders, will bear the cost of issuing and servicing such securities.

The warehouse agreements and credit facilities that we use to finance our investments may require us to provide additional collateral.

We use credit facilities, when available, including warehouse agreements, to finance our investments. If the market value of the loans or securities pledged or sold by us to a funding source decline in value, we may be required by the lending institution to provide additional collateral or pay down a portion of the funds advanced. For example, under a typical master repurchase agreement, the lender may, by notice to us, require us to transfer to the lender cash or additional collateral acceptable by the lender in its sole and absolute discretion not later than one business day after such notice was given. We may not have the funds available to pay down our debt, which could result in defaults. Posting additional collateral to support our credit facilities will reduce our liquidity and limit our ability to leverage our assets. In the event we do not have sufficient liquidity to meet such requirements, lending institutions can accelerate our indebtedness, increase interest rates and terminate our ability to borrow. Such a situation would likely result in a rapid deterioration of our financial condition and possibly necessitate a filing for protection under the U.S. Bankruptcy Code.

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Further, credit facility providers may require us to maintain a certain amount of cash uninvested or set aside unlevered assets sufficient to maintain a specified liquidity position which would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.

Investor demand for commercial real estate CDOs has been substantially curtailed.

The turmoil in the structured finance markets has negatively impacted the credit markets generally, and, as a result, investor demand for commercial real estate CDOs has been substantially curtailed. In recent years, we have relied, to a substantial extent, on CDO financings to obtain match funded financing for our investments. Until the market for commercial real estate CDOs recovers, we may be unable to utilize CDOs to finance our investments and we may need to utilize less favorable sources of financing to finance our investments on a long-term basis. There can be no assurance as to when demand for commercial real estate CDOs will return or the terms of such securities investors will demand or whether we will be able to issue CDOs to finance our investments on terms beneficial to us.

We may be required to repurchase loans that we have sold or to indemnify holders of our CDOs.

If any of the loans we originate or acquire and sell or securitize do not comply with representations and warranties that we make about certain characteristics of the loans, the borrowers and the underlying properties, we may be required to repurchase those loans (including from a trust vehicle used to facilitate a structured financing of the assets through CDOs) or replace them with substitute loans. In addition, in the case of loans that we have sold instead of retained, we may be required to indemnify persons for losses or expenses incurred as a result of a breach of a representation or warranty. Repurchased loans typically require a significant allocation of working capital to carry on our books, and our ability to borrow against such assets is limited. Any significant repurchases or indemnification payments could materially and adversely affect our financial condition, operating results, and ability to make distributions to stockholders.

Lack of diversification in number of investments increases our dependence on individual investments.

If we acquire larger loans or property interests, our portfolio will be concentrated in a smaller number of assets, increasing the risk of loss to stockholders if a default or other problem arises.

In a period of rising interest rates, our interest expense could increase while the interest we earn on our fixed-rate assets would not change, which would adversely affect our profitability.

Our operating results depend in large part on differences between the income from our assets, net of credit losses, and financing costs. We anticipate that, in most cases, for any period during which our assets are not match-funded, the income from such assets will respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income. Increases in these rates will tend to decrease our net income and market value of our assets. Interest rate fluctuations resulting in our interest expense exceeding our interest income would result in operating losses for us and may limit or eliminate our ability to make distributions to our stockholders.

If credit spreads widen before we obtain long-term financing for our assets, the value of our assets may suffer.

To the extent we are able to restart our lending activities, as we have not entered into any new investments since July 2007, we price our assets based on our assumption about future credit spreads for financing those assets. We have obtained and will attempt to obtain in the future longer term financing for our assets using structured financing techniques. Such issuance entail interest rates set at a spread over a certain benchmark, such as the yield on United States Treasury obligations, swaps or LIBOR. If the spread that investors are paying on our current structured finance vehicle and will pay on future structured finance vehicles we may engage in over the benchmark widens and the rates we are charging or will charge on our securitized assets are not increased accordingly, this may reduce our income or cause losses and affect our ability to make distributions to stockholders.

Hedging against interest rate exposure may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.

We may pursue various hedging strategies to seek to reduce our exposure to losses from adverse changes in interest rates. Our hedging activity will vary in scope based on the level and volatility of interest rates, the type of assets held, and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us because, among other things:

•

interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;

•

available interest rate hedges may not correspond directly with the interest rate risk for which protection is sought;

•

the duration of the hedge may not match the duration of the related liability;

•

the amount of income that a REIT may earn from hedging transactions (other than through TRSs) to offset interest rate losses is limited by U.S. federal tax provisions governing REITs;

•

the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and

•

the party owing money in the hedging transaction may default on its obligation to pay.

Our hedging activity may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.

Declines in the market values of our investments may adversely affect periodic reported results and credit availability, which may reduce earnings and, in turn, cash available for distribution to our stockholders.

A portion of our assets is classified for accounting purposes as “trading.” Changes in the market values of these assets will be directly charged or credited to earnings and a decline in value reduces the book value of our assets.

A decline in the market value of our assets may adversely affect us particularly in instances where we have borrowed money based on the market value of those assets. If the market value of those assets declines, the lender may require us to post additional collateral to support the loan. If we were unable to post the additional collateral, we would have to sell the assets at a time when we might not otherwise choose to do so. A reduction in credit available may reduce our earnings and, in turn, cash available for distribution to our stockholders.

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If we fail to achieve adequate operating cash flow, our ability to make distributions will be adversely affected.

As a REIT, we must distribute annually at least 90% of our net taxable income to our stockholders, determined without regard to the deduction for dividends paid and excluding net capital gains. Our ability to make and sustain cash distributions is based on many factors, including the return on our investments, operating expense levels and certain restrictions imposed by Maryland law. Some of the factors are beyond our control and a change in any such factor could affect our ability to pay future dividends. No assurance can be given as to our ability to pay distributions to stockholders.

We may suffer a loss if a borrower defaults on a non-recourse loan or on a loan that is not secured by underlying real estate.

In the event of a default by a borrower on a non-recourse loan, we will only have recourse to the real estate-related assets collateralizing the loan. For this purpose, we consider loans made to special purpose entities formed solely for the purpose of holding and financing particular assets to be non-recourse loans. If the underlying collateral value is below the loan amount, we will suffer a loss. Conversely, we sometimes make loan investments that are unsecured or are secured by equity interests in the borrowing entities. These loans are subject to the risk that other lenders may be directly secured by the real estate assets of the borrower. In the event of a default, those collateralized lenders would have priority over us with respect to the proceeds of a sale of the underlying real estate.

In cases described above, we may lack control over the underlying asset collateralizing our loan or the underlying assets of the borrower prior to a default, and as a result, their value may be reduced by acts or omissions by owners or managers of the assets.

We may suffer a loss if a borrower or guarantor defaults on recourse obligations under our loans.

We sometimes obtain individual or corporate guarantees from borrowers or their affiliates, which guarantees are not secured. In cases where guarantees are not fully or partially secured, we typically rely on financial covenants from borrowers and guarantors which are designed to require the borrower or guarantor to maintain certain levels of creditworthiness. Where we do not have recourse to specific collateral pledged to satisfy such guarantees or recourse loans, we will only have recourse as an unsecured creditor to the general assets of the borrower or guarantor, some or all of which may be pledged to satisfy other lenders. There can be no assurance that a borrower or guarantor will comply with its financial covenants, or that sufficient assets will be available to pay amounts owed to us under our loans and guarantees. As a result of these factors, we may suffer losses which could have a material adverse effect on our financial performance, the market prices of our securities and our ability to pay dividends.

We may suffer a loss in the event of a default or bankruptcy of a borrower, particularly in cases where the borrower has incurred debt that is senior to our loan.

If a borrower defaults on our loan but does not have sufficient assets to satisfy our loan, we may suffer a loss of principal or interest. In the event of a borrower bankruptcy, we may not have full recourse to the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy our loan. In addition, certain of our loans are subordinate to other debt of the borrower. If a borrower defaults on our loan or on debt senior to our loan, or in the event of a borrower bankruptcy, our loan will be satisfied only after the senior debt. Where debt senior to our loan exists, the presence of intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through “standstill” periods) and control decisions made in bankruptcy proceedings relating to borrowers. Bankruptcy and borrower litigation can significantly increase the time needed for us to acquire underlying collateral in the event of a default, during which time the collateral may decline in value. In addition, there are significant costs and delays associated with the foreclosure process.

We are subject to the risk that provisions of our loan agreements may be unenforceable.

Our rights and obligations with respect to our loans are governed by written loan agreements and related documentation. It is possible that a court could determine that one or more provisions of a loan agreement are unenforceable, such as a loan prepayment provision or the provisions governing our security interest in the underlying collateral. If this were to happen with respect to a material asset or group of assets we could be adversely affected.

We are subject to the risks associated with loan participations, such as less than full control rights.

Some of our assets are participation interests in loans or co-lender arrangements in which we share the rights, obligations and benefits of the loan with other lenders. We may need the consent of these parties to exercise our rights under such loans, including rights with respect to amendment of loan documentation, enforcement proceedings in the event of default and the institution of, and control over, foreclosure proceedings. Similarly, a majority of the participants may be able to take actions to which we object but to which we will be bound if our participation interest represents a minority interest. We may be adversely affected by this lack of full control.

Increases in interest rates during the term of a loan may adversely impact a borrower’s ability to repay a loan at maturity or to prepay a loan.

If interest rates increase during the term of our loan, a borrower may not be able to obtain the necessary funds to repay our loan at maturity through refinancing. Increasing interest rates may hinder a borrower’s ability to refinance our loan because the underlying property cannot satisfy the debt service coverage requirements necessary to obtain new financing or because the value of the property has decreased. If a borrower is unable to repay our loan at maturity, we could suffer a loss and we will not be able to reinvest proceeds in assets with higher interest rates. As a result, our financial performance and the market prices of our securities could be materially adversely affected.

We manage our portfolio pursuant to very broad investment guidelines and our board of directors does not approve each investment decision made by us, which may result in our making riskier investments.

To the extent we are able to restart our lending activities, as we have not entered into any new investments since July 2007, we are authorized to follow very broad investment guidelines. While our board of directors periodically review our investment guidelines and our investment portfolio, they do not review all of our proposed investments and are only required to approve investments or dispositions that exceed $50 million (or $75 million for investments and dispositions having credit ratings of “A” or better by a major rating agency), subject to certain limited exceptions. In addition, in conducting periodic reviews, our directors may rely primarily on information provided to them by us. Furthermore, we may use complex strategies and transactions that may be difficult or impossible to unwind by the time they are reviewed by our directors. We have great latitude within the broad investment guidelines in determining the types of assets we may decide are proper investments for us. Decisions made and investments entered into by us may not fully reflect your best interests. In addition, our directors may change the investment guidelines at any time without the approval of our stockholders.

Maintenance of our 1940 Act exemption imposes limits on our operations.

We intend to conduct our operations so as not to become regulated as an investment company under the 1940 Act. Because we are a holding company that will conduct our businesses through subsidiaries, the securities issued by our subsidiaries that are excepted from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis. This requirement limits the types of businesses in which we may engage through our subsidiaries. If we or our subsidiaries fail to maintain our exceptions or exemptions from the 1940 Act, we could, among other things, be required either (a) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company, either of which could have an adverse effect on our business and the market price for our common stock.

In addition, certain of our wholly owned subsidiaries intend to qualify for an exemption from registration under Section 3(c)(5)(C) of the 1940 Act, which generally means that at least 55% of each of their portfolios must be comprised of qualifying assets and 80% of each of their portfolios must be comprised of qualifying

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assets and real estate-related assets under the 1940 Act. To comply with these regulations, we may from time to time buy or originate whole loans, certain B Notes, mezzanine loans, and other qualifying assets. We will treat certain B Notes as qualifying real estate assets if, among other conditions, (i) we have approval rights in connection with any material decisions pertaining to the administration and servicing of the relevant mortgage loan and with respect to any material modification to the relevant loan agreements, and (ii) in the event that the relevant mortgage loan becomes non-performing, we have effective control over the remedies relating to the enforcement of the loan, including ultimate control of the foreclosure process by having the right to: (a) appoint the special servicer to manage the resolution of the loan, (b) advise, direct or approve the action of the special servicer, (c) terminate the special servicer at any time with or without cause, (d) cure the default so that the loan is no longer non-performing, and (e) purchase the A Note at par plus accrual interest, thereby acquiring the entire mortgage loan. We will treat certain mezzanine loans (Tier 1 mezzanine loans) as qualifying real estate assets, if, among other conditions, we (i) exercise ongoing control rights over the management of the underlying property, (ii) have the right to readily cure a default or purchase the mortgage loan, and (iii) have the right to foreclose on the collateral and, through our ownership in the property-owning entity become the owner of the underlying property. Although we intend to monitor our portfolio periodically and prior to each acquisition, there can be no assurance that we will be able to maintain this exemption from registration. Further, we may not be able to invest in sufficient qualifying and/or real estate-related assets and future revisions of the 1940 Act or further guidance from the SEC Staff may cause us to lose our exemption or force us to re-evaluate our portfolio and our business strategy. Such changes may prevent us from operating our business successfully.

We periodically evaluate our assets, and also evaluate prior to an acquisition or origination the structure of each prospective investment, to determine whether the investment will be a qualifying asset for purposes of maintaining our exemption or exclusion from registration under the 1940 Act, and will consult with counsel when necessary. Failure to maintain this exemption or exclusion would require us to significantly restructure our business plan.

Rapid changes in the values of our other real estate-related investments may make it more difficult for us to maintain our qualification as a REIT or exemption from the 1940 Act.

If the market value or income potential of real estate-related investments declines as a result of increased interest rates, prepayment rates or other factors, we may need to increase our real estate investments and income and/or liquidate our non-qualifying assets in order to maintain our REIT qualification or exemption from the 1940 Act. If the decline in real estate asset values and/or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of many of our non-real estate assets. We may have to make investment decisions that we otherwise would not make absent the REIT and 1940 Act considerations.

We face risks related to securities litigation that could have a material adverse effect on our business, financial condition and results of operations. We may face additional litigation in the future that could also harm our business.

On October 30, 2007, a putative class action lawsuit was commenced in the United States District Court for the District of Connecticut against our company, our former chief financial officer and our former chief executive officer seeking remedies under the Securities Act of 1933, as amended. Amended complaints filed on March 25, 2008 and May 6, 2008 added our chairman and the underwriters that participated in our October 2006 initial public offering as additional defendants. The underwriters have since been dropped from the suit by voluntary dismissal filed by the plaintiffs with the court in December 2008. The plaintiffs allege that the registration statement and prospectus relating to the initial public offering contained material misstatements and material omissions. Specifically, the plaintiffs allege that management had knowledge of certain loan impairments and did not properly disclose or record such impairments in the financial statements. The plaintiffs seek to represent a class of all persons who purchased or otherwise acquired common stock that is traceable to our initial public offering in September 2006 and seek damages in an unspecified amount. On July 29, 2008, we filed a Motion to Dismiss the putative class action suit with the federal district court for the District of Connecticut. Following oral arguments in November 2008, the plaintiffs filed a second amended complaint on December 22, 2008. We have since filed a revised Motion to Dismiss the second amended complaint, and are awaiting the court’s ruling on that motion.

In addition, on January 15, 2008 and February 7, 2008, we received complaints from an attorney representing two stockholders, alleging that certain officers and directors of our company knowingly violated generally accepted accounting principles for certain of our assets. The stockholders demanded that we take action to recover from such directors and officers the amount of damages sustained by us as a result of the misconduct alleged therein and to correct deficiencies in our internal controls and accounting practices that allowed the misconduct to occur. In response to the letters from stockholders’ counsel, our board of directors appointed a special committee to investigate the allegations set forth in the letters. On July 10, 2008, the special committee reported its findings to our board of directors and recommended that no further action be taken. Our board of directors has adopted the committee’s recommendation unanimously.

We believe that the allegations and claims against us and our directors, former chief financial officer and former chief executive officer are without merit and we intend to contest these claims vigorously. An adverse resolution of the action could have a material adverse effect on our financial condition and results of operations in the period in which the lawsuits and claims are resolved. We are not presently able to estimate potential losses to us, if any, related to these lawsuits and claims.

Adverse changes in general economic conditions have adversely affected our business.

Our success is dependent upon economic conditions in the U.S. generally, and in the geographic areas in which a substantial number of our investments are located. The recent adverse changes in national economic conditions and in the economic conditions of the regions in which we conduct substantial business have had an adverse effect on real estate values and our financial performance, the market prices of our securities and our ability to pay dividends.

In a recession or under other adverse economic conditions like the current credit crisis, non-earning assets and write-downs are likely to increase as debtors fail to meet their payment obligations. For example, our non-performing loans have increased materially through 2008, particularly in the third quarter. Although we maintain reserves for credit losses and an allowance for doubtful accounts in amounts that we believe are sufficient to provide adequate protection against potential write-downs in our portfolio, these amounts could prove to be insufficient.

As discussed in the preceding risk factors, the current credit crisis has contributed to a downgrading of our credit ratings. This downgrade and adverse market conditions generally have increased our funding costs, decreased our net investment income and limited our access to the capital markets. Further, this downgrade could result in a decision by the lenders under our existing bank credit facilities not to extend such credit facilities after their expiration. Such results have had a material adverse effect on our financial performance and the market prices of our securities.

We are required to make a number of judgments in applying accounting policies and different estimates and assumptions in the application of these policies could result in changes to our reporting of financial condition and results of operations.

Material estimates that are particularly susceptible to significant change relate to the determination of the reserve for loan losses, the effectiveness of derivatives and other hedging activities, the fair value of certain financial instruments (debt obligations, loan assets, securities, derivatives, and privately held investments), deferred income tax assets or liabilities, share-based compensation, and accounting for acquisitions, including the fair value determinations and the analysis of goodwill impairment. While we have identified those accounting policies that are considered critical and have procedures in place to facilitate the associated judgments, different assumptions in the application of these policies could result in material changes to our reports of financial condition and results of operations.

Quarterly results may fluctuate and may not be indicative of future quarterly performance.

Our quarterly operating results could fluctuate; therefore, you should not rely on past quarterly results to be indicative of our performance in future quarters. Factors that could cause quarterly operating results to fluctuate include, among others, variations in our investment origination volume, variations in the timing of prepayments, the degree to which we encounter competition in our markets and general economic conditions.

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We may incur losses as a result of ineffective risk management processes and strategies.

We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, internal controls, management review processes and other mechanisms. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Thus, we may, in the course of our activities, incur losses. Recent market conditions have involved unprecedented dislocations and highlight the limitations inherent in using historical data to manage risk.

The models that we use to assess and control our risk exposures reflect assumptions about the degrees of correlation or lack thereof among prices of various asset classes or other market indicators. In times of market stress or other unforeseen circumstances, such as those which occurred during 2008, previously uncorrelated indicators may become correlated, or conversely previously correlated indicators may move in different directions. These types of market movements have at times limited the effectiveness of our hedging strategies and have caused us to incur significant losses, and they may do so in the future. These changes in correlation can be exacerbated where other market participants are using risk models with assumptions or algorithms that are similar to ours. In these and other cases, it may be difficult to reduce our risk positions due to the activity of other market participants or widespread market dislocations, including circumstances where asset values are declining significantly or no market exists for certain assets. To the extent that we make investments directly through various of our businesses in securities, including private equity, that do not have an established liquid trading market or are otherwise subject to restrictions on sale or hedging, we may not be able to reduce our positions and therefore reduce our risk associated with such positions.

We operate in a highly competitive market for investment opportunities.

A number of entities compete with us to make the types of investments that we have historically made. To the extent we are able to restart our lending activities, as we have not entered into any new investments since July 2007, we compete with other REITs, public and private funds, commercial and investment banks and commercial finance companies. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. Several other REITs may have investment objectives that overlap with ours, which may create competition for investment opportunities. Some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective.

We are highly dependent on information systems and third parties, and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to pay dividends.

Our business is highly dependent on communications and information systems. Any failure or interruption of our systems could cause delays or other problems in our securities trading activities, which could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to make distributions to stockholders.

Terrorist attacks and other acts of violence or war may affect the market for our common stock, the industry in which we conduct our operations and our profitability.

Terrorist attacks may harm our results of operations and your investment. We cannot assure you that there will not be further terrorist attacks against the U.S. or U.S. businesses. These attacks or armed conflicts may directly impact the property underlying our asset-based securities or the securities markets in general. Losses resulting from these types of events are uninsurable.

More generally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets and economy. Adverse economic conditions could harm the value of the property underlying our asset-backed securities or the securities markets in general which could harm our operating results and revenues and may result in the volatility of the value of our securities.

Risks Related To Our Investments

We may not realize gains or income from our investments.

We seek to generate both current income and capital appreciation. However, the securities we invest in may not appreciate in value and, in fact, may decline in value, and the debt securities we invest in may default on interest and/or principal payments. Accordingly, we may not be able to realize gains or income from our investments. Any gains that we do realize may not be sufficient to offset any other losses we experience. Any income that we realize may not be sufficient to offset our expenses.

We have incurred substantial impairment of our assets and may incur significant impairments in the future.

Due to a variety of factors, including current adverse market conditions affecting the real estate market, we have incurred substantial impairments of our assets. These impairments have resulted in significant losses. For the year ended December 31, 2008, we recorded approximately $126.5 million in loan loss provisions and $46.2 in impairment losses related to certain of our investments. For the year ended December 31, 2007, we recorded approximately $19.6 million in loan loss provisions and $62.4 million in impairment losses related to certain of our investments. Our assets may suffer additional impairments in the future causing us to recognize significant losses. If we are unsuccessful in renegotiating, selling or otherwise resolving assets that are currently nonperforming or that we expect will become nonperforming, we may experience loss of principal or reduced income available for distributions. Investors and lenders alike could lose confidence in the quality and value of our assets. These impairments, or the perception that these impairments may occur, can depress our stock price, harm our liquidity and materially adversely impact our results of operations. We may be forced to sell substantial assets at a time when the market is depressed in order to support or enhance our liquidity. Despite our need to sell substantial assets, we may be unable to make such sales on favorable terms or at all, further materially damaging our liquidity and operations. If we are unable to maintain adequate liquidity as a result of these impairments or otherwise, you could lose some or all of your investment.

Our real estate investments are subject to risks particular to real property.

We own assets secured by real estate, interests in joint ventures that do own real estate, and in the future and may own real estate directly. Real estate investments will be subject to various risks, including:

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acts of God, including earthquakes, floods and other natural disasters, which may result in uninsured losses;

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acts of war or terrorism, including the consequences of terrorist attacks, such as those that occurred on September 11, 2001;

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adverse changes in national and local economic and market conditions, including the credit and securitization markets;

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changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances;

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costs of remediation and liabilities associated with environmental conditions such as indoor mold; and

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the potential for uninsured or under-insured property losses.

If any of these or similar events occurs, it may reduce our return from an affected property or investment and reduce or eliminate our ability to make distributions to stockholders.

Our assets may include high yield and subordinated corporate securities that have greater risks of loss than secured senior loans and if those losses are realized, it could adversely affect our earnings, which could adversely affect our cash available for distribution to our stockholders.

We invest in high yield and subordinated securities. However, we do not have any specific policy with respect to allocations in high yield and subordinated securities and our charter contains no limitations on the percentage we may invest in these assets. These investments involve a higher degree of risk than long-term senior secured loans. First, the high yield securities may not be secured by mortgages or liens on assets. Even if secured, these high yield securities may have higher loan-to-value ratios than a senior secured loan. Furthermore, our right to payment and the security interest may be subordinated to the payment rights and security interests of the senior lender. Therefore, we may be limited in our ability to enforce our rights to collect these loans and to recover any of the loan balance through a foreclosure of collateral.

Certain of these high yield and subordinated securities may have an interest only payment schedule, with the principal amount remaining outstanding and at risk until the maturity of the obligation. We do not have any policy regarding the maximum term (maturity) on these assets. In this case, a borrower’s ability to repay its obligation may be dependent upon a liquidity event that will enable the repayment of the obligation.

In addition to the above, numerous other factors may affect a company’s ability to repay its obligation, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. A deterioration in a company’s financial condition and prospects may be accompanied by deterioration in the collateral for the obligation. Losses in our high yield and subordinated securities could adversely affect our earnings, which could adversely affect cash available for distribution to our stockholders.

High yield and subordinated securities from highly leveraged companies may have a greater risk of loss which, in turn, could adversely affect cash available for distribution to our stockholders.

Leverage may have material adverse consequences to the companies in which we will hold investments. These companies may be subject to restrictive financial and operating covenants. The leverage may impair these companies’ ability to finance their future operations and capital needs. As a result, these companies’ flexibility to respond to changing business and economic conditions and to business opportunities may be limited. A leveraged company’s income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used. As a result, leveraged companies have a greater risk of loss. Losses on our investments could adversely affect our earnings, which could adversely affect cash available for distribution to our stockholders.

We retain equity interests of CDO issuances and such interests involve significant risks, including that CDO equity receives distributions from the CDO only if the CDO generates enough income to first pay the holders of its debt securities and its expenses.

We retain equity interests of CDO issuances. However, we do not have any specific policy with respect to allocations in CDOs and our charter contains no limitations on the percentage we may invest in this asset class. A CDO is a special purpose vehicle that purchases collateral (such as real estate-related investments, bank loans or asset-backed securities) that is expected to generate a stream of interest or other income. The CDO issues various classes of securities that participate in that income stream, typically one or more classes of debt instruments and a class of equity securities. The equity is usually entitled to all of the income generated by the CDO after the CDO pays all of the interest due on the debt securities and its expenses. However, there will be little or no income available to the CDO equity if there are defaults by the issuers of the underlying collateral and those defaults exceed a certain amount. In that event, the value of our investment in the CDOs equity could decrease substantially. In addition, the equity securities of CDOs are generally illiquid, and because they represent a leveraged investment in the CDO’s assets, the value of the equity securities will generally have greater fluctuations than the values of the underlying collateral.

We may enter into warehouse agreements in connection with CDOs and if the investment in the CDO is not consummated, the warehoused collateral will be sold and we must bear any loss resulting from the purchase price of the collateral exceeding the sale price.

In connection with CDOs that we structure, when markets permit, we expect to enter into warehouse agreements with investment banks or other financial institutions, pursuant to which the institution will initially finance the purchase of the collateral that will be transferred to the CDO. We will select the collateral. If the CDO transaction is not consummated, the institution may liquidate the warehoused collateral and we would have to pay any amount by which the original purchase price of the collateral exceeds its sale price, subject to negotiated caps, if any, on our exposure. In addition, regardless of whether the CDO transaction is consummated, if any of the warehoused collateral is sold before the consummation, we will have to bear any resulting loss on the sale. The amount at risk in connection with the warehouse agreements supporting our investments in CDOs, generally is the amount that we have agreed to invest in the equity securities of the CDO. Although we would expect to complete the CDO transaction within about three to nine months after the warehouse agreement is signed, we cannot assure you that we would in fact be able to complete any such transaction, or complete it within the expected time period.

Increases in interest rates could negatively affect the value of our investments, which could result in reduced earnings or losses and negatively affect the cash available for distribution to our stockholders.

We invest indirectly in mortgage loans by purchasing CMBS. Under a normal yield curve, an investment in CMBS will decline in value if long-term interest rates increase. Declines in market value may ultimately reduce earnings or result in losses to us, which may negatively affect cash available for distribution to our stockholders.

A significant risk associated with our investment in CMBS is that both long-term and short-term interest rates will increase significantly. If long-term rates increased significantly, the market value of these CMBS would decline and the duration and weighted average life of the investments would increase. We could realize a loss if the securities were sold. At the same time, an increase in short-term interest rates would increase the amount of interest owed on the warehouse agreements we may enter into in order to finance the purchase of CMBS.

Market values of our investments may decline without any general increase in interest rates for a number of reasons, such as increases in defaults, increases in voluntary prepayments for those investments that are subject to prepayment risk, market illiquidity and widening of credit spreads.

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Some of our portfolio investments are recorded at fair value as determined in good faith by us and, as a result, there is uncertainty as to the value of these investments.

Some of our portfolio investments are in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded is not readily determinable. We value these investments quarterly at fair value as determined in good faith by our management using a variety of industry accepted techniques and report the results to our board of directors. Because such valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. The value of our common stock could be adversely affected if our determinations regarding the fair value of these investments were materially higher than the values that we ultimately realize upon their disposal.

Negative covenants contained in repurchase agreements increase the possibility that we will be unable to maintain adequate capital and funding and may reduce cash available for distribution.

We historically have obtained a significant portion of our funding for new investments through the use of repurchase facilities. Any future repurchase agreements may include negative covenants that, if breached, may cause transactions to be terminated early. The occurrence of an event of default or termination event could give our counterparty the option to terminate all repurchase transactions existing with us and make any amount due by us to the counterparty payable immediately. If we were required to terminate outstanding repurchase transactions and were unable to negotiate more favorable funding terms, cash would be negatively impacted. This would reduce the amount of capital available for investing and/or could negatively impact our ability to make distributions to our stockholders. In addition, we could have to sell assets at a time when we might not otherwise choose to do so.

A prolonged economic slowdown, a recession or declining real estate values could impair our investments and harm our operating results.

We believe the risks associated with our business will be more severe during periods of economic slowdown or recession if these periods are accompanied by declining real estate values. Declining real estate values will likely reduce our level of, or halt our making of, new mortgage loan originations, since borrowers often use increases in the value of their existing properties to support the purchase or investment in additional properties. Borrowers may also be less able to pay principal and interest on our loans if the real estate economy weakens. Further, declining real estate values significantly increase the likelihood that we will incur losses on our loans in the event of default because the value of our collateral may be insufficient to cover our cost on the loan. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income from loans in our portfolio as well as our ability to originate, sell and securitize loans, which would significantly harm our revenues, results of operations, financial condition, business prospects and our ability to make distributions to you. Beginning in 2007, there was significant volatility in the capital markets and, as a result, we have not entered into a new investment since July 2007. We believe we are currently in a period of economic slowdown and that such conditions will likely persist through at least the remainder of 2009.

We may be adversely affected by unfavorable economic changes in geographic areas where properties that we may acquire are concentrated.

Adverse conditions in the areas where the properties underlying our investments are located (including business layoffs or downsizing, industry slowdowns, changing demographics and other factors) and local real estate conditions (such as oversupply of, or reduced demand for, office and industrial properties) may have an adverse effect on the value of the properties underlying our investments. A material decline in the demand or the ability of tenants to pay rent for office and industrial space in these geographic areas may result in a material decline in our cash available for distribution.

Joint investments could be adversely affected by our lack of sole decision-making authority and reliance upon a co-venturer’s financial conditions.

We co-invest with third parties through partnerships, joint ventures, co-tenancies or other entities, acquiring non-controlling interests in, or sharing responsibility for managing the affairs of, a property, partnership, joint venture, co-tenancy or other entity. Therefore, we will not be in a position to exercise sole decision-making authority regarding that property, partnership, joint venture or other entity. Investments in partnerships, joint ventures, or other entities may involve risks not present were a third party not involved, including the possibility that our partners, co-tenants or co-venturers might become bankrupt or otherwise fail to fund their share of required capital contributions. Additionally, our partners or co-venturers might at any time have economic or other business interests or goals which are inconsistent with our business interests or goals. These investments may also have the potential risk of impasses on decisions such as a sale, because neither we nor the partner, co-tenant or co-venturer would have full control over the partnership or joint venture. Consequently, actions by such partner, co-tenant or co-venturer might result in subjecting properties owned by the partnership or joint venture to additional risk. In addition, we may in specific circumstances be liable for the actions of our third-party partners, co-tenants or co-venturers.

Although our existing joint venture agreements do not contain such provisions, and we have suspended new investments in joint ventures, we may in the future enter into joint venture agreements that contain terms in favor of our partners that may have an adverse effect on the value of our investments in the joint ventures. For example, we may be entitled under a particular joint venture agreement to an economic share in the profits of the joint venture that is smaller than our ownership percentage in the joint venture, our partner may be entitled to a specified portion of the profits of the joint venture before we are entitled to any portion of such profits and our partner may have rights to buy our interest in the joint venture, to force us to buy the partner’s interest in the joint venture or to compel the sale of the property owned by such joint venture. These rights may permit our partner in a particular joint venture to obtain a greater benefit from the value or profits of the joint venture than us, which may have an adverse effect on the value of our investment in the joint venture and on our financial condition and results of operations.

Liability relating to environmental matters may impact the value of properties that we may acquire or the properties underlying our investments.

Under various U.S. federal, state and local laws, an owner or operator of real property may become liable for the costs of removal of certain hazardous substances released on its property. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances.

If we acquire properties directly, there may be environmental problems associated with the property of which we were unaware. The presence of hazardous substances may adversely affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of a property underlying one of our debt investments becomes liable for removal costs, the ability of the owner to make debt payments to us may be reduced, which in turn may adversely affect the value of the relevant mortgage asset held by us and our ability to make distributions to stockholders.

If we acquire any properties, the presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs, thus harming our financial condition. In addition, although our leases, if any, will generally require our tenants to operate in compliance with all applicable laws and to indemnify us against any environmental liabilities arising from a tenant’s activities on the property, we nonetheless would be subject to strict liability by virtue of our ownership interest for environmental liabilities created by such tenants, and we cannot ensure you that any tenants we might have would satisfy their indemnification obligations under the applicable sales agreement or lease. The discovery of material environmental liabilities attached to such properties could have a material adverse effect on our results of operations and financial condition and our ability to make distributions to our stockholders.

Our hedging transactions may not completely insulate us from interest rate risk.

Subject to maintaining our qualification as a REIT, we engage in certain hedging transactions to limit our exposure to changes in interest rates and we may also

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hedge against the decline in the values of our portfolio position, and therefore may expose ourselves to risks associated with such transactions. We may conduct certain of our hedging activity in our TRS for REIT qualification purposes. We may utilize instruments such as forward contracts and interest rate swaps, caps, collars and floors to seek to hedge against mismatches between the cash flows on our assets and the interest payments on our liabilities or fluctuations in the relative values of our portfolio positions, in each case resulting from changes in market interest rates. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to hedge against an interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.

Our board of directors will be responsible for approving the types of hedging instruments we may use, absolute limits on the notional amount and term of a hedging instrument and parameters for the credit-worthiness of hedge counterparties. Management is responsible for executing transactions with our finance and capital market professionals, documenting the transactions, monitoring the valuation and effectiveness of the hedges, and providing reports concerning our hedging activities and the valuation and effectiveness of our hedges, to the audit committee of our board of directors no less often than quarterly. We expect to engage experienced third party advisors to provide us with assistance in the identification of interest rate risks, the analysis, selection and timing of risk protection strategies, the administration and negotiation of hedge documentation, settlement or disposition of hedges, compliance with hedge accounting requirements and measurement of hedge effectiveness and valuation.

The success of our hedging transactions will depend on our ability to correctly predict movements of interest rates. Therefore, while we may enter into such transactions to seek to reduce interest rate risks, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss.

Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities and involve risks and costs.

The cost of using hedging instruments increase as the period covered by the instrument increases and during periods of rising and volatile interest rates. We may increase our hedging activity and thus increase our hedging costs during periods when interest rates are volatile or rising and hedging costs have increased.

In addition, hedging instruments involve risk since they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities.

Consequently, there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then current market price. Although generally we will seek to reserve the right to terminate our hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot assure you that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.

Prepayments can adversely affect the yields on our investments.

The yield of our assets may be affected by the rate of prepayments differing from our projections. Prepayments on debt instruments, where permitted under the debt documents, are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of declining interest rates, prepayments on mortgages, and loans generally increase. If we are unable to invest the proceeds of such prepayments received at similar yields, the yield on our portfolio will decline. In addition, we may acquire assets at a discount or premium and if the asset does not repay when expected, our anticipated yield may be impacted. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments.

The mortgage loans we originate and acquire and the mortgage loans underlying the mortgage and asset-backed securities we originate and acquire are subject to delinquency, foreclosure and loss, which could result in losses to us.

We originate and acquire commercial mortgage loans. However, we do not have any specific policy with respect to allocations in commercial mortgage loans and our charter contains no limitations on the percentage we may invest in this product type. Commercial mortgage loans are secured by multi-family or commercial properties and are subject to risks of delinquency and foreclosure and risks of loss that are greater than similar risks associated with loans made on the security of a single family residential property. The ability of a borrower to pay the principal of and interest on a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the exercise of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expense or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes in national, regional or local economic conditions and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances.

In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our cash flow from operations. In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law.

Foreclosure of a mortgage loan can be an expensive and lengthy process which could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan. Accordingly, the CMBS we invest in are subject to all of the risks of the underlying mortgage loans.

The B Notes we originate and acquire may be subject to additional risks relating to the privately negotiated structure and terms of the transaction, which may result in losses to us.

We originate and acquire B Notes. However, we do not have any specific policy with respect to allocations in B Notes and our charter contains no limitations on the percentage we may invest in this product type. B Notes are mortgage loans that are typically (i) secured by a first mortgage on a single large commercial property or group of related properties and (ii) subordinated to an A Note secured by the same first mortgage on the same collateral. As a result, if a borrower defaults, there may

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not be sufficient funds remaining for B Note owners after payment to the A Note owners. B Notes reflect similar credit risks to comparably rated CMBS. However, since each transaction is privately negotiated, B Notes can vary in their structural characteristics and risks. For example, the rights of holders of B Notes to control the process following a borrower default may be limited in certain investments. We cannot predict the terms of each B Note investment. Further, B Notes typically are secured by a single property, and so reflect the increased risks associated with a single property compared to a pool of properties. B Notes also are less liquid than CMBS, thus we may be unable to dispose of underperforming or non-performing investments. The higher risks associated with our subordinate position in our B Note investments could subject us to increased risk of losses.

Investment in non-conforming and non-investment grade loans may involve increased risk of loss.

Except in rare instances, loans we may acquire or originate will not conform to conventional loan criteria applied by traditional lenders and will not be rated or will be rated as non-investment grade (for example, for investments rated by Moody’s Investors Service, ratings lower than Baa3, and for Standard & Poor’s, BBB-, or below). The non-investment grade ratings for these loans typically result from the overall leverage of the loans, the lack of a strong operating history for the properties underlying the loans, the borrowers’ credit history, the properties’ underlying cash flow or other factors. As a result, loans we originate or acquire may have a higher risk of default and loss than conventional loans. Any loss we incur may reduce distributions to stockholders and adversely affect the value of our common stock. We currently anticipate investing primarily in unrated or non-investment grade assets. There are no limits on the percentage of unrated or non-investment grade assets we may hold in our portfolio.

Investments in mezzanine loans involve greater risks of loss than senior loans secured by income producing properties.

We originate and acquire mezzanine loans. However, we do not have any policy with respect to allocations in mezzanine loans and our charter contains no limitations on the percentage we may invest in this asset class. Investments in mezzanine loans take the form of subordinated loans secured by second mortgages on the underlying property or loans secured by a pledge of the ownership interests in the entity that directly or indirectly owns the property. These types of investments involve a higher degree of risk than a senior mortgage loan because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of the property owning entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is paid in full. As a result, we may not recover some or all of our investment, which could result in losses. In addition, mezzanine loans may have higher loan to value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal.

We evaluate the collectibility of both interest and principal of each of our loans, if circumstances warrant, to determine whether they are impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the existing contractual terms. When a loan is impaired, the amount of the loss accrual is calculated by comparing the carrying amount of the investment to the value determined by discounting the expected future cash flows at the loan’s effective interest rate or, as a practical expedient, to the value of the collateral if the loan is collateral dependent. There can be no assurance that our estimates of collectible amounts will not change over time or that they will be representative of the amounts we actually collect, including amounts we would collect if we chose to sell these investments before their maturity. If we collect less than our estimates, we will record charges which could be material.

Bridge loans involve a greater risk of loss than traditional mortgage loans.

We provide bridge loans secured by first lien mortgages on a property to borrowers who are typically seeking short-term capital to be used in an acquisition or renovation of real estate. The borrower has usually identified an undervalued asset that has been under-managed or is located in a recovering market. If the market in which the asset is located fails to recover according to the borrower’s projections, or if the borrower fails to improve the quality of the asset’s management or the value of the asset, the borrower may not receive a sufficient return on the asset to satisfy the bridge loan, and we may not recover some or all of our investment.

In addition, owners usually borrow funds under a conventional mortgage loan to repay a bridge loan. We may therefore be dependent on a borrower’s ability to obtain permanent financing to repay our bridge loan, which could depend on market conditions and other factors. Bridge loans are also subject to risks of borrower defaults, bankruptcies, fraud, losses and special hazard losses that are not covered by standard hazard insurance. In the event of any default under bridge loans held by us, we bear the risk of loss of principal and non-payment of interest and fees to the extent of any deficiency between the value of the mortgage collateral and the principal amount of the bridge loan. To the extent that we suffer such losses with respect to our investments in bridge loans, the value of our company and the price of our common stock may be adversely affected.

Preferred equity investments involve a greater risk of loss than traditional debt financing.

We may make preferred equity investments. However, we do not have any specific policy with respect to allocations in preferred equity investments and our charter contains no limitations on the percentage we may invest in this asset class. Preferred equity investments are subordinate to debt financing and are not secured. Should the issuer default on our investment, we would only be able to proceed against the entity that issued the preferred equity in accordance with the terms of the preferred security, and not any property owned by the entity. Furthermore, in the event of bankruptcy or foreclosure, we would only be able to recoup our investment after any lenders to the entity are paid. As a result, we may not recover some or all of our investment, which could result in losses.

Loans to owners of net lease properties may generate losses.

We may make loans to owners of net leased real estate assets. The value of our investments and the income from our investments in loans to owners of net lease properties, if any, will depend upon the ability of the applicable tenant to meet its obligations to maintain the property under the terms of the net lease. If a tenant fails or becomes unable to so maintain a property, the borrower would have difficulty making its required loan payments to us. In addition, under many net leases the owner of the property retains certain obligations with respect to the property, including among other things, the responsibility for maintenance and repair of the property, to provide adequate parking, maintenance of common areas and compliance with other affirmative covenants in the lease. If the borrower were to fail to meet these obligations, the applicable tenant could abate rent or terminate the applicable lease, which may result in a loss of our capital invested in, and anticipated profits from, the property to the borrower and the borrower would have difficulty making its required loan payments to us. In addition, the borrower may find it difficult to lease property to new tenants that may have been suited to the particular needs of a former tenant.

Our investments in subordinated loans and subordinated CMBS are generally in the “second loss” position and therefore subject to losses.

We intend to acquire subordinated loans and invest in subordinated CMBS. In the event a borrower defaults on a loan and lacks sufficient assets to satisfy our loan, we may suffer a loss of principal or interest. In the event a borrower declares bankruptcy, we may not have full recourse to the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy the loan. In addition, certain of our loans may be subordinate to other debt of the borrower. If a borrower defaults on our loan or on debt senior to our loan, or in the event of a borrower bankruptcy, our loan will be satisfied only after the senior debt is paid in full. Where debt senior to our loan exists, the presence of intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through “standstill periods”) and control decisions made in bankruptcy proceedings relating to borrowers.

In general, losses on an asset securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit, if any, and then by the “first loss” subordinated security holder and then by the “second loss” subordinated security holder. In the event of

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default and the exhaustion of any equity support, reserve fund, letter of credit and any classes of securities junior to those in which we invest, we will not be able to recover all of our investment in the securities we purchase. In addition, if the underlying mortgage portfolio has been overvalued by the originator, or if the values subsequently decline and, as a result, less collateral is available to satisfy interest and principal payments due on the related CMBS, the securities in which we invest may effectively become the “first loss” position behind the more senior securities, which may result in significant losses to us. The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments. A projection of an economic downturn, for example, could cause a decline in the price of lower credit quality securities because the ability of obligors of mortgages underlying CMBS to make principal and interest payments may be impaired. In such event, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities.

An economic downturn could increase the risk of loss on our investments in subordinated mortgage-backed securities. The prices of lower credit-quality securities, such as the subordinated mortgage-backed securities in which we invest, are generally less sensitive to interest rate changes than more highly rated investments, but are more sensitive to adverse economic downturns or individual property developments. An economic downturn or a projection of an economic downturn could cause a decline in the price of lower credit quality securities because the ability of obligors of mortgages underlying mortgage-backed securities to make principal and interest payments may be impaired. In such event, existing credit support to a securitized structure may be insufficient to protect us against loss of our principal on these securities.

We may enter into derivative contracts that could expose us to contingent liabilities in the future.

Subject to maintaining our qualification as a REIT, part of our investment strategy involves entering into derivative contracts that could require us to fund cash payments in the future under certain circumstances, e.g. , the early termination of the derivative agreement caused by an event of default or other early termination event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the derivative contract. The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. These economic losses will be reflected in our financial results of operations, and our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time, and the need to fund these obligations could adversely impact our financial condition.

Our investments in debt securities are subject to specific risks relating to the particular issuer of the securities and to the general risks of investing in subordinated real estate securities.

Our investments in debt securities involve special risks. REITs generally are required to invest substantially in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed herein. Our investments in debt are subject to the risks described above with respect to mortgage loans and CMBS and similar risks, including:

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risks of delinquency and foreclosure, and risks of loss in the event thereof;

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the dependence upon the successful operation of and net income from real property;

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risks generally incident to interests in real property; and

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risks that may be presented by the type and use of a particular commercial property.

Debt securities are generally unsecured and may also be subordinated to other obligations of the issuer. We may also invest in debt securities that are rated below investment grade. As a result, investments in debt securities are also subject to risks of:

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limited liquidity in the secondary trading market;

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substantial market price volatility resulting from changes in prevailing interest rates;

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subordination to the prior claims of banks and other senior lenders to the issuer;

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the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest premature redemption proceeds in lower yielding assets;

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the possibility that earnings of the debt security issuer may be insufficient to meet its debt service; and

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the declining creditworthiness and potential for insolvency of the issuer of such debt securities during periods of rising interest rates and economic downturn.

These risks may adversely affect the value of outstanding debt securities and the ability of the issuers thereof to repay principal and interest.

We may make investments in non-U.S. dollar denominated securities, which subject us to currency rate exposure and the uncertainty of foreign laws and markets.

We may purchase CMBS denominated in foreign currencies. We expect that our exposure, if any, would be principally to the British pound and the Euro. A change in foreign currency exchange rates may have an adverse impact on returns on our non-dollar denominated investments. Although we may hedge our foreign currency risk subject to the REIT income qualification tests, we may not be able to do so successfully and may incur losses on these investments as a result of exchange rate fluctuations. Investments in foreign countries also subject us to risks of multiple and conflicting tax laws and regulations and political and economic instability abroad, which could adversely affect our receipt of interest income on these investments.

The lack of liquidity in our investments may adversely affect our business.

We have made investments, and expect to make additional investments in securities that are not publicly traded. A portion of these securities may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. In addition, we may face other restrictions on our ability to liquidate an investment in a business entity to the extent that we could be attributed with material non-public information regarding such business entity.

Our due diligence may not reveal all of a borrower’s liabilities and may not reveal other weaknesses in its business.

Before investing in a company or making a loan to a borrower, we assess the strength and skills of such entity’s management and other factors that we believe are material to the performance of the investment. In making the assessment and otherwise conducting customary due diligence, we rely on the resources available to us and, in some cases, an investigation by third parties. This process is particularly important and subjective with respect to newly organized entities because there may be little or no information publicly available about the entities. There can be no assurance that our due diligence processes will uncover all relevant facts or that any investment will be successful.

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Risks Related To Our Trading

Our common stock has been delisted from the NYSE and we will shortly be ineligible to be traded on the OTCBB which would severely decrease its liquidity.

On November 4, 2008, the 30 trading-day average market capitalization of our common stock fell below $25 million, resulting in the permanent delisting of our common stock from the NYSE. On November 10, 2008, our common stock began trading through normal brokerage channels on the OTCBB. The OTCBB is an electronic, regulated quotation service that displays real-time quotes, last-sale prices, and volume information for over-the-counter equity securities issued by companies that are subject to periodic filing requirements with the SEC or other regulatory authority. However, if we deregister our common stock from the Exchange Act and suspend our obligation to file periodic reports with the SEC, our common stock will become ineligible to be traded on the OTCBB and will be forced to trade on Pink Sheets. While the trading of our common stock on the OTCBB or the Pink Sheets does not affect our business operations, the trading volume and liquidity of our common stock may be adversely impacted.

We have not established a minimum distribution and payment level and we cannot assure you of our ability to make distributions in the future.

We have not established a minimum distribution payment level, and our ability to make distributions may be adversely affected by the risk factors described herein. All distributions will be made at the discretion of our board of directors and will depend on our earnings, our financial condition, maintenance of our REIT status and other factors as our board of directors may deem relevant from time to time. We may not be able to make distributions in the future, or we may reduce our distributions as compared to historical levels; particularly if our revenues decline due to a reduction in our total assets from repayments, asset sales or credit losses. In addition, some of our distributions may include a return of capital. To the extent that we decide to make distributions in excess of our current and accumulated tax earnings and profits, such distributions would generally be considered a return of capital for federal income tax purposes. A return of capital is not taxable, but it has the effect of reducing the holder’s basis in its investment.

The market price and trading volume of our common stock may be volatile.

The market price of our common stock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. If the market price of our common stock declines significantly, you may be unable to resell your shares at or above the initial public offering price or the price you paid in the market. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include:

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actual or anticipated variations in our quarterly operating results or distributions;

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changes in our funds from operations or earnings estimates or publication of research reports about us or the real estate or specialty finance industry;

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increases in market interest rates that lead purchasers of our shares of common stock to demand a higher yield;

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changes in market valuations of similar companies;

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adverse market reaction to any increased indebtedness we incur in the future;

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additions or departures of our key personnel;

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actions by institutional stockholders;

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hostile merger and acquisition activities such as unsolicited hostile offers or dissident nomination of director slates;

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speculation in the press or investment community; and

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general market and economic conditions, including the current state of the credit and capital markets.

Broad market fluctuations could negatively impact the market price of our common stock.

The stock market has experienced extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to ours and that have been unrelated to these companies’ operating performances. These broad market fluctuations could reduce the market price of our common stock. Furthermore, our operating results and prospects may be below the expectations of public market analysts and investors or may be lower than those of companies with comparable market capitalizations, which could lead to a material decline in the market price of our common stock.

Future offerings of debt securities, which would rank senior to our common stock upon our liquidation, and future offerings of equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock.

In the future, we may attempt to increase our capital resources by making offerings of debt or additional offerings of equity securities. Upon liquidation, holders of our debt securities and shares of preferred stock, if any, and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Our preferred stock, if issued, could have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. Sales of substantial amounts of our common stock (including shares of our common stock issued pursuant to our incentive plan), or the perception that these sales could occur, could have a material adverse effect on the price of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.

Your interest in us may be diluted if we issue additional shares.

Existing stockholders do not have preemptive rights to any common stock issued by us in the future. Therefore, you may experience dilution of their equity investment if we sell additional common stock in the future, sell securities that are convertible into common stock or issue shares of common stock, including shares issued as incentive compensation under our management agreement, or options exercisable for shares of common stock.

Future sales of shares of our common stock may depress the price of our shares.

We cannot predict the effect, if any, of future sales of our common stock or the availability of shares for future sales on the market price of our common stock. Any sales of a substantial number of our shares in the public market, or the perception that sales might occur, may cause the market price of our shares to decline.

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An increase in market interest rates may have an adverse effect on the market price of our common stock.

One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is our distribution rate as a percentage of our share price relative to market interest rates. If the market price of our common stock is based primarily on the earnings and return that we derive from our investments and income with respect to our investments and our related distributions to stockholders, and not from the market value of the investments themselves, then interest rate fluctuations and capital market conditions will likely affect the market price of our common stock. For instance, if market rates rise without an increase in our distribution rate, the market price of our common stock could decrease as potential investors may require a higher distribution yield on our common stock or seek other securities paying higher distributions or interest. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and pay distributions.

Risks Related To Our Organization and Structure

Our charter and bylaws and the provisions of Maryland law contain provisions that may inhibit potential acquisition bids that you and other stockholders may consider favorable, and the market price of our common stock may be lower as a result.

Our charter and bylaws and the provisions of Maryland law contain provisions that may have an anti-takeover effect and inhibit a change in our board of directors. These provisions include the following:

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There are ownership limits and restrictions on transferability and ownership in our charter. In order to qualify as a REIT for each taxable year beginning after December 31, 2005, not more than 50% of the value of our outstanding stock may be owned, directly or constructively, by five or fewer individuals during the second half of any calendar year and our shares must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months or during a proportionate part of a shorter taxable year. Our charter generally prohibits any person from beneficially or constructively owning more than 9.8% by number or value, whichever is more restrictive, of our outstanding shares of common stock or more than 9.8% by number or value, whichever is more restrictive, of the outstanding shares of any class or series of our capital stock, subject to important exceptions. This restriction may:

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discourage a tender offer or other transactions or a change in the composition of our board of directors or control that might involve a premium price for our shares or otherwise be in the best interests of our stockholders; or

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result in shares issued or transferred in violation of such restrictions being automatically transferred to a trust for a charitable beneficiary and thereby resulting in a forfeiture of ownership of the additional shares.

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Our charter permits our board of directors to issue stock with terms that may discourage a third party from acquiring us. Our charter permits our board of directors to amend the charter without stockholder approval to increase the total number of authorized shares of stock or the number of shares of any class or series and to issue common or preferred stock, having preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications, or terms or conditions of redemption as determined by our board. Thus, our board could authorize the issuance of stock with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of our shares might receive a premium for their shares over the then-prevailing market price of our shares.

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Maryland Control Share Acquisition Act. Maryland law provides that “control shares” of a corporation acquired in a “control share acquisition” will have no voting rights except to the extent approved by a vote of two-thirds of the votes eligible to be cast on the matter under the Maryland Control Share Acquisition Act. “Control shares” means voting shares of stock that, if aggregated with all other shares of stock owned by the acquiror or in respect of which the acquiror is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power: one-tenth or more but less than one-third, one-third or more but less than a majority, or a majority or more of all voting power. A “control share acquisition” means the acquisition of control shares, subject to certain exceptions.

If voting rights or control shares acquired in a control share acquisition are not approved at a stockholders’ meeting or if the acquiring person does not deliver an acquiring person statement as required by the Maryland Control Share Acquisition Act, then subject to certain conditions and limitations, the issuer may redeem any or all of the control shares for fair value. If voting rights of such control shares are approved at a stockholders’ meeting and the acquiror becomes entitled to vote a majority of the shares of stock entitled to vote, all other stockholders may exercise appraisal rights. Our bylaws contain a provision exempting acquisitions of our shares from the Maryland Control Share Acquisition Act. However, our board of directors may amend our bylaws in the future to repeal or modify this exemption, in which case any control shares of our company acquired in a control share acquisition will be subject to the Maryland Control Share Acquisition Act.

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Business Combinations. Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as:

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any person who beneficially owns ten percent or more of the voting power of the corporation’s shares; or

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an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of ten percent or more of the voting power of the then outstanding voting stock of the corporation.

A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which such person otherwise would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board of directors.

After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:

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eighty percent of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and

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two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder.

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These super-majority vote requirements do not apply if the corporation’s common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares.

The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors prior to the time that the interested stockholder becomes an interested stockholder. Our board of directors has adopted a resolution which provides that any business combination between us and any other person is exempted from the provisions of the Act, provided, that the business combination is first approved by the board of directors. This resolution, however, may be altered or repealed in whole or in part at any time. If this resolution is repealed, or the board of directors does not otherwise approve a business combination, this statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.

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Our charter and bylaws contain other possible anti-takeover provisions. Our charter and bylaws contain other provisions that may have the effect of delaying, deferring or preventing a change in control of us or the removal of existing directors and, as a result, could prevent our stockholders from being paid a premium for their common stock over the then-prevailing market price.

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Maryland law allows a staggered board without a stockholder vote. Maryland law permits a public Maryland corporation that meets certain requirements to add certain anti-takeover provisions to its charter without a stockholders vote, including a classified or staggered board of directors.

Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit your recourse in the event of actions not in your best interests.

Our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:

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actual receipt of an improper benefit or profit in money, property or services; or

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a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.

In addition, our charter authorizes us to obligate our company to indemnify our present and former directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify each present or former director or officer, to the maximum extent permitted by Maryland law, in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service to us. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.

Our access to confidential information may restrict our ability to take action with respect to some investments, which, in turn, may negatively affect the potential return to stockholders.

We may obtain confidential information about the companies in which we have invested or may invest. If we do possess confidential information about such companies, there may be restrictions on the ability to dispose of, increase the amount of, or otherwise take action with respect to an investment in those companies. Our management of investment funds could create a conflict of interest to the extent we are aware of inside information concerning potential investment targets. We will implement compliance procedures and practices designed to ensure that inside information is not used for making investment decisions on behalf of the funds and to monitor funds invested. We cannot assure you, however, that these procedures and practices will be effective. In addition, this conflict and these procedures and practices may limit the freedom of us to make potentially profitable investments, which could have an adverse effect on our operations. These limitations imposed by access to confidential information could therefore negatively affect the potential market price of our common stock and the ability to distribute dividends.

Tax Risks

Complying with REIT requirements may cause us to forego otherwise attractive opportunities.

To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy various tests regarding the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. In order to meet these tests, we may be required to forego investments we might otherwise make. Thus, compliance with the REIT requirements may hinder our investment performance.

Our qualification as a REIT and exemption from U.S. federal income tax with respect to certain assets may be dependent on the accuracy of legal opinions rendered to or statements by the issuers of securities in which we invest.

When purchasing securities, we may rely on opinions of counsel for the issuer of such securities, or statements made in related offering documents, for purposes of determining whether such securities represent debt or equity securities for U.S. federal income tax purposes, and therefore to what extent those securities constitute REIT real estate assets for purposes of the REIT asset tests and produce income which qualifies under the 75% REIT gross income test. In addition, when purchasing CDO equity, we may rely on opinions of counsel regarding the qualification of the CDO for exemption from U.S. corporate income tax and the qualification of interests in such CDO as debt for U.S. federal income tax purposes. The inaccuracy of any such opinions or statements may adversely affect our REIT qualification and result in significant corporate-level tax.

Certain financing activities may subject us to U.S. federal income tax and increase the tax liability of our stockholders and limit the manner in which we effect securitizations.

We have and may continue to enter into transactions that will result in us or a portion of our assets being treated as a “taxable mortgage pool” for U.S. federal income tax purposes. Specifically, we have and may in the future continue to securitize whole loans, B Notes, mezzanine loans or CMBS assets that we acquire and such securitizations will likely result in us owning interests in a taxable mortgage pool. We have and may enter into such transactions at the REIT level. We are taxed at the highest corporate income tax rate on a portion of the income arising from a taxable mortgage pool that is allocable to the percentage of our stock held by “disqualified organizations,” which are generally certain cooperatives, governmental entities and tax-exempt organizations that are exempt from tax on unrelated business taxable income. To the extent that common stock owned by “disqualified organizations” is held in record name by a broker/dealer or other nominee, the broker/dealer or other nominee would be liable for the corporate level tax on the portion of our excess inclusion income allocable to the common stock held by the broker/dealer or other nominee on behalf of the “disqualified organizations.” We expect that disqualified organizations will own our shares. Because this tax would be imposed on us, all of our investors, including investors that are not disqualified organizations, would bear a portion of the tax cost associated with the classification of us or a portion of our assets as a taxable mortgage pool. A regulated investment company (“RIC”) or other pass-through entity owning our common stock in record name will be subject to tax at the highest corporate tax rate on any excess inclusion income allocated to their owners that are disqualified organizations.

In addition, if we realize excess inclusion income and allocate it to stockholders, this income cannot be offset by net operating losses of our stockholders. If the stockholder is a tax-exempt entity and not a disqualified organization, then this income would be fully taxable as unrelated business taxable income under Section 512

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of the Internal Revenue Code. If the stockholder is a foreign person, it would be subject to U.S. federal income tax withholding on this income without reduction or exemption pursuant to any otherwise applicable income tax treaty. If the stockholder is a REIT, RIC, common trust fund, or other pass-through entity its allocable share of our excess inclusion income could be considered excess inclusion income of such entity. Accordingly, such investors should be aware that a significant portion of our income may be considered excess inclusion income. Finally, if we fail to qualify as a REIT, our taxable mortgage pool securitizations will be treated as separate taxable corporations for U.S. federal income tax purposes.

Failure to qualify as a REIT would subject us to U.S. federal income tax, which would reduce the cash available for distribution to our stockholders.

We operate in a manner that is intended to cause us to qualify as a REIT for U.S. federal income tax purposes. However, the U.S. federal income tax laws governing REITs are extremely complex, and interpretations of the U.S. federal income tax laws governing qualification as a REIT are limited. Qualification as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. While we operate in such a way as to qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.

If we fail to qualify as a REIT in any calendar year and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income. We might need to borrow money or sell assets in order to pay that tax. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT and we do not qualify for certain statutory relief provisions, we no longer would be required to distribute substantially all of our net income to our stockholders. Unless our failure to qualify as a REIT were eligible for relief under U.S. federal tax laws, we could not re-elect to qualify as a REIT until the fifth calendar year following the year in which we failed to qualify.

Even if we qualify as a REIT for U.S. federal income tax purposes, we may be required to pay some federal, state and local taxes on our income or property and, in certain cases, a 100% penalty tax in the event we sell property, including mortgage loans, as a dealer or if a TRS of ours, including RFC TRS, Inc., enters into agreements with us on a basis that is determined to be other than an arm’s-length basis. In addition, any TRS we own, including RFC TRS, Inc., will be required to pay federal, state and local income taxes on its taxable income, including income from the sale of any loans that we do not hold in our portfolio, as well as an other applicable taxes.

Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our stockholders.

In order to qualify as a REIT, we must distribute to our stockholders, each calendar year, at least 90% of our net taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than the sum of:

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85% of our ordinary income for that year;

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95% of our capital gain net income for that year; and

•

100% our undistributed taxable income from prior years.

We intend to distribute our net taxable income to our stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax. However, there is no requirement that taxable REIT subsidiaries distribute their after-tax net income to their parent REIT or their stockholders and RFC TRS, Inc., our TRS, may determine not to make any distributions to us.

Our taxable income may substantially exceed our net income as determined based on generally accepted accounting principles, or GAAP, because, for example, realized capital losses will be deducted in determining our GAAP net income, but may not be deductible in computing our taxable income. In addition, we may invest in assets that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets, referred to as phantom income. For example, we may invest in debt instruments or notes whose face value may exceed its issue price as determined for U.S. federal income tax purposes (“original issue discount,” or OID), such that we will be required to include in our income a portion of the OID each year that the instrument is held before we receive any corresponding cash. Although some types of phantom income are excluded to the extent they exceed 5% of our REIT taxable income in determining the 90% distribution requirement, we will incur corporate income tax and the 4% nondeductible excise tax with respect to any phantom income items if we do not distribute those items on an annual basis. As a result of the foregoing, we may generate less cash flow than taxable income in a particular year. In that event, we may be required to use cash reserves, incur debt, or liquidate non-cash assets at rates or times that we regard as unfavorable in order to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax in that year.

Dividends payable by REITs do not qualify for the reduced tax rates.

Tax legislation enacted in 2003 reduced the maximum U.S. federal tax rate on certain corporate dividends paid to individuals and other non-corporate taxpayers to 15% (through 2010). Dividends paid by REITs to these stockholders are generally not eligible for these reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to non-REIT corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.

Liquidation of assets may jeopardize our REIT qualification.

To continue to qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our mortgage loan and preferred equity investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.

The stock ownership diversification rules applicable to REITs under the Internal Revenue Code and the stock ownership limitation imposed by our charter may inhibit market activity in our common stock and may restrict our business combination opportunities in which our stockholders might receive a premium for their shares.

In order for us to qualify as a REIT for each taxable year beginning after December 31, 2005, no more than 50% in value of our outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals at any time during the last half of any calendar year. “Individuals” for this purpose include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. Our charter generally prohibits any person from directly or indirectly owning more than 9.8% by number or value, whichever is more restrictive, of our outstanding shares of common stock or more than 9.8% by number or value, whichever is more restrictive, of the outstanding shares of any class or series of our capital stock, subject to important exceptions.

This ownership limitation could have the effect of discouraging a takeover or other transaction in which holders of our common stock might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests.

- 28 -

Our ownership of and relationship with our TRS is limited and a failure to comply with the limits may jeopardize our REIT qualification and may result in the application of a 100% excise tax.

A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 25% (20% for tax years commencing before January 1, 2009) of the value of a REIT’s assets may consist of stock or securities of one or more TRSs. A TRS will pay federal, state and local income tax at regular corporate rates on any net taxable income that it earns. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.

Our TRS, RFC TRS, Inc., will pay federal, state and local income tax on its taxable income, and its after-tax net income is available for distribution to us but is not required to be distributed to us. The aggregate value of the TRS stock and securities owned by us will be less than 25% (20% for tax years commencing before January 1, 2009) of the value of our attractive total assets (including the TRS stock and securities). Furthermore, we will monitor the value of our investments in TRSs for the purpose of ensuring compliance with the rule that no more than 25% (20% for tax years commencing before January 1, 2009) of the value of our assets may consist of TRS stock and securities (which is applied at the close of each calendar quarter). In addition, we scrutinize all of our transactions with TRSs for the purpose of ensuring that they are entered into on arm’s-length terms in order to avoid incurring the 100% excise tax described above. The value of the securities of that we hold in our TRSs may not be subject to precise valuation. Accordingly, there can be no complete assurance that we will be able to comply with the 25% (or 20%) limitation discussed above or to avoid application of the 100% excise tax discussed above.

Complying with REIT requirements may limit our ability to hedge effectively.

The REIT provisions of the Internal Revenue Code limit our ability to hedge our investments. Except to the extent provided by Treasury regulations, (i) for transactions entered into on or prior to July 30, 2008, any income from a hedging transaction we enter into in the normal course of our business primarily to manage risk of interest rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, to acquire or carry real estate assets, including gain from the sale or disposition of such a transaction, will not constitute gross income for purposes of the 95% gross income test (and will generally constitute non-qualifying income for purposes of the 75% gross income test) and (ii) for transactions entered into after July 30, 2008, any income from a hedging transaction where the instrument hedges interest rate risk on liabilities used to carry or acquire real estate or hedges risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the REIT 75% or 95% gross income tests will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests. To qualify under either (i) or (ii) of the preceding sentence, the hedging transaction must be clearly identified as specified in Treasury regulations before the close of the day on which it was acquired, originated or entered into. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result, we might have to limit our use of advantageous hedging techniques or implement those hedges through RFC TRS, Inc. This could increase the cost of our hedging activities or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear.

The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing mortgage loans, that would be treated as sales for U.S. federal income tax purposes.

A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to sell or securitize loans in a manner that was treated as a sale of the loans for U.S. federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans and may limit the structures we utilize for our securitization transactions even though such sales or structures might otherwise be beneficial for us.

It may be possible to reduce the impact of the prohibited transaction tax and the holding of assets not qualifying as real estate assets for purposes of the REIT asset tests by conducting certain activities, holding non-qualifying REIT assets or engaging in CDO transactions through our TRSs, subject to certain limitations as described below. To the extent that we engage in such activities through TRSs, the income associated with such activities may be subject to full corporate income tax.

We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our common stock.

At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation.

If we make distributions in excess of our current and accumulated earnings and profits, those distributions will be treated as a return of capital, which will reduce the adjusted basis of your stock, and to the extent such distributions exceed your adjusted basis, you may recognize a capital gain.

Unless you are a tax-exempt entity, distributions that we make to you generally will be subject to tax as ordinary income to the extent of our current and accumulated earnings and profits as determined for U.S. federal income tax purposes. If the amount we distribute to you exceeds your allocable share of our current and accumulated earnings and profits, the excess will be treated as a return of capital to the extent of your adjusted basis in your stock, which will reduce your basis in your stock but will not be subject to tax. To the extent the amount we distribute to you exceeds both your allocable share of our current and accumulated earnings and profits and your adjusted basis, this excess amount will be treated as a gain from the sale or exchange of a capital asset.

Forward-Looking Information

This report includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act. In some cases, you can identify forward looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “project,” “should,” “will” and “would” or the negative of these terms or other comparable terminology.

The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks along with the following factors that could cause actual results to vary from our forward-looking statements:

•

our future operating results;

- 29 -

•

our business operations and prospects;

•

general volatility of the securities markets in which we invest and the market price of our common stock;

•

changes in our business strategy;

•

the effect of trading on the OTCBB and/or the Pink Sheets;

•

availability, terms and deployment of short-term and long-term capital;

•

availability and retention of qualified personnel;

•

our ability to effectively internalize the management function of our business and operate as an internally managed company;

•

changes in our industry, interest rates, the debt securities, credit and capital markets, the general economy or the commercial finance and real estate markets specifically;

•

unanticipated increases in financing and other costs, including a rise in interest rates, or requirements for additional collateral;

•

the cost of our capital, which depends in part on our asset quality, the nature of our relationships with our lenders and other capital providers, our business prospects and outlook and general market conditions;

•

increased rates of default and/or decreased recovery rates on our investments;

•

our ability to satisfy complex rules in order for us to qualify as a REIT for U.S. federal income tax purposes and qualify for our exemption under the Investment Company Act of 1940, as amended, and the ability of certain of our subsidiaries to qualify as REITs and certain our subsidiaries to qualify as taxable REIT subsidiaries for U.S federal income tax purposes, and our ability and the ability of our subsidiary to operate effectively with the limitations imposed by these rules;

•

risk of structured finance investments;

•

the performance and financial condition of borrowers and corporate customers;

•

legislative and regulatory changes (including changes to laws governing the taxation of REITs or the exemptions from registration as an investment company);

•

increased prepayments of the mortgage and other loans underlying the company’s investments;

•

status of the class action lawsuit;

•

potential derivative stockholder claims and any future litigation that may arise;

•

the ultimate resolution of our six non-performing loans totaling $128.4 million and our three watch list loans totaling $75.5 million;

•

the monetization of our joint venture investments;

•

availability of investment opportunities in real estate-related and other securities;

•

the degree and nature of our competition;

•

the ability to come back into compliance with the covenants under CDO I;

•

the ability to maintain compliance with the covenants under CDO II;

•

whether the company remains as collateral manager of CDO II;

•

working capital;

•

the timing of cash flows, if any, from our investment;

•

available liquidity;

•

other factors, which are beyond the company’s control; and

•

other factors discussed under the heading “Risk Factors” in our Annual Report on form 10-K for the year ended December 31, 2008.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of future events, new information or otherwise.

The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None.

ITEM 2.

PROPERTIES

Our principal office is located at City Place 1, 185 Asylum Street, 31st Floor, Hartford, CT 06103 and our telephone number is (860) 275-6200. We believe that our office facilities are suitable and adequate for our business as it is conducted. Our website is located at http://www.realtyfinancecorp.com . The information found on, or otherwise accessible through, our website is not incorporated into, and does not form a part of, this annual report or any other report or document we file with or furnish to the SEC.

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ITEM 3.

LEGAL PROCEEDINGS

On October 30, 2007, a putative class action lawsuit was commenced in the United States District Court for the District of Connecticut against our company, our former chief financial officer and our former chief executive officer seeking remedies under the Securities Act of 1933, as amended. Amended complaints filed on March 25, 2008 and May 6, 2008 added our chairman and the underwriters that participated in our October 2006 initial public offering as additional defendants. The underwriters have since been dropped from the suit by voluntary dismissal filed by the plaintiffs with the court in December 2008. The plaintiffs allege that the registration statement and prospectus relating to the initial public offering contained material misstatements and material omissions. Specifically, the plaintiffs allege that management had knowledge of certain loan impairments and did not properly disclose or record such impairments in the financial statements. The plaintiffs seek to represent a class of all persons who purchased or otherwise acquired common stock that is traceable to our initial public offering in September 2006 and seek damages in an unspecified amount. On July 29, 2008, we filed a Motion to Dismiss the putative class action suit with the federal district court for the District of Connecticut. Following oral arguments in November 2008, the plaintiffs filed a second amended complaint on December 22, 2008 and voluntarily dismissed the action against the underwriters. We have since filed a revised Motion to Dismiss the second amended complaint, and are awaiting the court’s ruling on that motion.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock began trading on the NYSE on September 27, 2006 under the symbol “CBF.” On November 4, 2008, the 30 trading-day average market capitalization of our common stock fell below $25 million, resulting in the permanent delisting of our common stock from the New York Stock Exchange. On November 10, 2008, our common stock began trading through normal brokerage channels on the OTCBB. The OTCBB is an electronic, regulated quotation service that displays real-time quotes, last-sale prices, and volume information for over-the-counter equity securities issued by companies that are subject to periodic filing requirements with the SEC or other regulatory authority. While the trading on our common stock on the OTCBB does not affect our business operations, the trading volume and liquidity of our common stock may be adversely impacted.

As of March 10, 2009, the reported closing sale price per share of common stock on the OTCBB was $0.06 and we had 30,936,533 shares of our common stock issued and outstanding held by approximately 32 holders of record. The table below sets forth the quarterly high and low closing sales prices of our common stock on the NYSE and OTCBB since our initial public offering and the distributions paid by us with respect to the periods indicated.

NYSE


Quarter/Period Ended	High		Low
September 30, 2006	$	15.60	$	14.50
December 31, 2006	$	18.39	$	14.70
March 31, 2007	$	16.86	$	12.88
June 30, 2007	$	13.49	$	11.89
September 30, 2007	$	12.69	$	4.25
December 31, 2007	$	7.37	$	3.78
March 31, 2008	$	6.27	$	3.00
June 30, 2008	$	4.50	$	3.44
September 30, 2008	$	3.64	$	0.91
October 1, 2008 – November 7, 2008	$	1.20	$	0.38

OTCBB

Period Ended	High		Low
November 10, 2008 – December 31, 2008	$	0.44	$	0.11

There had been no public trading market for our common stock prior to our October 2006 initial public offering. Shares of our common stock issued to qualified institutional buyers in connection with our June 2005 private offering were eligible for trading in the PORTAL (SM) Market, or PORTAL, a subsidiary of the NASDAQ Stock Market, Inc., which permits secondary sales of eligible unregistered securities to qualified institutional buyers in accordance with Rule 144A under the Securities Act. From June 9, 2005 through September 27, 2006, the high and low sales prices for our common stock was $15.00 per share.

Distributions

We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended on December 31, 2005. U.S. federal income tax law requires that a REIT distribute with respect to each year at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gain. We will not be required to make distributions with respect to income derived from the activities conducted through RFC TRS, Inc., our TRS, that are not distributed to us. To the extent our TRS’s income is not distributed and is instead reinvested in the operations of our TRS, the value of our equity interest in our TRS will increase. The aggregate value of the securities that we hold in our TRS may not exceed 20% of the total value of our gross assets. Distributions from our TRS to us will qualify for the 95% gross income test, but will not qualify for the 75% gross income test. Therefore, distributions from our TRS to us in no event will exceed 25% of our gross income with respect to any given taxable year.

To satisfy the requirements to qualify as a REIT and generally not be subject to U.S. federal income and excise tax, we intend to make regular quarterly distributions of all or substantially all of our net income to holders of our common stock out of assets legally available. Any future distributions we make will be at the discretion of our board of directors and will depend upon our earnings and financial condition, maintenance of REIT qualification, applicable provisions of the Maryland General Corporation Law, and such other factors as our board of directors deems relevant.

The following table shows the distributions declared in 2006, 2007 and 2008:


Record Date	Payment Date	Cash Distribution Declared per Share
April 14, 2006	April 25, 2006	$	0.17
June 30, 2006	July 17, 2006	$	0.18
September 18, 2006	October 11, 2006	$	0.28
December 29, 2006	January 16, 2007	$	0.19
March 30, 2007	April 16, 2007	$	0.21
June 29, 2007	July 16, 2007	$	0.21
September 28, 2007	October 15, 2007	$	0.17
December 31, 2007	January 15, 2008	$	0.21
March 31, 2008	April 14, 2008	$	0.15
June 30, 2008	July 17, 2008	$	0.10
September 30, 2008	October 17, 2008	$	0.05

On December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to maintain our financial flexibility.

To the extent that our cash available for distribution is less than 90% of our REIT taxable income, we may consider various funding sources to cover any such shortfall, including borrowings, selling certain of our assets or future offerings. Our distribution policy enables us to review the alternative funding sources available to us from time to time.

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The following table summarizes information, as of December 31, 2008, relating to our equity compensation plans pursuant to which shares of our common stock or other equity securities may be granted from time to time.


Plan category	(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(b) Weighted average exercise price of outstanding options, warrants and rights		(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders⁽¹⁾	855,868	$	14.37	165,416
Equity compensation plans not approved by security holders	N/A		N/A	N/A
Total	855,868	$	14.37	165,416

⁽¹⁾	Includes information related to our 2005 equity incentive plan.

Recent Sales of Unregistered Securities

We issued 0, 357,700 and 134,000 shares of our common stock in 2008, 2007 and 2006, respectively, for stock-based compensation in connection with our 2005 equity incentive plan. We also issued options to purchase shares of 0, 136,000 and 95,400 shares of our common stock in 2008, 2007 and 2006, respectively. The options have a term of five years from the date of grant and become exercisable in three equal annual installments beginning on the first anniversary of the date of the grant. These transactions were not registered under the Securities Act of 1933, as amended, pursuant to the exemption contemplated by Section 4(2) thereof for transactions not involving a public offering.

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ITEM 6.

SELECTED FINANCIAL DATA

Summary Consolidated Financial Information

The following table presents summary consolidated financial information for the year ended December 31, 2008, 2007, 2006 and for the period May 10 (inception) through December 31, 2005. Since the information presented below is only a summary and does not provide all of the information contained in our historical consolidated financial statements, including the related notes, you should read it in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements, including the related notes, included in Item 8.


	For the Year Ended December 31, 2008			For the Year Ended December 31, 2007			For the Year Ended December 31, 2006			For the Period May 10, 2005 (inception) through December 31, 2005
	(in thousands, except per share and share data)
Revenues:
Investment income	$	100,522		$	129,416		$	64,631		$	9,342
Property operating income		4,439			4,005			3,076			—
Other income		976			4,609			3,322			3,057

Total revenues		105,937			138,030			71,029			12,399

Expenses:
Interest expense		82,036			92,157			40,546			2,664
Management fees		5,059			7,695			6,515			3,158
Property operating expenses		3,270			2,662			1,685			—
Other general and administrative expenses (including $770, $1,292, $3,867 and $1,770, respectively, of stock-based compensation)		16,478			9,351			10,404			5,549
Depreciation and amortization		1,121			1,398			529			—
Provision for loan losses		126,504			19,650			—			—
Loss on impairment of assets		5,966			7,764			—			—

Total expenses		240,434			140,677			59,679			11,371

Gain (loss) on sale of investment		(2,021	)		(500	)		258			—
Gain (loss) on financial instruments		20,834			(1,668	)		3,634			24

Income (loss) from continuing operations before equity in net loss of unconsolidated joint ventures and discontinued operations		(115,684	)		(4,815	)		15,242			1,052
Equity in net loss of unconsolidated joint ventures		(39,863	)		(5,721	)		(453	)		—

Income (loss) before minority interest and discontinued operations		(155,547	)		(10,536	)		14,789			1,052
Minority interest		(689	)		(132	)		(75	)		—

Income (loss) from continuing operations		(154,858	)		(10,404	)		14,864			1,052


Discontinued operations
Operating results from discontinued operations		(2,896	)		(5,633	)		(1,121	)		—
Loss on impairment of asset held for sale		(6,057	)		(54,729	)		—			—
Gain on sale of investment		6,780			—			—			—

Loss from discontinued operations		(2,173	)		(60,362	)		(1,121	)		—

Net income (loss)	$	(157,031	)	$	(70,766	)	$	13,743		$	1,052

Basic earnings per share
Income (loss) from continuing operations	$	(5.07	)	$	(0.34	)	$	0.66		$	0.05
Loss from discontinued operations		(0.07	)		(1.99	)		(0.05	)		—
Net income (loss)	$	(5.14	)	$	(2.33	)	$	0.61		$	0.05
Diluted earnings per share
Income (loss) from continuing operations	$	(5.07	)	$	(0.34	)	$	0.65		$	0.05
Loss from discontinued operations		(0.07	)		(1.99	)		(0.05	)		—
Net income (loss)	$	(5.14	)	$	(2.33	)	$	0.60		$	0.05
Weighted average shares of common stock outstanding
Basic weighted average common shares outstanding		30,553			30,287			22,688			20,000
Diluted weighted average common shares and common share equivalents outstanding		30,553			30,287			22,837			20,108
Dividends per common share	$	0.30		$	0.80		$	0.82		$	0.19

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	As of December 31, 2008			As of December 31, 2007		As of December 31, 2006		As of December 31, 2005
	(in thousands)
Consolidated Balance Sheet Data:
Cash and equivalents	$	23,133		$	25,954	$	17,933	$	49,377
Total investments, net⁽¹⁾	$	1,234,584		$	1,664,210	$	1,369,609	$	538,068
Total assets	$	1,402,943		$	2,069,299	$	1,522,689	$	623,718
Debt-repurchase obligations	$	—		$	144,183	$	433,438	$	304,825
Mortgages payable	$	54,964		$	54,899	$	52,194	$	25,001
Junior subordinated deferrable interest debentures held by trusts that issued trust preferred securities (at fair value in 2008 only)	$	8,375		$	50,000	$	50,000	$	—
Bonds payable ($124,292 at fair value in 2008 only)	$	949,292		$	1,339,500	$	508,500	$	—
Total liabilities	$	1,184,535		$	1,855,820	$	1,110,006	$	343,651
Minority interest	$	(21	)	$	663	$	813	$	436
Stockholders’ equity	$	218,429		$	212,816	$	411,870	$	279,631

⁽¹⁾	Includes (i) loans and other lending investments, net (ii) commercial mortgage backed securities, (iii) investments in unconsolidated joint ventures, (iv) real estate, net and (v) our two consolidated VIEs, with assets and liabilities reported on a net basis.

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ITEM 7.

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

Overview

On November 4, 2008, the 30 trading-day average market capitalization of our common stock fell below $25 million, resulting in the permanent delisting of our common stock from the New York Stock Exchange, or NYSE. Our common stock has since been traded through normal brokerage channels on the OTC Bulletin Board, or the OTCBB. The OTCBB is an electronic, regulated quotation service that displays real-time quotes, last-sale prices, and volume information for over-the-counter equity securities issued by companies that are subject to periodic filing requirements with the Securities and Exchange Commission, or the SEC, or other regulatory authority.

On December 8, 2008, the NYSE filed a Form 25 with the SEC to delist our common stock from trading on the NYSE and to deregister our common stock under the Securities and Exchange Act of 1934, as amended, or the Exchange Act, which became effective on March 9, 2009. Given that we have fewer than 300 holders of record of our common stock, we voluntarily choose to become a non-reporting company, which would suspend our obligation to file periodic reports with the SEC pursuant to the Exchange Act. Our board of directors has elected to file Form 15 with the SEC on or around March 16, 2009 to effectuate this change. Eliminating our requirement to make further SEC filings will permit us to reduce expenses associated with compliance efforts as well as listing fees, professional fees, insurance and other administrative costs. Currently, we do not believe the benefits of being a periodic reporting company and continuing to make SEC filings justify these significant costs. Upon the filing of the Form 15, we will no longer be obligated to file periodic reports with the SEC, including Forms 10-K, 10-Q and 8-K. As a result, management anticipates that our shares of common stock will not be eligible to be traded on the OTCBB and will instead be traded on the Pink OTC Markets, or the Pink Sheets. However, we can make no assurances that any broker will make a market in our common stock. The Pink Sheets is a centralized quotation service that collects and publishes market maker quotes in real time, primarily through its web site, http://www.pinksheets.com. We intend to continue to release unaudited quarterly earnings reports and audited annual financial statements by posting information on our website as well as on the OTC Disclosure and News Service.

During 2008, the global capital markets continued to experience tremendous volatility and a wide-ranging lack of liquidity. The impact of the global credit crisis on our sector has been acute. Transaction volume has declined significantly, credit spreads for all forms of mortgage debt have reached all-time highs, issuance levels of commercial mortgage backed securities, or CMBS, have ground to a halt, and other forms of financing from the debt markets have been dramatically curtailed. Financial institutions still hold significant inventories of unsold loans and CMBS, creating a further overhang on the markets. The continuing dislocation in the debt capital markets, coupled with a slowdown in the U.S. economy, has already reduced property valuations and is impacting real estate fundamentals. These developments can and have impacted the performance of our existing portfolio of assets. Furthermore, the volatility in the capital markets has caused stress to all financial institutions and, our business is dependent upon these counterparties for, among other things, financing and interest rate derivatives. As we await the credit and capital markets to improve and stabilize, our primary focus has been securing our liquidity by paying down and terminating outstanding short-term repurchase agreements and managing our existing portfolio of assets to minimize credit risks where possible. The current credit and capital market environment remains unstable and we continue to review and analyze the impact on potential avenues of liquidity. We expect credit and capital market conditions to continue to be challenging throughout 2009 and into 2010.

During 2008, we undertook a process of evaluating strategic and operational initiatives assisted by our financial advisor, Goldman Sachs & Co., or Goldman Sachs. Based on the continued decline in the capital and credit markets which has had a severe adverse impact on our valuations and our ability to obtain financing, management concluded that a sale of our company, merger or other business combination, capital investment or other strategic alternatives at the present time was either not available or was not in the best interest of stockholders. We will continue to explore and evaluate future opportunities as they present themselves, however, our primary focus will remain on maximizing the value of our current $1.2 billion investment portfolio and non-recourse long-term financing in place through our two CDOs. As a result of the rapidly changing and evolving markets that continue to create challenges in our industry and in the general economy, we are experiencing the following: (i) no loan originations or other investment activity, (ii) lower operating margins due to lack of scale, (iii) reduced access to capital, if at all, and if such capital is available at significantly increased costs (iv) an increase in non-performing loans and watch list assets, (v) reduced operating cash flows due to breach of CDO covenants and a reduced asset base, and (vi) reduced cash available for distribution to stockholders, particularly as our portfolio is reduced by scheduled maturities, prepayments and non-performing loans. Our $1.2 billion investment portfolio has decreased by approximately 26% from December 31, 2007 based on these factors. On December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to increase our liquidity and maintain our financial flexibility.

As we continue to assess the impact of the credit and capital markets on our long-term business strategy, we have been focused on actively managing our existing investment portfolio. As of December 31, 2008, the net carrying value of our investments was approximately $1.2 billion, including origination costs and fees and net of repayments and sales of partial interests in loans and CMBS, with a weighted average spread to 30-day LIBOR of 311 basis points for our floating rate investments and a weighted average yield of 7.12% for our fixed rate investments. Our portfolio is comprised solely of commercial real estate debt and equity investments with no sub-prime exposure. We have long-term financing in place through our first CDO issuance, which provides approximately $508.5 million of

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financing with an average cost of 30-day LIBOR plus 50.6 basis points and our second CDO issuance which provides $853.2 million of financing with an average cost of 90-day LIBOR plus 40.6 basis points. Our CDOs contain reinvestment periods of five years during which we can use the proceeds of loan repayments to fund new investments. As of December 31, 2008, we had approximately 2.3 years and 3.3 years remaining in our reinvestment period for our first and second CDO, respectively. Reinvestment is not permitted during periods that we are not in compliance with our CDO covenants.

Due to continued market turbulence, we do not anticipate having the ability in the near term to access equity capital through public or private markets or debt capital through warehouse lines, new CDO issuances, or new trust preferred issuances. We continue to explore equity and other capital raising options as well as other strategic alternatives as they present themselves; however, in the event we are not able to successfully secure financing, we will rely on existing cash on hand, cash flows from operations, principal payments on our investments, and proceeds from asset and loan sales if any, to satisfy these requirements. If we (i) are unable to renew, replace or expand our sources of financing, (ii) are unable to execute asset and loan sales in a timely manner or to receive anticipated proceeds therefrom or (iii) fully utilize available cash, it may have an adverse effect on our business, results of operations and ability to make distributions to our stockholders.

The majority of our investments are pledged as collateral for our CDO bonds and the income generated from these investments is used to fund interest obligations of our CDO bonds and the remaining income, if any, is retained by us. Our CDO bonds contain interest coverage and asset overcollateralization covenants that must be met in order for us to receive such payments. If we fail our interest coverage or asset overcollateralization covenants in either of our CDOs, all cash flows from the CDOs (including interest on the bonds we own, distributions on our common and preferred equity and our subordinate management fees) would be diverted to repay principal and interest on the outstanding CDO bonds and we would not receive any residual payments until the CDO was back in compliance with such tests. We were in compliance with all such covenants as of December 31, 2008. In the event of a breach of our CDO covenants that we could not cure in the near term, we would be required to fund interest on trust preferred securities and other expenses (including compensation expenses) through (i) cash on hand, (ii) income from any CDO not in default, (iii) sale of unencumbered assets or (iv) accessing debt or equity capital markets, if available. We have the ability to cure defaults, which would resume normal payments to us, by purchasing non-performing loans out of our CDOs. However, we may not have sufficient liquidity available to do so at such time. In some cases, collateral may be continuing to pay interest but may be considered a defaulted interest for the purpose of the covenant calculations, such as our CMBS in our 2006 CDO, or CDO I, which are considered defaulted interests for the purpose of covenant calculation if any rating agency downgrade occurs. To the extent noncompliance continues for an extended period of time, our ability to continue as a going concern may be jeopardized. At December 31 2008, our most restrictive covenants on our CDOs had an interest coverage ratio of 2.21x and 1.22x for CDO I and CDO II, respectively, compared to minimum requirements of 1.21x and 1.09x. At December 31, 2008, our most restrictive covenants on our CDOs had an asset overcollateralization ratio of 1.15x and 1.10x for CDO I and our 2007 CDO, or CDO II, respectively, compared to minimum requirements of 1.12x and 1.10x. If we experience an additional $15,050 or $500 in reductions of collateral in CDO I or CDO II, respectively, due to further investment losses or other factors, we will fail the overcollateralization test for the respective CDO.

On February 25, 2009, we were notified by the CDO I trustee that we failed the overcollateralization test for CDO I on the February 25, 2009 payment date and, as a result, future net cash flows from CDO I, including approximately $488,000 due on the February 25, 2009 payment date, will be diverted to pay down principal of senior bond holders rather than being paid to us until such time the covenant is back in compliance, if ever. As of February 27, 2009, CDO II was in compliance with the overcollateralization test, however, if an additional $0.5 million in defaults occur, CDO II will also breach the overcollateralization covenant. Management believes it is likely that CDO II will fail the overcollateralization test at some point in 2009, which will result in the cash flows of CDO II being diverted to pay down principal of senior bond holders, eliminating residual cash inflows paid to us. With both CDOs out of compliance with overcollateralization covenants, we will have minimal incoming cash flows from our primary business and there is no assurance when or if we will be able to regain compliance with these covenants. As discussed further in “—Related Party Transactions,” the breach of the overcollateralization covenant in either CDO provides MBIA Insurance Corporation, or MBIA, the controlling class of CDO II bondholders, the ability to terminate the existing collateral management agreement, as amended, and to remove us as the collateral manager of CDO II. We have incurred significant losses since our inception and may incur additional losses in the future as we continue to navigate the difficult issues in the credit and real estate markets. With minimal incoming cash flows, management’s plans to fulfill short-term capital requirements include (i) use of $23.1 million of cash on hand as of December 31, 2008 to fund operating expenses, (ii) senior collateral management fees, (iii) reduction in administrative costs, as a result of becoming a non-reporting company, (iv) reduction in employee headcount, and (v) sale of our unencumbered 1515 Market Street LLC joint venture interest, if possible under current market conditions. We believe these sources of funds will be sufficient to meet our liquidity requirements for at least the next 12 months. We continue to seek and explore partnerships and new business opportunities; however, there is no assurance that such partnerships or business opportunities will be available on favorable terms or at all.

As of December 31, 2008, our investment portfolio of approximately $1.2 billion in assets, including origination costs and fees, and net of repayments and sales of partial interests in loans, consisted of the following:


							Weighted Average
Security Description	Carrying Value			Number of Investments	Percent of Total Investments		Coupon		Yield to Maturity		LTV
	(In thousands)
Whole loans⁽¹⁾	$	843,934		38	61.3	%	5.28	%	5.09	%	72	%
B Notes		218,427		11	15.9	%	5.42	%	5.76	%	52	%
Mezzanine loans		247,437		12	18.0	%	6.36	%	6.38	%	53	%
CMBS		54,620		67	4.0	%	4.76	%	7.20	%	—
Joint venture investments⁽²⁾		11,231		7	0.8	%	—		—		—

Total investments		1,375,649		135	100.0	%
Loan loss reserve		(141,065	)

Total investments, net	$	1,234,584

⁽¹⁾	Includes originated whole loans, acquired whole loans and bridge loans.

⁽²⁾	Includes our equity investment in two limited liability companies which are deemed to be VIEs and which we consolidate in our financial statements because we are deemed to be the primary beneficiary of these VIEs under FIN 46R.

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Outlook

Our historical business strategy of originating and acquiring investments is affected by general U.S. commercial real estate fundamentals and the overall U.S. economic environment. Further, our strategy is influenced by the specific characteristics of the underlying real estate assets that serve as collateral for our investments. We have designed our strategy to be flexible so that we can adjust our investment activities and portfolio weightings given changes in the U.S. commercial real estate capital and property markets and the U.S. economy.

Beginning in the third quarter of 2007, the global economy was impacted by the deterioration of the U.S. sub-prime residential mortgage market and the weakening of the U.S. housing markets, both of which have become much worse than many economists had predicted. The significant increase in the foreclosure activity and rising interest rates in mid-2007 depressed housing prices further as problems in the sub-prime markets spread to the other mortgage markets. The well-publicized problems in the residential markets spread to other financial markets, causing corporate credit spreads (or cost of funds) to widen dramatically. Banks and other lending institutions started to tighten lending standards and restrict credit. The structured credit markets, including the CMBS and CDO markets, have seized up as investors have shunned the asset class due to sub-prime and transparency worries. In particular, the short-term, three to five year floating rate debt market has effectively shut down and as the turmoil continues to spread, almost all fixed income capital markets have been negatively impacted and liquidity in these markets remains severely limited. While delinquencies in the commercial real estate markets remain low, the lack of liquidity in the CMBS and other commercial mortgage markets is negatively impacting sales and financing activity. We are unable to predict how long these trends will continue and what long-term impact they may have on the market.

Even if legislative or regulatory initiatives or other efforts successfully stabilize and add liquidity to the financial markets, we likely will need to modify our strategies, businesses or operations, and we may incur increased capital requirements and constraints or additional costs in order to satisfy new regulatory requirements or to compete in a changed business environment. It is uncertain what effects recently enacted or future legislation or regulatory initiatives will have on us. Given the volatile nature of the current market disruption and the uncertainties underlying efforts to mitigate or reverse the disruption, we may not timely anticipate or manage existing, new or additional risks, contingencies or developments, including regulatory developments and trends in new products and services, in the current or future environment. Our failure to do so could materially and adversely affect our business, financial condition, results of operations and prospects.

During 2008, the global capital markets continued to experience tremendous volatility and a wide-ranging lack of liquidity. The impact of the global credit crisis on our sector has been acute. Transaction volume has declined significantly, credit spreads for all forms of mortgage debt have reached all-time highs, issuance levels of CMBS have ground to a halt, and other forms of financing from the debt markets have been dramatically curtailed. Financial institutions still hold significant inventories of unsold loans and CMBS, creating a further overhang on the markets. We believe that the continuing dislocation in the debt capital markets, coupled with a slowdown in the U.S. economy, has already reduced property valuations and is impacting real estate fundamentals. These developments can impact and have impacted the performance of our existing portfolio of assets. Furthermore, the volatility in the capital markets has caused stress to all financial institutions and, our business is dependent upon these counterparties for, among other things, financing and interest rate derivatives. As we await the credit and capital markets to improve and stabilize, our primary focus has been securing our liquidity by paying down and terminating outstanding short-term repurchase agreements and managing our existing portfolio of assets to minimize credit risks where possible. The current credit and capital market environment remains unstable and we continue to review and analyze the impact on potential avenues of liquidity. We expect credit and capital market conditions to continue to be challenging throughout 2009.

During 2008, we undertook a process of evaluating strategic and operational initiatives with Goldman Sachs. Based on the continued decline in the capital and credit markets which has had a severe adverse impact on our valuations and our ability to obtain financing, management concluded that a sale of our company, merger or other business combination, capital investment or other strategic alternatives at the present time was either not available or was not in the best interest of stockholders. We will continue to explore and evaluate future opportunities as they present themselves, however, our primary focus will remain on maximizing the value of our current $1.2 billion investment portfolio and non-recourse long-term financing in place through our two CDOs.

In the short-term, we believe the current environment of rapidly changing and evolving markets will provide increasing challenges to our industry, our company and the general economy. Due to the uncertainties in the capital and credit markets, we are experiencing the following: (i) no loan originations or other investment activity, (ii) lower operating margins due to lack of scale, (iii) reduced access to capital, if at all, and if such capital is available at significantly increased costs, (iv) an increase in non-performing loans and watch list assets, (v) reduced operating cash flows due to breach of CDO covenants and (vi) reduced cash available for distribution to stockholders, particularly as our portfolio is reduced by scheduled maturities, prepayments and non-performing loans. Our $1.2 billion investment portfolio has decreased by approximately 26% from December 31, 2007 based on these factors.

Due to our status as a REIT, we are required to distribute at least 90% of our REIT taxable income to stockholders. As our loans are repaid and/or we sell our loans, if we do not begin lending again, we will experience declines in the size of the investment portfolio over time. Net losses and a reduction in the size of our investment portfolio would also result in reduced taxable income and cash available for distribution and a lower dividend as compared to historical standards. As a result of these factors, on December 17, 2008, we announced that our board of directors suspended the quarterly dividend in order to maintain our financial flexibility.

Our CDOs contain reinvestment periods of five years during which we can use the proceeds of loan repayments, if any, to fund new investments. As of December 31, 2008, we have approximately 2.3 years and 3.3 years remaining in our reinvestment period for our first and second CDOs, respectively. The volume of any new investment activity, if any, would be substantially lower than our historical production levels. Reinvestment is not permitted during periods that we are not in compliance with our CDO covenants.

As of December 31, 2008, we had approximately $23.1 million of unrestricted cash and cash equivalents. We have long-term financing for 100% of our encumbered portfolio in place through our existing CDOs and mortgage loans. In order to effectively match-fund our investment portfolio, we aggressively reduced amounts under our former repurchase facility with Wachovia from $217.0 million at September 30, 2007 to being fully repaid in June 2008. We expect the availability of warehouse lines, which we had historically used to finance loan originations that were ultimately packaged in CDO offerings, will be limited in the near to medium-term due to reduced liquidity in the CDO market and a lesser appetite for new CDO issuances. As we await the recovery of these traditional avenues of liquidity, we are considering several alternative equity and debt capital raising options, as well as analyzing our fundamental business model.

Results of Operations

Comparison of the year ended December 31, 2008 to the year ended December 31, 2007

Revenues

Investment income is generated on our whole loans and bridge loans, subordinate interests in whole loans, mezzanine loans and CMBS investments. Investment income decreased by $28.9 million to $100.5 million for the year ended December 31, 2008, from $129.4 million for the year ended December 31, 2007, driven primarily by lower interest rates earned on floating rate loans indexed to LIBOR, a lower average investment portfolio balance and a greater number of non-performing loans in 2008 compared to 2007.

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Property operating income increased by $0.4 million to $4.4 million for the year ended December 31, 2008, from $4.0 million for the year ended December 31, 2007, which primarily represents an increase in rental income from our consolidated Loch Raven joint venture.

Other income decreased by $3.6 million to $1.0 million for the year ended December 31, 2008, from $4.6 million for the year ended December 31, 2007. The reduction in other income, which represents interest earned on cash balances primarily from overnight repurchase investments, is the result of lower interest rates.

Expenses

Interest expense decreased by $10.1 million to $82.0 million for the year ended December 31, 2008, from $92.2 million for the year ended December 31, 2007. The primary components of interest expense included $51.9 million of interest on our CDO financings, $17.2 million attributable to hedging activities, $1.1 million of interest on borrowings on our warehouse facilities, $1.7 million of interest on our consolidated Loch Raven joint venture mortgage, and $4.1 million of interest on our trust preferred securities. The primary reason for the decrease is due to lower interest rates on variable rate debt in 2008 compared to 2007 and lower outstanding debt under short-term warehouse facilities, offset in part by higher average outstanding debt resulting from the issuance of our second CDO in April of 2007.

Management fees decreased by $2.6 million to $5.1 million for the year ended December 31, 2008, from $7.7 million for the year ended December 31, 2007. The reduced fees are a result of a decline in our stockholder’s equity primarily attributable to impairments and loan loss provisions. The management fees, expense reimbursements, formation costs and the relationship between our former Manager, our affiliates and us are discussed further in “—Related Party Transactions.”

Property operating expenses increased by $0.6 million to $3.3 million for the year ended December 31, 2008, from $2.7 million for the year ended December 31, 2007, which primarily represents an increase in rental expenses from our Loch Raven consolidated joint venture.

General and administrative expenses increased by $7.1 million to $16.5 million for the year ended December 31, 2008, from $9.4 million for December 31, 2006. The largest components of the increase were $3.0 million increase in consulting fees incurred in connection with our evaluation of strategic alternatives, $2.8 million increase in legal fees due to costs associated with non-performing loans, proxy defense, investigation expense for derivative stockholder claims and the class action lawsuit and $1.6 million of compensation expense related to the severance and retention plan for employees of our Manager.

Depreciation and amortization expenses decreased by $0.3 million to $1.1 million for the year ended December 31, 2008 from $1.4 million for the year ended December 31, 2007, which primarily represents depreciation and amortization from our consolidated Loch Raven joint venture. The decrease is the result of certain intangible assets capitalized upon acquisition becoming fully amortized during 2007 and the first quarter of 2008.

Loss on impairment of assets

Loss on impairment of long-lived assets decreased $1.8 million to $6.0 million for the year ended December 31, 2008 from $7.8 million for the year ended December 31, 2007. Loss on impairment of long-lived assets of $6.0 million for the year ended December 31, 2008 is attributable to an impairment of the long-lived assets of the Loch Raven property. In the third quarter of 2008, management made a decision to no longer fund operating deficits at the Loch Raven property based on (i) the property’s current and forecasted operating performance, (ii) lack of liquidity in the credit markets that make refinancing more difficult, (iii) declines and expected declines in commercial real estate valuations and (iv) the general expectation of a prolonged economic slow down that would adversely impact the performance and value of the property. The decision to no longer fund operating deficits will put us in default with the non-recourse first mortgage on the property, which will likely result in the senior lender foreclosing on the property. Management determined that the change in strategy indicated that the carrying amount of Loch Raven long-lived assets may not be fully recoverable. Based our current estimate of undiscounted cash flows over the expected life of the investment, we determined that the carrying value of the Loch Raven long-lived assets was not fully recoverable. As a result of this assessment, we recorded an impairment loss of $6.0 million for the year ended December 31, 2008 based on the difference between the carrying value of the long-lived assets and their estimated fair value. Loss on impairment of asset of $7.8 million for the year ended December 31, 2007 resulted from a loss realized upon foreclosure of the Monterey property in the second quarter of 2007.

Provision for loan losses

The provision for loan losses increased to $126.5 million for the year ended December 31, 2008 from $19.7 million for the year ended December 31, 2007. The loan loss reserve in 2008 is due to several non-performing loans and watch list assets, where management estimated the loans may not be fully recoverable, reflecting current adverse market conditions and specific facts and circumstances for each loan, as discussed further in “-Risk Management”

Loss on sale of investment

Loss on sale of investment increased by $1.5 million to $2.0 million for the year ended December 31, 2008 from $0.5 million for the year ended December 31, 2007. The loss in 2008 is related to the sale of a whole loan. The loss in 2007 is related to the sale of a CMBS investment.

Gain on financial instruments

Gain on financial instruments increased by $22.5 million to $20.8 million for the year ended December 31, 2008 from a loss of $1.7 million for the year ended December 31, 2007. The increase is due to the adoption of SFAS 159 on January 1, 2008 which resulted in us recording certain assets and liabilities at fair value with the corresponding changes in fair value being recorded in the statement of operations.

During the year ended December 31, 2008, the CMBS and CDO markets continued to experience widening of credit spreads, resulting in a decrease in the fair value of CMBS which we hold as investments and decreases in the fair value of our CDO bonds and junior subordinated debenture liabilities. The fair value of our CMBS investments decreased, resulting in a loss of $181.2 million for the year ended December 31, 2008. The fair value of our liabilities related to CDO bonds and junior subordinated debentures decreased, resulting in gains of $261.0 million and $18.1 million, respectively, for the year ended December 31, 2008. The fair value of liabilities associated with derivative instruments decreased during the year ended December 31, 2008 resulting in an unrealized loss of $69.0 million.

Equity in net loss of unconsolidated joint ventures

Equity in net loss of unconsolidated joint ventures increased by $34.1 million to $39.9 million for the year ended December 31, 2008 from $5.7 million for the year ended December 31, 2007. The increase in the equity in net loss of unconsolidated joint ventures for the year ended December 31, 2008 is due primarily to a $7.3 million impairment loss on the Prince George’s Station Retail LLC joint venture, $0.8 million impairment loss on the 32 Leone Lane joint venture investment, $2.0 million impairment loss on the Nordhoff joint venture investment, $15.1 million impairment loss on the KS-CBRE Shiraz LLC joint venture and a $9.0 million impairment loss on the KS-CBRE GS LLC joint venture. In the third quarter of 2008, the second largest tenant of the Prince George’s Station Retail LLC property terminated their lease. The lease termination, combined with increasing credit concerns over the property’s largest tenant, who has since declared bankruptcy, indicated that the carrying amount of long-lived assets may not be fully recoverable and an impairment loss of $7.3 million was recorded, bringing the carrying value of our investment to zero. A $0.8 million loss was recognized on our 32 Leone Lane joint venture investment, bringing the carrying value of our investment to zero, where it was determined that the carrying value of long-lived assets of the joint venture were no longer recoverable due to management’s expectations that the sponsor will be unable to successfully lease or sell the 100% vacant building under current market conditions, necessitating a write down to fair value. The $2.0 million impairment loss

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on the Nordhoff joint venture was recorded in the second quarter and fourth quarter of 2008 when it was determined that the carrying value of long-lived assets of the joint venture were no longer recoverable, necessitating a write down to fair value. Impairment losses of $15.1 million and $9.0 million for KS-CBRE Shiraz LLC and KS-CBRE GS LLC, respectively, were recognized in the fourth quarter of 2008, reducing the carrying value of each investment to zero, based on continued weakening of the credit and real estate markets that has resulted in significant declines in commercial real estate valuations that we anticipate will make it very difficult to sell or refinance the underlying properties at values in excess of the senior first mortgage obligations.

Operating results from discontinued operations

Operating results from discontinued operations consist primarily of rental income, rental expenses and interest expenses attributable to rental operations of Springhouse, Rodgers Forge and Monterey properties during the year ended December 31, 2008 and 2007.

Loss on impairment of assets held for sale – discontinued operations

Loss on impairment of assets held for sale of $6.1 million for the year ended December 31, 2008 represents an impairment of the Springhouse property. In the third quarter of 2008, management made a decision to market the Springhouse property for sale, resulting in classification of assets and liabilities as “held for sale” as of December 31, 2008 and results from operations classified as “discontinued operations” for all periods presented. Based on management’s commitment to sell the property and the resulting held for sale classification, we have recorded the long-lived assets of Springhouse at estimated fair value less costs to sell, which resulted in an impairment loss of $6.1 million for the year ended December 31, 2008. Loss on impairment of assets held for sale of $54.7 million for the year ended December 31, 2007 represents impairment of the Rodgers Forge and Monterey properties. Subsequent to foreclosure of the Monterey and Rodgers Forge properties, there was significant deterioration in the Baltimore area and metropolitan DC area condominium markets as well as a severe dislocation of the capital and credit markets precipitated by the sub-prime lending crisis. As a result of these events, management determined that its original plans to convert the Rodgers Forge and Monterey properties to condominiums were no longer viable and that the properties may be impaired. Based on the management estimate of future undiscounted cash flows as apartment properties, the long-lived assets of the Rodgers Forge and Monterey properties were no longer fully recoverable. Impairment losses of $17.7 million and $37.0 million, respectively, on the Rodgers Forge and Monterey properties were determined based on the difference between the carrying values of the long-lived assets and their estimated fair market values. The estimated fair market values were based on discounted cash flow projections which assumed the properties were sold when stabilized and were supported by third party offers to purchase the Rodgers Forge property and an independent third party appraisal for the Monterey property.

Gain on sale of investment – discontinued operations

During the year ended December 31, 2008, we sold our interest in Rodgers Forge and Monterey and recognized gains of $3.6 million and $3.2 million, respectively, related to the sale of these properties.

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

Revenues

Investment income is generated on our whole loans and bridge loans, subordinate interests in whole loans, mezzanine loans and CMBS investments. Investment income increased by $64.8 million to $129.4 million for the year ended December 31, 2007, from $64.6 million for the year ended December 31, 2006, as the overall average investment portfolio increased to $1.5 billion December 31, 2007, from $922.0 million for the year ended December 31, 2006. Specifically, the primary components of the increase for the year ended December 31, 2007 was generated by our whole loans ($36.1 million), B Notes ($5.6 million), mezzanine loans ($10.4 million) and CMBS ($10.0 million).

Property operating income increased by $0.9 million to $4.0 million for the year ended December 31, 2007, from $3.1 million for the year ended December 31, 2006, which primarily represents the inclusion of twelve months of rental income for the Loch Raven joint venture, which was acquired on March 28, 2006.

Other income increased by $1.3 million to $4.6 million for the year ended December 31, 2007, from $3.3 million for the year ended December 31, 2006, which represents interest earned on cash balances primarily from overnight repurchase investments.

Expenses

Interest expense increased by $51.6 million to $92.2 million for the year ended December 31, 2007, from $40.5 million for the year ended December 31, 2006. The primary components of interest expense included $65.3 million of interest on our CDO financings, $18.5 million of interest on borrowings on our warehouse facilities, $1.5 million of interest on our consolidated real estate joint venture mortgages, and $4.1 million of interest on our trust preferred securities. The primary reason for the increase in 2007 was due to higher average outstanding debt resulting from the issuance of our second CDO in 2007.

Management fees increased by $1.2 million to $7.7 million for the year ended December 31, 2007, from $6.5 million for December 31, 2006. The increase is due primarily to an increased average equity balance from which management fees are derived, due to additional equity raised through our October 2006 initial public offering.

Property operating expenses increased by $1.0 million to $2.7 million for the year ended December 31, 2007, from $1.7 million for December 31, 2006, which primarily represents operating expenses from our Loch Raven joint venture investment. The increase is due primarily to the inclusion of twelve months of expenses for the Loch Raven joint venture, which was acquired on March 28, 2006.

General and administrative expenses decreased by $1.0 million to $9.4 million for the year ended December 31, 2007, from $10.4 million for December 31, 2006. The largest component of the decrease was stock-based compensation expense, which decreased $2.6 million from the prior period driven by a lower stock price at December 31, 2007 from which the fair value of unvested restricted stock and options is derived. Offsetting the overall decrease was an increase in professional fees of approximately $1.1 million which increased primarily due to implementation of Section 404 of the Sarbanes Oxley Act of 2002 and having a full year of public company reporting requirements.

The management fees, expense reimbursements, formation costs and the relationship between our Manager, our affiliates and us are discussed further in “—Related Party Transactions.”

Depreciation and amortization expenses increased by $0.9 million to $1.4 million for the year ended December 31, 2007 from $0.5 million for the year ended December 31, 2006, which primarily represents depreciation and amortization from our Loch Raven joint venture investment. The increase is due primarily to the inclusion of twelve months of expenses for the Loch Raven joint venture, which was acquired on March 28, 2006.

Loss on impairment of assets

Loss on impairment of loan increased to $7.8 million for the year ended December 31, 2007 from $0 for the year ended December 31, 2006. After taking control and possession of the Monterey property, management estimated the fair value of the Monterey property at the date of foreclosure and concluded the carrying value exceeded the estimated fair value of net assets acquired and, as a result, an impairment of $7.8 million was recorded.

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Provision for loan losses

The provision for loan losses increased to $19.7 million for the year ended December 31, 2007 from $0 for the year ended December 31, 2006. The loan loss reserve in 2007 is due to three loans that are either on the watch-list or are non-performing, where management estimated the loans may not be fully recoverable based on current market conditions and specific facts and circumstances for each loan.

Gains (losses) on sale of investments

Losses on sale of investments changed by $0.8 million to a loss of $0.5 million for the year ended December 31, 2007, from a gain of $0.3 million for the year ended December 31, 2006. The loss in 2007 is related to the sale of a loan investment.

Gains (losses) on financial instruments

Loss on financial instruments changed by $5.3 million to a loss of $1.7 million for the year ended December 31, 2007 from a gain of $3.6 million for the year ended December 31, 2006. The $3.6 million was a realized gain related to the termination of interest rate swaps in conjunction with our first CDO transaction and the sale of an A note in the first quarter of 2006. $1.7 million realized of the realized losses in 2007 was due to a terminated interest rate swap that was settled in connection with the sale of a loan investment that was being hedged.

Operating results from discontinued operations

Operating results from discontinued operations consist primarily of rental income, rental expenses and interest expenses attributable to rental operations of Rodgers Forge and Monterey properties that were consolidated by us after the properties were foreclosed upon in May of 2007.

Loss on impairment of assets held for sale

Subsequent to foreclosure of the Monterey and Rodgers Forge properties, there was significant deterioration in the Baltimore area and metropolitan DC area condominium markets as well as a severe dislocation of the capital and credit markets precipitated by the sub-prime lending crisis. As a result of these events, management determined that its original business plans to convert the Rodgers Forge and Monterey properties to condominiums were no longer viable and that the properties may be impaired. Based on the management estimate of future undiscounted cash flows as apartment properties, the long-lived assets of the Rodgers Forge and Monterey properties were no longer fully recoverable. Impairment losses of $17.7 million and $37.0 million, respectively, on the Rodgers Forge and Monterey properties were determined based on the difference between the carrying values of the long-lived assets and their estimated fair market values. The estimated fair market values were based on discounted cash flow projections which assumed the properties were sold when stabilized and were supported by third party offers to purchase the Rodgers Forge property and an independent third party appraisal for the Monterey property.

Risk Management

As of December 31, 2008, we had the following watch list and non-performing loans (in thousands):


Investment Type	Classification	Net Loan Balance⁽¹⁾		% of Total Assets
Whole Loan	Watch⁽²⁾	$	10,500	0.7	%
Whole Loan	Watch		47,000	3.3	%
Mezzanine Loan	Watch		18,000	1.3	%
B-Note	Non-Performing⁽⁴⁾		42,830	3.0	%
Mezzanine Loan	Non-Performing⁽⁴⁾		40,000	2.8	%
Whole Loan	Non-Performing		11,000	0.8	%
Bridge Loan	Non-Performing⁽³⁾		7,500	0.5	%
Mezzanine Loan	Non-Performing		25,000	1.8	%
Bridge Loan	Non-Performing⁽³⁾		2,123	0.2	%

Total		$	203,953	14.4	%

(1)	At December 31, 2008, we had loan loss reserves of $139,690 against these assets out of our total loan loss reserves of $141,065.

(2)	Subsequent to December 31, 2008 this loan became non-performing.

(3)	Investments are with the same sponsor.

(4)	Investments are with the same sponsor.

Watch List Assets

We conduct a quarterly comprehensive credit review, resulting in an individual risk classification being assigned to each asset.

The first watch list asset is a $10.5 million whole loan secured by a mixed use industrial and commercial facility located in Windsor, Connecticut. The borrower determined that the primary business occupying the facility was not economically feasible and has engaged a broker to sell the building. In June 2008, we received payment of $2.0 million from the borrower, which included a $1.5 million reduction of principal to $10.5 million and $0.5 million to replenish interest reserves, in exchange for the removal of a personal guaranty. The borrower has since triggered personal recourse pursuant to the exculpation provisions in the loan documents. In November 2008, the interest reserve balance was fully depleted. Management concluded that no loan loss reserve was necessary at this time based on the estimated fair market value of the underlying collateral from a recent third party appraisal. If the borrower is not successful in locating a buyer for the building at an adequate price, or at all, such an adverse event could have an adverse impact on our ability to recover our loan balance. In December 2008, we initiated foreclosure proceedings.

The second watch list asset is a $47.0 million whole loan secured by an office building located in San Francisco, California. The building has a below market occupancy rate and does not fully cover debt service obligations, requiring the borrower to contribute significant capital. The loan was current as of December 31, 2008 and January and February 2009 interest payments were received. The loan matured on March 9, 2009 without payment and therefore is in default. If we foreclose on the property, given current market conditions where it is difficult to sell and finance commercial real estate properties at reasonable levels, we may not be able to fully recover the loan balance. Based on the Company’s internal valuation of the collateral, at this time the range of potential losses is between $0 and $11.0 million.

The third watch list asset is a $18.0 million mezzanine loan for a specialty retail development located in Tennessee. Our loan originally matured on December 1,

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2008 and the senior construction loan matured on December 24, 2008 and both were extended until January 24, 2009, at which time they went into maturity default. Construction on the project has halted as the lending group and borrower negotiate long-term financing and capitalization for the project. We believe it will be difficult for the borrower to find permanent financing given current credit market conditions. Currently, the project has a construction funding budget deficit that will be required to complete tenant improvements and the borrower is working closely with the lending group to obtain the remaining funding requirements. Based on our consideration of the difficulty under current market conditions of (i) resuming and completing construction, (ii) obtaining additional capital required, (iii) negotiating an extension of the current capital structure at reasonable terms, (iv) obtaining permanent financing for the property and (v) operating a specialty retail property during a prolonged economic downturn that severely impacts leisure travel, we believe there is substantial doubt about our ability to recover our loan balance. Based on these uncertainties and management’s inability to reasonably predict recovery upon restructuring or assumption of the collateral, we recorded a loan loss reserve against the balance of this loan in the fourth quarter of 2008 to reduce the net carrying value to $0.

Subsequent to December 31, 2008, we added a $32.0 million whole loan secured by seven office buildings in Albany, New York and Rochester, New York to the watch list. The buildings have been under performing compared to original underwriting expectations, resulted in the borrower having to fund cash operating deficits. As a result of current and projected operating deficits, management expects it may have to restructure the loan to provide the borrower some relief on interest payments and concluded that a $1.4 million reserve was necessary at this time.

Non-Performing Loans

Non-performing loans include all loans on non-accrual status. We transfer loans to non-accrual status at such time as: (1) management determines the borrower is incapable of curing, or has ceased efforts towards curing the cause of a default; (2) the loan becomes 90 days delinquent; or (3) the loan has a maturity default. Interest income is recognized only upon actual cash receipt for loans on non-accrual status.

The $42.8 million B-Note investment classified as non-performing had a maturity default on December 1, 2007 and is secured by a class A parcel of land in New York City that is intended to be developed into a mixed use retail and residential site. The B-Note was originally due on October 1, 2007 and was extended for 60 days with the sponsor funding an additional $150.0 million of cash equity. Interest on the loan has been paid through December 31, 2007 at the contractual rate. As of December 31, 2008, we have initiated foreclosure proceedings on the collateral of our loan. At the current time, the lending group is conducting an appraisal of the site and, if the appraisal indicates the value of the site does not support our position in the capital structure, we will lose our ability to control foreclosure and voting rights over major decisions. The value of the loan is dependent on several factors that are outside of our control, such as the ultimate use of the project, the timing of completion and negotiations with potential tenants, and adverse events not currently anticipated could have a material impact on the value of the underlying collateral and ultimate realization of our loan balance. Based on our consideration of (i) the current state of the credit and capital markets, (ii) the long duration of the maturity default and (iii) the time and expense associated with foreclosure proceedings, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

The $40.0 million mezzanine loan had a maturity default on February 9, 2008 and is collateralized by four class A office properties located in New York City. The sponsor of this investment is also the sponsor of the $42.8 million B-Note investment discussed above. In April 2008, the borrower and lending group for the properties reached a consensual sale agreement that will allow the properties to be sold in an orderly fashion. The consensual sale agreement expired in February 2009. Based on the negotiated sales prices of three of the four class A office properties prior to the expiration of the agreement, we will not recover any of our loan balance, therefore we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

The $11.0 million whole loan is secured by a mixed use office and industrial facility located in Phoenix, Arizona. The facility has been 100% vacant for greater than two years and interest reserves were fully depleted in April 2008. In November 2008, the borrower notified us that it will no longer be making interest payments and we expect to assume possession of the collateral from the borrower by deed-in-lieu of foreclosure. Management obtained an independent, third party appraisal of the collateral value of this property which indicated that the fair value of the collateral, net of expected selling costs, was less than our historical carrying value. As a result, we have a loan loss reserve against the balance of this loan to reduce the net carrying value to the estimated net realizable value of $6.2 million.

The $7.5 million bridge loan is secured by development rights to build an office building in the Washington, DC area. The loan matures in April 2009, interest reserves were depleted in April 2008 and subsequent interest payments have been deferred until the maturity date of the loan. The borrower is in the process of completing predevelopment activities and obtaining necessary regulatory approvals to start construction. The borrower is exploring alternative uses of the site, including student housing. At December 31, 2008, based on the continued decline of the credit markets, which we believe makes it very difficult to obtain financing on projects of this nature, combined with the growing concern of a prolonged economic slowdown that is making it more difficult to execute long-term lease commitments, we concluded that the significance of these uncertainties raises substantial doubt about our ability to recover our loan balance. Based on these uncertainties and management’s inability to reasonably predict recovery upon (i) pursuit of a personal guaranty from the borrower or (ii) assumption of the collateral, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

The $25.0 million mezzanine loan is secured by an interest in an apartment complex in New York City. The borrower notified us in July 2008 that it will cease servicing the debt and has requested significant modifications to the outstanding loans in order to continue its involvement with the property. Management is currently in the process of negotiating with the borrower, however, the ultimate outcome remains uncertain. Given the continued adverse market conditions that have negatively impacted commercial real estate valuations and the ability to refinance and based on our assessment of the current fair value of the underlying collateral, we believe there is significant uncertainty about our ability to recoup our loan balance in the event of sale or foreclosure. As a result, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

The $2.1 million bridge loan is secured by development rights to build a mixed use office, retail and hotel facility in the Miami, Florida area. The borrower is in the process of obtaining construction financing for the development and completing other predevelopment activities. The loan matured on November 2008 and the borrower has communicated to us that it is unable to repay the loan. At December 31, 2008, based on the continued decline of the credit markets, which we believe makes it very difficult to obtain financing on projects of this nature, combined with the growing concern of a prolonged economic slowdown that is making it more difficult to execute long-term lease commitments, management concluded that the significance of these uncertainties raises substantial doubt about our ability to recover our loan balance. Based on these uncertainties and management’s inability to reasonably predict recovery upon (i) pursuit of a personal guaranty from the sponsor or (ii) assumption of the collateral, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

Loan Loss Reserve

As of December 31, 2008 and 2007, our loan loss reserve was $141.1 million and $19.7 million, respectively. Management estimated the loan loss reserve based on consideration of current economic conditions and trends, the intent and wherewithal of the sponsors, the quality and estimated value of the underlying collateral and other factors.

Liquidity and Capital Resources

Overview

Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund loans and other investments, pay dividends, fund debt service and for other general corporate purposes. On December 31, 2008, we had approximately $23.1 million of unrestricted

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cash and cash equivalents. We have long-term financing for 100% of our encumbered portfolio in place through our existing CDOs and mortgage loans. Our primary sources of funds for short-term liquidity requirements, including working capital, distributions, if any, debt service and additional investments, if any, consist of (i) cash flow from operations; (ii) proceeds from our existing CDOs; (iii) proceeds from principal and interest payments on our unencumbered investments; (iv) proceeds from potential loan and asset sales; and, to a lesser extent; (v) new financings or additional securitization or CDO offerings and (vi) proceeds from additional common or preferred equity offerings. We believe these sources of funds will be sufficient to met our short-term liquidity requirements.

The majority of our investments are pledged as collateral for our CDO bonds and the income generated from these investments is used to fund interest obligations of our CDO bonds and the remaining income, if any, is retained by us. Our CDO bonds contain interest coverage and asset overcollateralization covenants that must be met in order for us to receive such payments. If we fail our interest coverage or asset overcollateralization covenants in either of our CDOs, all cash flows from the CDO (including interest on the bonds we own, distributions on our common and preferred equity and our subordinate management fees) would be diverted to repay principal and interest on the outstanding CDO bonds and we would not receive any residual payments until the CDO was back in compliance with such tests. We were in compliance with all such covenants as of December 31, 2008. In the event of a breach of our CDO covenants that we could not cure in the near term, we would be required to fund interest on trust preferred securities and other expenses (including compensation expenses) through (i) cash on hand, (ii) income from any CDO not in default, (iii) sale of unencumbered assets or (iv) accessing debt or equity capital markets, if available. We have the ability to cure defaults, which would resume normal payments to us, by purchasing non-performing loans out of our CDOs. However, we may not have sufficient liquidity available to do so at such time. In some cases, collateral may be continuing to pay interest but may be considered a defaulted interest for the purpose of the covenant calculations, such as our CMBS in our 2006 CDO, or CDO I, which are considered defaulted interests for the purpose of covenant calculation if any rating agency downgrade occurs. To the extent noncompliance continues for an extended period of time, our ability to continue as a going concern may be jeopardized. At December 31 2008, our most restrictive covenants on our CDOs had an interest coverage ratio of 2.21x and 1.22x for CDO I and CDO II, respectively, compared to minimum requirements of 1.21x and 1.09x. At December 31, 2008, our most restrictive covenants on our CDOs had an asset overcollateralization ratio of 1.15x and 1.10x for CDO I and our 2007 CDO, or CDO II, respectively, compared to minimum requirements of 1.12x and 1.10x. If we experience an additional $15,050 or $500 in reductions of collateral in CDO I or CDO II, respectively, due to further investment losses or other factors, we will fail the overcollateralization test for the respective CDO.

On February 25, 2009, we were notified by the CDO I trustee that we failed the overcollateralization test for CDO I on the February 25, 2009 payment date and, as a result, future net cash flows from CDO I, including approximately $488,000 due on the February 25, 2009 payment date, will be diverted to pay down principal of senior bond holders rather than being paid to us until such time the covenant is back in compliance, if ever. As of February 27, 2009, CDO II was in compliance with the overcollateralization test, however, if an additional $0.5 million in defaults occur, CDO II will also breach the overcollateralization covenant. Management believes it is likely that CDO II will fail the overcollateralization test at some point in 2009, which will result in the cash flows of CDO II being diverted to pay down principal of senior bond holders, eliminating residual cash inflows paid to us. With both CDOs out of compliance with overcollateralization covenants, we will have minimal incoming cash flows from our primary business and there is no assurance when or if we will be able to regain compliance with these covenants. As discussed further in “—Related Party Transactions,” the breach of the overcollateralization covenant in either CDO provides MBIA the controlling class of CDO II bondholders, the ability to terminate the existing collateral management agreement, as amended, and to remove us as the collateral manager of CDO II. We have incurred significant losses since our inception and may incur additional losses in the future as we continue to navigate the difficult issues in the credit and real estate markets. With minimal incoming cash flows, management’s plans to fulfill short-term capital requirements include (i) use of $23.1 million of cash on hand as of December 31, 2008 to fund operating expenses, (ii) senior collateral management fees, (iii) reduction in administrative costs, as a result of becoming a non-reporting company, (iv) reduction in employee headcount, and (v) sale of our unencumbered 1515 Market Street LLC joint venture interest, if possible under current market conditions. We believe these sources of funds will be sufficient to meet our liquidity requirements for at least the next 12 months. We continue to seek and explore partnerships and new business opportunities; however, there is no assurance that such partnerships or business opportunities will be available on favorable terms or at all.

Due to our status as a REIT, we are required to distribute at least 90% of our REIT taxable income to stockholders. As our loans are repaid and/or we sell our loans, if we do not begin lending again, we will experience declines in the size of the investment portfolio over time. Net losses and a reduction in the size of our investment portfolio would also result in reduced taxable income and cash available for distribution and a lower dividend as compared to historical standards. As a result of these factors, on December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to maintain our financial flexibility.

As of December 31, 2008, we had approximately $23.1 million of unrestricted cash and cash equivalents. We have long-term financing for 100% of our encumbered portfolio in place through our existing CDOs and mortgage loans. In order to effectively match-fund our investment portfolio, we have aggressively reduced amounts under our former repurchase facility with Wachovia from $217.0 million at September 30, 2007 to being fully repaid in June 2008. We expect the availability of warehouse lines, which we had historically used to finance loan originations that were ultimately packaged in CDO offerings, will be limited in the near to medium term due to reduced liquidity in the CDO market and a lesser appetite for new CDO issuances. As we await the recovery of these traditional avenues of liquidity, we are considering several alternative equity and debt capital raising options, as well as analyzing our fundamental business model.

Capitalization

Our authorized capital stock consists of 150,000,000 shares of capital stock, $0.01 par value per share, of which we have authorized the issuance of up to 100,000,000 shares of common stock, par value $0.01 per shares, and 50,000,000 shares of preferred stock, par value $0.01 per share. As of December 31, 2008 and December 31, 2007, 30,823,200 and 30,920,225 shares, respectively, of our common stock were issued and outstanding and no shares of our preferred stock were issued and outstanding.

On June 9, 2005, we completed our private offering of 20,000,000 shares of common stock resulting in gross proceeds of $300.0 million and net proceeds of approximately $282.5 million, which were used primarily to fund investments.

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On September 27, 2006, we priced our initial public offering, or IPO, of common stock, with public trading of our common stock commencing on September 28, 2006. We sold 11,012,624 shares of our common stock in our IPO at a price of $14.50 per share, which includes the exercise in full of the underwriters’ option to purchase an additional 1,436,429 shares of common stock. Of these shares, 9,945,020 were sold by us and 1,067,604 were sold by selling stockholders. Net proceeds from both our IPO and the over allotment option, after underwriting discounts and commissions of approximately $8.7 million and other offering expenses of approximately $2.4 million, were approximately $133.2 million, which we received on October 3, 2006 and used to repay debt.

On March 7, 2007, 130,200 shares of restricted stock and options to purchase 66,500 shares of our common stock with an exercise price of $13.08 per share were issued to certain employees of our Manager under the 2005 equity incentive plan. Options granted under the 2005 Equity Incentive Plan are exercisable at the fair market value on the date of the grant and, expire five years from the date of the grant, subject to termination of employment, are not transferable other than at death, and are exercisable ratably over a three year period commencing one year from the date of the grant.

In August 2007, 60,000 shares of restricted stock were issued to certain of our officers under the 2005 Equity Incentive Plan.

In September 2007, 75,000 shares of restricted stock and options to purchase 24,000 shares of our common stock with an exercise price of $5.89 per share were issued to our newly hired president and chief executive officer under the 2005 Equity Incentive Plan.

In December 2007, 92,500 shares of restricted stock and options to purchase 45,500 shares of our common stock with an exercise price of $5.34 per share were issued to certain employees of our Manager under the 2005 Equity Incentive Plan.

Warehouse Facilities

We have historically financed our portfolio of securities and loans through the use of repurchase agreements. Currently, we have no warehouse facilities in place that will allow future borrowings. Below is a description of our warehouse line in place as of December 31, 2007.

Wachovia Warehouse Facility

In August 2006, we entered into a master repurchase agreement with Wachovia Bank N.A, or Wachovia, that provided $300,000 of aggregate borrowing capacity. This facility previously financed our origination or acquisition of whole loans, subordinate mortgage interests and CMBS. As of December 31, 2007, the outstanding balance under this facility was approximately $144.2 million with a weighted average borrowing rate of 6.28%. In June 2008, we repaid our remaining obligations and terminated the facility and there is no balance outstanding as of December 31, 2008.

CDO Bonds Payable

On March 28, 2006, we closed on our CDO I issuance and retained the entire BB rated J Class with a face amount of $24.0 million for $19.2 million, retained the entire B-rated K Class with a face amount of $20.3 million for $14.2 million and also retained the non-rated common and preferred shares of CDO I, which issued the CDO bonds with a face amount of $47.3 million for $51.7 million. We issued and sold CDO bonds with a face amount of $508.5 million in a private placement to third parties. The proceeds of the CDO issuance were used to repay substantially all of the outstanding principal balance of our then existing two warehouse facilities with an affiliate of Deutsche Bank Securities Inc. of $343.6 million and all of the outstanding principal balance of our then existing warehouse facilities with the Bank of America Securities, LLC of $16.3 million at closing. The CDO bonds are collateralized by real estate debt investments, consisting of B Notes, mezzanine loans, whole loans and CMBS investments, which are recorded in our unaudited condensed consolidated balance sheet at December 31, 2008. As of December 31, 2008, prior to our internalization, our Manager was the collateral manager for our CDO subsidiary and did not receive any fees in connection therewith. Effective January 1, 2009, we have assumed the role as collateral manager. CDO I is not a qualified special purpose entity (“QSPE”) as defined under FASB Statement No. 140, (“SFAS 140”) “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” due to certain permitted activities of CDO I that are not consistent with activities of a QSPE permitted under SFAS 140, such as having the ability to sell impaired securities and acquire replacement securities with the proceeds at the discretion of the collateral administrator. CDO I is consolidated in our financial statements and we have accounted for the CDO I transaction as a financing. The collateral assets that we transferred to CDO I are reflected in our balance sheet. The bonds issued to third parties are reflected as debt on our balance sheet. As of December 31, 2008, CDO bonds of $508.5 million were outstanding, with a weighted average interest rate of 0.98%.

In March 2007, Wachovia acted as the exclusive structurer and placement agent with respect to our CDO II totaling $1,000 million which priced on March 2, 2007, and closed on April 2, 2007. We sold $880.0 million of bonds with an average cost of 90-day LIBOR plus 40.6 basis points and retained 100% of the equity interests in our CDO subsidiary that issued the CDO notes consisting of preferred and common shares. The notes issued by our CDO subsidiary are secured initially by a portfolio of whole loans, B Notes, mezzanine loans and CMBS. As of December 31, 2008, prior to our internalization, our Manager was the collateral manager for our CDO subsidiary and does not receive any fees in connection therewith. Effective January 1, 2009, we have assumed the role as collateral manager, however, the controlling class of bond holders may, at their discretion, reassign the collateral manager if we breach CDO covenants discussed below. We acted as the advancing agent in connection with the issuance of the CDO notes. CDO II is not a QSPE as defined under SFAS 140 due to certain permitted activities of CDO II that are not consistent with activities of a QSPE permitted under SFAS 140, such as having the ability to sell impaired securities and acquire replacement securities with the proceeds at the discretion of the collateral administrator. CDO II is consolidated in our financial statements and we account for the CDO II transaction as a financing. The collateral assets that we transferred to CDO II are reflected in our balance sheet. The bonds issued to third parties are reflected as debt on our balance sheet. As of December 31, 2008, CDO II bonds of $853.2 million were outstanding, with a weighted average interest rate of 5.11%. As of December 31, 2008, we had a $75.0 million revolver available with $48.2 million of borrowing outstanding and $26.8 million of remaining capacity. The revolver is available to fund future funding commitments on loans.

The majority of our investments are pledged as collateral for our CDO bonds and the income generated from these investments is used to fund interest obligations of our CDO bonds and the remaining income, if any, is retained by us. Our CDO bonds contain interest coverage and asset overcollateralization covenants that must be met in order for us to receive such payments. If we fail our interest coverage or asset overcollateralization covenants in either of our CDOs, all cash flows from the CDO (including interest on the bonds we own, distributions of our common and preferred equity and our subordinate management fees) would be diverted to repay principal and interest on the outstanding CDO bonds and we would not receive any residual payments until the CDO was back in compliance with such tests. We were in compliance with all such covenants as of December 31, 2008. In the event of a breach of our CDO covenants that we could not cure in the near term, we would be required to fund interest on trust preferred securities and other expenses (including compensation expenses) through (i) cash on hand, (ii) income from any CDO not in default, (iii) sale of unencumbered assets or (iv) accessing debt or equity capital markets, if available. We have the ability to cure defaults, which would resume normal payments to us, by purchasing non-performing loans out of our CDOs. However, we may not have sufficient liquidity available to do so at such time. In some cases, collateral may be continuing to pay interest but may be considered a defaulted interest for the purpose of the covenant calculations, such as our CMBS in CDO I, which are considered defaulted interests for the purpose of covenant calculation if any rating agency downgrade occurs. To the extent noncompliance continues for an extended period of time, our ability to continue as a going concern may be jeopardized. At December 31 2008, our most restrictive covenants on our CDOs had an interest coverage ratio of 2.21x and 1.22x for CDO I and CDO II, respectively, compared to minimum requirements of 1.21x and 1.09x. At December 31, 2008, our most restrictive covenants on our CDOs had an asset overcollateralization ratio of 1.15x and 1.10x for CDO I and CDO II, respectively, compared to minimum requirements of 1.12x and 1.10x. If we experience an additional $15,050 or $500 in reductions of collateral in CDO I or CDO II, respectively, due to further investment losses or other factors, we will fail the overcollateralization test for the respective CDO.

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On February 25, 2009, we were notified by the CDO I trustee that we failed the overcollateralization test for CDO I on the February 25, 2009 payment date and, as a result, future net cash flows from CDO I, including approximately $488,000 due on the February 25, 2009 payment date, will be diverted to pay down principal of senior bond holders rather than being paid to us until such time the covenant is back in compliance, if ever. As of February 27, 2009, CDO II was in compliance with the overcollateralization test, however, if an additional $0.5 million in defaults occur, CDO II will also breach the overcollateralization covenant. Management believes it is likely that CDO II will fail the overcollateralization test at some point in 2009, which will result in the cash flows of CDO II being diverted to pay down principal of senior bond holders, eliminating residual cash inflows paid to us. With both CDOs out of compliance with overcollateralization covenants, we will have minimal incoming cash flows from our primary business and there is no assurance when or if we will be able to regain compliance with these covenants. As discussed further in “—Related Party Transactions,” the breach of the overcollateralization covenant in either CDO provides MBIA, the controlling class of CDO II bondholders, the ability to terminate the existing collateral management agreement, as amended, and to remove us as the collateral manager of CDO II. We have incurred significant losses since our inception and may incur additional losses in the future as we continue to navigate the difficult issues in the credit and real estate markets. With minimal incoming cash flows, management’s plans to fulfill short-term capital requirements include (i) use of $23.1 million of cash on hand as of December 31, 2008 to fund operating expenses, (ii) senior collateral management fees, (iii) reduction in administrative costs, as a result of becoming a non-reporting company, (iv) reduction in employee headcount, and (v) sale of our unencumbered 1515 Market Street LLC joint venture interest, if possible under current market conditions. We believe these sources of funds will be sufficient to meet our liquidity requirements for at least the next 12 months. We continue to seek and explore partnerships and new business opportunities; however, there is no assurance that such partnerships or business opportunities will be available on favorable terms or at all.

Mortgage Indebtedness

On December 14, 2005, Springhouse, one of our consolidated joint ventures, obtained a $26.2 million mortgage loan in conjunction with the acquisition of real estate located in Prince George’s County, Maryland. The loan is guaranteed by Bozzuto Associates, Inc., or Bozzuto, our joint venture partner, has a maturity date of December 14, 2008, and bears interest at 30-day LIBOR plus 1.75%. As of December 31, 2008 and 2007, the outstanding balance was $25.8 million. The loan is secured by the Springhouse property and there is no recourse to us. We are currently in the process of marketing the Springhouse property for sale and the loan, which matured on December 14, 2008, is in default. In the event we are unable to sell the property in a short period of time, we will be unable to satisfy the obligation of the mortgage and may be required to (i) pay default interest after the maturity default, (ii) contribute additional capital to facilitate an extension and protect our interest, (iii) pay significant extension fees or (iv) seek financing from a different lender, which may not be available. We may also lose the property through foreclosure by the first mortgage holder. The occurrence of any of these events could further impair our position.

On March 28, 2006, Loch Raven, one of our consolidated joint ventures, obtained a $29.2 million mortgage loan in conjunction with the acquisition of real estate located in Baltimore, Maryland. The loan is guaranteed by Bozzuto, our joint venture partner, matures on April 10, 2010, and bears interest at a fixed rate of 5.96%. The lender has exercised a call option on the note and the loan is now due on April 9, 2009. As of December 31, 2008 and 2007 the outstanding balance was $29.2 million. The loan is secured by the Loch Raven property and there is no recourse to us. As discussed in Note 3, in the third quarter of 2008, management made a decision to no longer fund operating deficits at the Loch Raven property, which will likely result in the first mortgage holder foreclosing on our position. We do not expect further losses as the net carrying value of Loch Raven assets and liabilities, including the mortgage payable, is less than zero after reflecting the impairment of long-lived assets recorded in 2008.

On May 4, 2007, we assumed a $36.3 million mortgage loan in conjunction with the Rodgers Forge foreclosure. As of December 31, 2007, we were in technical default of certain covenants in this loan. The loan had a maturity date of April 16, 2009 and bore interest equal to one-half of one percent (0.50%) above the Prime Rate. As of December 31, 2007, the outstanding balance was $36.3 million, which is included in liabilities held for sale in the consolidated balance sheet. Subsequent to December 31, 2007, we sold the Rodgers Forge property and paid off the mortgage loan in full.

On May 9, 2007, we assumed a $103.9 million mortgage loan in conjunction with the Monterey foreclosure. As of December 31, 2007, we were in default of certain covenants in this loan. The loan had a maturity date of February 1, 2008 and bore interest at six-month LIBOR plus 3.25. As of December 31, 2007, the outstanding balance was $104.0 million, which is included in liabilities held for sale in the consolidated balance sheet. Subsequent to December 31, 2007, we sold the Monterey property and the buyer assumed the mortgage in full.

In January of 2008, we sold the Rodgers Forge property and paid off the $36.3 million mortgage loan in full. In March of 2008, we sold the Monterey property and the buyer assumed the $104.0 million mortgage loan in full.

Junior Subordinated Debentures

In July 2006, we completed the issuance of $50.0 million in unsecured trust preferred securities through a newly formed Delaware statutory trust, RFC Trust I, (“RFCT I”), which is one of our wholly-owned subsidiaries. The securities bear interest at a fixed rate of 8.10% for the first ten years ending July 2016. Thereafter the rate will float based on the 90-day LIBOR plus 249 basis points. The base management fee that we pay to our Manager pursuant to the management agreement is based on gross stockholders’ equity which our board of directors had previously determined to include the trust preferred securities. As a result of a resolution of our board of directors, beginning September 28, 2006, we no longer pay such a fee on trust preferred securities to our Manager.

RFCT I issued $1.55 million aggregate liquidation amount of common securities, representing 100% of the voting common stock of RFCT I to us for a total purchase price of $1.55 million. RFCT I used the proceeds from the sale of trust preferred securities and the common securities to purchase our junior subordinated notes. The terms of the junior subordinated notes match the terms of the trust preferred securities. The notes are subordinate and junior in right of payment to all present and future senior indebtedness and certain other financial obligations. We realized net proceeds from the offering of approximately $48.8 million.

Contractual Obligations

The table below summarizes our contractual obligations as of December 31, 2008. The table excludes contractual commitments related to our derivatives, which we discuss in “Qualitative and Quantitative Disclosures about Market Risk,” and the incentive fee payable under the management agreement that we have with our Manager, which we discuss in “—Related Party Transactions” because those contracts do not have fixed and determinable payments.


	Contractual commitments (in thousands) Payments due by period
	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
CDO I bonds payable	$	508,500	$	—	$	—	$	—	$	508,500
CDO II bonds payable		853,200		—		—		—		853,200
Mortgage payable⁽¹⁾		54,964		54,964		—		—		—
Trust preferred securities		50,000		—		—		—		50,000

Total	$	1,466,664	$	54,964	$	—	$	—	$	1,411,700

⁽¹⁾	Non-recourse to us.

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Off-Balance Sheet Arrangements

As of December 31, 2008 and 2007, we had approximately $11.4 million and $53.1 million, respectively, of equity interest in five joint ventures as described in Note 10 to our consolidated financial statements for the year ended December 31, 2008, included elsewhere in this Annual Report on Form 10-K.

Dividends

To qualify as a REIT, we must pay annual dividends to our stockholders of at least 90% of our net taxable income, determined before taking into consideration the dividends paid deduction and net capital gains. We intend to continue to pay regular quarterly dividends to our stockholders to the extent required to meet REIT requirements. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, which would only be paid out of available cash to the extent permitted under our secured credit facilities, we must first meet both our operating requirements and scheduled debt service on our warehouse lines and other debt payable. On December 17, 2008, we announced that our board of directors suspended the quarterly cash dividend in order to maintain our financial flexibility.

Related Party Transactions

Management Agreement

Upon completion of our June 2005 private offering, we entered into a management agreement with our Manager, which was subsequently amended and restated on April 29, 2008, was further amended on October 13, 2008 and has expired by its own terms on December 31, 2008, pursuant to which our Manager provided for the day-to-day management of our operations and received substantial fees in connection therewith. The management agreement required our Manager to manage our business affairs in conformity with the policies and the investment guidelines that are approved and monitored by our board of directors. Ray Wirta, our chairman, is the vice chairman of CBRE, Kenneth J. Witkin, our chief executive officer and president and one of our directors, is the executive managing director of our Manager and Michael J. Melody, one of our former directors, is the vice chairman in CBRE/Melody. As of December 31, 2008, Mr. Wirta does not hold an economic interest in our Manager and Messrs. Witkin and Melody and certain of our other former executive officers indirectly hold an economic interest in our Manager. Our chairman and chief executive officer and president also serve as officers and/or directors of our Manager. As a result, the management agreement between us and our Manager was negotiated between related parties, and the terms, including fees payable, may not have been as favorable to us as if it had been negotiated with an unaffiliated third party. Our executive officers and directors owned approximately 9.8% of our Manager at December 31, 2008.

Historically, we have paid our Manager an annual management fee monthly in arrears equal to 1/12th of the sum of (i) 2.0% of our gross stockholders’ equity (as defined in the management agreement), or equity, of the first $400.0 million of our equity, (ii) 1.75% of our gross stockholders’ equity in an amount in excess of $400.0 million and up to $800.0 million and (iii) 1.5% of our gross stockholders’ equity in excess of $800.0 million. Additionally, from July 26, 2006 to September 27, 2006, we considered the outstanding trust preferred securities as part of gross stockholders’ equity in calculating the base management fee. Our Manager used the proceeds from its management fee in part to pay compensation to its officers and employees. For the years ended December 31, 2008 and 2007, respectively, we paid $5.4 million and $7.8 million to our Manager for the base management fee under this agreement. As of December 31, 2008 and 2007, respectively, $0.2 million and $0.5 million of management fees were accrued.

In addition to the base management fee, our Manager was eligible to receive quarterly incentive compensation. The purpose of the incentive compensation was to provide an additional incentive for our Manager to achieve targeted levels of Funds From Operations (as defined in the management agreement) (after the base management fee and before incentive compensation) and to increase our stockholder value. Our Manager was eligible to receive quarterly incentive compensation in an amount equal to the product of: (i) twenty-five percent (25%) of the dollar amount by which (A) our Funds From Operations (after the base management fee and before the incentive fee) per share of our common stock for such quarter (based on the weighted average number of shares outstanding for such quarter) exceeds (B) an amount equal to (1) the weighted average of the price per share of our common stock in our June 2005 private offering and the prices per share of our common stock in any subsequent offerings (including our IPO), multiplied by (2) the greater of (a) 2.25% or (b) 0.75% plus one-fourth of the Ten Year Treasury Rate (as defined in the management agreement) for such quarter, multiplied by (ii) the weighted average number of shares of our common stock outstanding during the such quarter. We record any incentive fees as a management fee expense in the period when earned and when payments of such amounts have become probable and reasonably estimable in accordance with the management agreement. As of December 31, 2008 and 2007, respectively, no amounts were paid or were payable to our Manager for the incentive management fee under this agreement.

The management agreement also provided that we would reimburse our Manager for various expenses incurred by our Manager or its affiliates for documented expenses of our Manager or its affiliates incurred on our behalf, including but not limited to costs associated with formation and capital raising activities and general and administrative expenses. Without regard to the amount of compensation received under the management agreement, our Manager was responsible for the salaries and bonuses of its officers and employees. As of December 31, 2008 and 2007, respectively, $0.2 million and $0.1 million of expense reimbursements were accrued and are included in other liabilities.

Pursuant to the management agreement, after April 30, 2008, CBRE and CBRE Melody & Company may compete with us with respect to the acquisition and finance of real estate-related loans, structured finance debt investments and CMBS. In addition, we were responsible for severance of all employees of our Manager, including certain of our then executive officers, an obligation that we estimated would not exceed $2.9 million.

The management agreement with our Manager expired by its terms on December 31, 2008. The expiration of the management agreement ends our affiliation with CBRE and affiliates of CBRE effective December 31, 2008. On December 15, 2008, we, our Manager and CBRE|Melody entered into the “Termination Agreement”. In addition to terminating the Amended and Restated Management Agreement, dated April 29, 2008, and acknowledging certain survival provisions in the Amended Management Agreement, the parties to the Termination Agreement acknowledged and/or agreed, among other things, that (i) the termination of the Amended Management Agreement will be effective as of December 31, 2008, (ii) there will be no termination fee in connection with the Termination Agreement, (iii) the Manager will make payment to us for certain accrued bonuses, (iv) we will make a payment to the Manager of (x) the final installment of the base management fee earned or accrued by our Manager as of December 31, 2008, (y) the reimbursement of CBRE’s operating expenses, and (z) the reimbursement of certain 2008 personnel bonuses, each on or before February 15, 2009, and (v) we will hire all employees of the Manager effective January 1, 2009.

Collateral Management Agreements

In connection with the closing of CDO I on March 28, 2006, the CDO I issuer, RFC CDO 2006-1 Ltd., entered into a collateral management agreement with our Manager (the “2006 Collateral Management Agreement”). Pursuant to this agreement, our Manager had agreed to provide certain advisory and administrative services in relation to the collateral debt securities and other eligible investments securing the CDO notes. This collateral management agreement provides for a senior collateral management fee, payable monthly in accordance with the priority of payments as set forth in the indenture, equal to 1/12 of 0.10% per annum of the net outstanding portfolio balance, and an additional subordinate collateral management fee, payable monthly in accordance with the priority of payments as set forth in the indenture, equal to 1/12 of 0.15% per annum of the net outstanding portfolio balance. Net outstanding portfolio balance is the sum of the (i) aggregate principal balance of the collateral debt securities, excluding defaulted securities, (ii) aggregate principal balance of all principal proceeds held as cash and eligible investments in certain

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accounts, and (iii) with respect to the defaulted securities, the calculation amount of such defaulted securities. Effective March 28, 2006, the collateral manager agreed to remit to us the collateral management fees that it is entitled to receive. At December 31, 2008, we owned all of the non-investment grade bonds, preferred equity and equity in CDO I. The senior collateral management fee and the subordinate collateral management fee is allocated to us. As of December 31, 2008 and 2007, we did not reimburse our Manager for any expenses to our Manager under such collateral management agreement.

On December 17, 2008, we entered into an Assignment and Assumption Agreement with our Manager (the “2006 Assignment Agreement”) in connection with CDO I. Pursuant to the 2006 Assignment Agreement, our Manager agreed to assign and delegate to us all of its rights and obligations under the 2006 Collateral Management Agreement, effective on January 1, 2009.

We will receive the senior collateral management fee and the subordinated collateral management fee if we are in compliance with the interest coverage and overcollateralization coverage tests under CDO I. However, we will receive only the senior collateral management fee if we are not in compliance with the interest coverage and overcollateralization coverage tests under CDO I.

In connection with the closing of CDO II on April 2, 2007, the CDO II issuer, RFC CDO 2007-1 Ltd., entered into a collateral management agreement with our Manager (the “2007 Collateral Management Agreement”). Pursuant to this agreement, our Manager had agreed to provide certain advisory and administrative services in relation to the collateral debt securities and other eligible investments securing the CDO II notes. This collateral management agreement provides for a senior collateral management fee, payable monthly in accordance with the priority of payments as set forth in the indenture, equal to 1/4 of 0.15% per annum of the net outstanding portfolio balance, and an additional subordinate collateral management fee, payable monthly in accordance with the priority of payments as set forth in the indenture, equal to 1/4 of 0.20% per annum of the net outstanding portfolio balance. Net outstanding portfolio balance is the sum of the (i) aggregate principal balance of the collateral debt securities, excluding defaulted securities, (ii) aggregate principal balance of all principal proceeds held as cash and eligible investments in certain accounts, and (iii) with respect to the defaulted securities, the calculation amount of such defaulted securities. The collateral manager agreed to remit to us the collateral management fees that it is entitled to receive. At December 31, 2008, we owned all of the non-investment grade bonds, preferred equity and equity in the CDO. The senior collateral management fee and the subordinate collateral management fee are allocated to us. As of December 31, 2008 and 2007, we did not reimburse our Manager for any expenses to our Manager under such collateral management agreement.

On December 12, 2008, RFC CDO 2007-1 Ltd. entered into an Amendment Number One to the Collateral Management Agreement (the “Amendment”) with CBRE Realty Finance Management, LLC, and us as the “collateral manager” and consented to by MBIA Insurance Corporation, as controlling class of CDO II bondholders (“MBIA”). The Amendment establishes three additional collateral manager termination events which may be enforced in the sole discretion of MBIA. The first additional termination event relates to the departure of certain key persons from the collateral manager (or a successor thereof), while the second additional termination event is predicated on the continuing satisfaction of a collateral coverage test established by the Amendment. The third additional termination event relates to the continuing satisfaction of a particular collateral coverage test under our CDO I. In addition, the collateral manager has agreed to (i) cause the trustee of the CDO I and the trustee of the CDO II to provide certain additional reports concerning the above-noted tests to MBIA and (ii) pay the trustee of the CDO II a monthly fee for performing such additional reporting services.

On December 17, 2008, we entered into an Assignment and Assumption Agreement with our Manager (the “2007 Assignment Agreement”) in connection with CDO II. Pursuant to the 2007 Assignment Agreement, our Manager agreed to assign and delegate to us all of its rights and obligations under the 2007 Collateral Management Agreement, effective on January 1, 2009.

We will receive the senior collateral management fee and the subordinated collateral management fee if we are in compliance with the interest coverage and overcollateralization coverage tests under CDO II. However, we will receive only the senior collateral management fee if we are not in compliance with the interest coverage and overcollateralization coverage tests under CDO II.

Affiliates

As of December 31, 2008, an affiliate of our Manager, CBRE Melody of Texas, LP and its principals, owned 1.1 million shares (which were purchased in our June 2005 private offering) of our common stock, 300,000 shares of restricted common stock, and had options to purchase an additional 500,000 shares of common stock.

GEMSA Servicing

GEMSA Loan Services, L.P., which we refer to as GEMSA, is utilized by us as a loan servicer. GEMSA is a joint venture between CBRE|Melody and GE Capital Real Estate. GEMSA is a rated master and primary servicer. Our fees for GEMSA’s services are at what we believe to be market rates. For the years ended December 31, 2008 and 2007, we paid or had payable an aggregate of approximately $0.3 million to GEMSA in connection with its loan servicing of a part of our portfolio.

CBRE License Agreement

In connection with our June 2005 private offering, we entered into a license agreement with CBRE and one of its affiliates pursuant to which they granted us a non-exclusive, royalty-free license to use the name “CBRE.” Other than with respect to this limited license, we have no legal right to the “CBRE” name. After the management agreement expired by its terms on December 31, 2008, we changed our name and no longer have the right to use the “CBRE” mark in our name or in the name of any of our subsidiaries.

Torto Wheaton Research License Agreement

Torto Wheaton Research, or TWR, is a wholly-owned subsidiary of CBRE that provides research products and publications to us under a license agreement. The cost of this license agreement is at what we believe to be market rates. For the years ended December 31, 2008 and 2007, we paid or had payable an aggregate of approximately $0.1 million in licensing fees to TWR in connection with the license agreement.

Funds from Operations

Funds from Operations, or FFO, which is a non-GAAP financial measure, is a widely recognized measure of REIT performance. We compute FFO in accordance with standards established by the National Association of Real Estate Investment Trusts, or NAREIT, which may not be comparable to FFO reported by other REITs that do not compute FFO in accordance with the NAREIT definition, or that interpret the NAREIT definition differently than we do. The revised White Paper on FFO approved by the Board of Governors of NAREIT in April 2002 defines FFO as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from debt restructuring and sales of properties, plus real estate related depreciation and amortization and after adjustments for unconsolidated/uncombined partnerships and joint ventures. We present FFO because we consider it an important supplemental measure of our operating performance and believe that it is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs. We also use FFO as one of several criteria to determine performance-based equity bonuses for members of our senior management team. FFO is intended to exclude GAAP historical cost depreciation and amortization of real estate and related assets, which assumes that the value of real estate assets diminishes ratably over time. Historically, however, real estate values have risen or fallen with market conditions. Because FFO excludes depreciation and amortization unique to real estate, gains and losses from property dispositions and extraordinary items,

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it provides a performance measure that, when compared year over year, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, interest costs, providing perspective not immediately apparent from net income. We consider gains and losses on the sale of debt investments to be a normal part of its recurring operations and therefore does not exclude such gains or losses while arriving at FFO. FFO does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income (determined in accordance with GAAP), as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make cash distributions.

FFO for the years ended December 31, 2008, 2007 and 2006 are as follows (dollars in thousands):


	For the Year Ended December 31, 2008			For the Year Ended December 31, 2007			For the Year Ended December 31, 2006
Funds from operations:
Net income (loss)	$	(157,031	)	$	(70,766	)	$	13,743
Adjustments:
Gain from sale of property – discontinued operations		(6,780	)		—			—
Real estate depreciation and amortization – wholly-owned		49
Real estate depreciation and amortization – consolidated joint ventures		745			1,233			489
Real estate depreciation and amortization – unconsolidated joint ventures		5,624			10,391			2,027
Real estate depreciation and amortization – discontinued operations		476			838			1,003

Funds from operations	$	(156,917	)	$	(58,304	)	$	17,262

Cash flows provided by operating activities	$	12,648		$	29,407		$	7,925
Cash flows provided by (used in) investment activities	$	123,863		$	(542,090	)	$	(860,191	)
Cash flows provided by (used in) financing activities	$	(139,331	)	$	521,165		$	820,822

Critical Accounting Policies

Our critical accounting policies are those that have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates. We believe that our judgments and assessments are consistently applied and produce financial information that fairly presents our results of operations. Our most critical accounting policies concern our accounting for investments, accounting for derivatives, accounting for FIN 46R and valuation of investments, CDOs, junior subordinated securities and derivatives.

Loans and Other Lending Investments

Loans held for investment are intended to be held to maturity and, accordingly, are carried at amortized cost, including unamortized loan origination costs and fees, and net of repayments and sales of partial interests in loans, unless such loan or investment are deemed to be impaired. At such time as we invest in real estate loans, we determine whether such investment should be accounted for as a loan, real estate investment, or equity method joint venture in accordance with AICPA Practice Bulletin No. 1 on acquisition, development, and construction (ADC) arrangements.

We evaluate our assets on a regular basis to determine if they continue to satisfy our investment criteria. Subject to certain restrictions applicable to REITs and to maintain our exclusion from regulation as an investment company, we may sell investments opportunistically and use the proceeds of any such sales for debt reduction, additional acquisitions or working capital purposes.

Variable Interest Entities

In December 2003, FIN 46R was issued as a modification of FIN No. 46 “Consolidation of Variable Interest Entities.” FIN 46R, which became effective in the first quarter of 2004, clarified the methodology for determining whether an entity is a Variable Interest Entity, or VIE and the methodology for assessing who is the primary beneficiary of a VIE. VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. If an entity is determined to be a VIE, it must be consolidated by the primary beneficiary. The primary beneficiary is the enterprise that absorbs the majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both. Generally, expected losses and expected residual returns are the expected negative and positive variability, respectively, in the fair value of the variable interest entities’ net assets.

When we make an investment, we assess whether we have a variable interest in a VIE and, if so, whether we are the primary beneficiary of the VIE. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they involve subjective probability weighting of various cash flow scenarios. Incorrect assumptions or estimates of future cash flows may result in an inaccurate determination of the primary beneficiary. The result could be the consolidation of an entity acquired or formed in the future that would otherwise not have been consolidated or the non-consolidation of such an entity that would otherwise have been consolidated.

We have evaluated our investments in CMBS, loans and other lending investments, and joint venture interests to determine whether they are variable interests in VIEs. For each of the investments, we have evaluated the sufficiency of the entities’ equity investment at risk to absorb expected losses, and whether as a group, does the equity have the characteristics of a controlling financial interest.

FIN 46R has certain scope exceptions, one of which provides that an enterprise that holds a variable interest in a qualifying special-purpose entity (“QSPE”) does not consolidate that entity unless that enterprise has unilateral ability to cause the entity to liquidate. SFAS No. 140 (“SFAS 140”) “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” provides the requirements for an entity to be considered a QSPE. To maintain the QSPE exception, the entity must continue to meet the QSPE criteria both initially and in subsequent periods. An entity’s QSPE status can be impacted in future periods by activities by its transferor(s) or other involved parties, including the manner in which certain servicing activities are performed. To the extent our CMBS investments were issued by an entity that meets the requirements to be considered a QSPE, we record the investments at purchase price paid. To the extent the underlying entities are not QSPEs, we follow the guidance set forth in FIN 46R as the entities would be considered VIEs.

We have analyzed the governing pooling and servicing agreements for each of its CMBS investments and believe that the terms are industry standard and are consistent with the QSPE criteria. However, there is uncertainty with respect to QSPE treatment due to ongoing review by accounting standard setters, potential actions by various parties involved with the QSPE, as discussed above, as well as varying and evolving interpretations of the QSPE criteria under SFAS 140. Additionally, the standard setters continue to review the FIN 46R provisions related to the computations used to determine the primary beneficiary of a VIE. Our maximum exposure to loss as a result of our investments in these CMBS investments was $54.6 million and $279 million as of December 31, 2008 and 2007, respectively.

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The financing structures, including loans and other lending investments, that we offer to borrowers on certain of our loans involve the creation of entities that could be deemed VIEs and, therefore, could be subject to FIN 46R. We have identified one mezzanine loan as a variable interest in a VIE and have determined that we are not the primary beneficiary of this VIE and as such the VIE should not be consolidated in our consolidated financial statements. The loan is for a mixed use development project. Our maximum exposure to loss would not exceed the carrying amount of this investment of $0.

We have determined that two of our joint venture investments are VIEs in which we are deemed to be the primary beneficiary and under FIN 46R have consolidated these investments. The primary effect of the consolidation is that we reflect the real estate assets, mortgage loan payable, property operating revenue, and property operating expenses related to these entities in our consolidated financial statements.

Fair Value Measurements under SFAS 157 and SFAS 159

We apply the provisions of SFAS No. 157, which establishes a fair value hierarchy, giving the highest priority to quoted prices in active markets and the lowest priority to unobservable data. SFAS 157 is applicable to our CMBS, derivatives, collateralized debt obligations, junior subordinated notes and collateral dependent loans. We also apply the provisions of SFAS No. 159, which allows us to measure certain financial assets and financial liabilities at fair value. We have elected SFAS 159 for all CDO bonds below AAA rating at the date of issuance, $50 million of junior subordinated debentures and all CMBS investments rated below AAA at the date of acquisition. Our intent is to hold CMBS, derivatives, CDO bonds and junior subordinated notes to maturity, therefore we believe the unrealized gains and losses are generally not reflective of the economic consideration we expect to be realized from holding them to maturity but rather are a product of short-term fluctuations in fair value due to changes in credit spreads and other market conditions. Our CDO bonds are in compliance with all interest coverage and over collateralization tests at December 31, 2008, therefore we believe our underlying investment portfolio will generate sufficient cash flows to repay our CDO bonds and as a result, we would not expect to ultimately realize the current unrealized gains on these securities. Our CMBS portfolio has experienced below market credit defaults, minimal downgrades and no adverse changes in cash flows, therefore we expect the majority of these unrealized losses will not be realized as we have the ability and intent to hold these investments to maturity. For derivative instruments, we plan to hold these instruments until maturity at which their fair value will be zero, preventing current unrealized losses from being realized. Our expectation of the ultimate realization of unrealized gains and losses is based on our current estimates and outlook. A prolonged continuation of current market conditions, further deterioration of real estate market or other market factors outside of our control could have a significant impact on whether we will ultimately realize unrealized gains or losses on financial instruments.

At December 31, 2008, 4% of our assets and 20% of our liabilities were measured at fair value using unobservable inputs.

Valuation and Accounting for CMBS

CMBS are classified as trading securities as of December 31, 2008, in connection with the adoption of SFAS 159 and available-for-sale securities at December 31, 2007 and are carried on our balance sheet at fair value. Prior to the adoption of Statement of Financial Accounting Standards No. 159 on January 1, 2008 when CMBS were classified as held for sale, in accordance with Emerging Issues Task Force, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” or EITF Issue 99-20, we assessed whether unrealized losses on securities, if any, reflect a decline in value which is other than temporary and, accordingly, writes the impaired security down to its value through earnings. For example, a decline in value is deemed to be other than temporary if it is probable that we will be unable to collect all amounts due according to the contractual terms of a security which was not impaired at acquisition. Temporary declines in value generally result from changes in market factors, such as market interest rates, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly impact our ability to collect amounts contractually due. Additionally, for an impairment to be temporary, we must demonstrate the intent and ability to hold the investments through at least their anticipated recovery period. Significant judgment is required in this analysis. No such write-downs were made through December 31, 2007.

Our primary basis for estimating fair values for CMBS is using indicative prices from third parties that actively participate in the CMBS market. We receive non-binding quotes from established financial institutions, which may range from one to four quotes for each investment, and select a fair value using the quotes received based on a methodology that is applied on a consistent basis each reporting period. These quotations are subject to significant variability based on market conditions, such as interest rates, liquidity, trading activity and credit spreads. We generally do not adjust values from broker quotes received. In the event we are unable to obtain any quotes from market participants or if in our judgment we believe quotes received are inaccurate, we estimate fair value using internal models that consider, among other things, the CMBX index, expected cash flows, known and expected defaults and rating agency reports. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in the recorded amount of our investment. As of December 31, 2008 and 2007, $4.3 million and $0 CMBS investments were valued using internal models, respectively. Significant judgment is involved in valuations and different judgments and assumptions used in management’s valuation could result in different valuations. As the severe dislocation in the real estate and credit markets continues and worsens, resulting in illiquidity, our estimates of fair value will continue to have significant volatility. Since there are no active markets for our CMBS investments, we classify the investment as Level 3 under the SFAS 157 fair value hierarchy. If our estimate of fair value at December 31, 2008 changed by 5%, our net loss for the year ended December 31, 2008 would change by approximately $2.7 million.

Derivative Instruments

We recognize all derivatives on the balance sheet at fair value. On January 1, 2008, we adopted SFAS 159 for several financial instruments, including certain CDO bonds, which are the instruments for which we seek to minimize interest rate risk through hedging activities. Because certain CDO bonds are recorded at fair value, all interest rate swaps outstanding at January 1, 2008 no longer qualify for hedge accounting and subsequent changes in fair value are recorded as a component of income from continuing operations.

Derivatives that do not qualify, or are not designated as hedge relationships, must be adjusted to fair value through income. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or liability. To the extent hedges are effective, a corresponding amount, adjusted for swap payments, is recorded in accumulated other comprehensive income within stockholders’ equity. Amounts are then reclassified from accumulated other comprehensive income to the income statement in the period or periods the hedged forecasted transaction affects earnings. Ineffectiveness, if any, is recorded in the income statement. We periodically review the effectiveness of each hedging transaction, which involves estimating future cash flows, at least quarterly as required by SFAS Statement No. 133, or SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by FASB Statement No. 138 “Accounting for Certain Derivative Instruments and Hedging Activities of an Amendment of FASB 133” and FASB Statement No. 149 “Amendment of Statement 133 on Derivative Instrument and Hedging Activities.” Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, will be considered fair value hedges under SFAS 133. We currently have no fair value hedges outstanding. Fair values of derivatives are subject to significant variability based on changes in interest rates. The results of such variability could be a significant increase or decrease in our derivative assets, derivative liabilities, book equity, and/or earnings.

To estimate the fair values of derivative instruments, we use a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. For the valuation of derivative instruments, standard market conventions and techniques such as discounted cash flow analysis, option-pricing models, replacement cost, and termination cost are used to determine fair value. The values are also adjusted to reflect nonperformance and credit risk. Significant judgment is involved in valuations and different judgments and assumptions used in management’s valuation could result in different valuations.

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Valuation of CDO bonds and Junior Subordinated Notes

Estimated fair values for CDO bonds and junior subordinated debentures are based on independent valuations. Currently, there is not an active market for our CDO bonds or our junior subordinated debentures and the independent appraiser estimates fair value using a valuation model that considers, among other things, (i) anticipated cash flows (ii) current market credit spreads, such as CMBX, (iii) known and anticipated credit issues of underlying collateral (iv) term and reinvestment period and (v) market transactions of similar securities. When available, management will compare fair values estimated by the independent appraiser to third party quotes and transactions of identical or similar securities, however, such information is not available on a consistent basis. Estimates of fair value are subject to significant variability based on market conditions, such as interest rates and credit spreads. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in the recorded amount of our fair value. Significant judgment is involved in valuations and different judgments and assumptions used in management’s valuation could result in different valuations. If our estimate of fair value of CDO bonds at December 31, 2008 changed by 5%, our net loss for the year ended December 31, 2008 would change by approximately $6.2 million. If our estimate of fair value of Junior Subordinated Notes at December 31, 2008 changed by 5%, our net loss for the year ended December 31, 2008 would change by approximately $0.4 million.

Revenue Recognition

Interest income on loan investments is recognized over the life of the investment using the effective interest method. Fees received in connection with loan commitments are deferred until the loan is funded and are then recognized over the term of the loan as an adjustment to yield. Fees on commitments that expire unused are recognized at expiration.

Income recognition is suspended for debt investments when receipt of income is not reasonably assured at the earlier of (i) management determining the borrower is incapable of curing, or has ceased efforts towards curing the cause of a default; (ii) the loan becoming 90 days delinquent; or (iii) the loan having a maturity default. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. While income recognition is suspended, interest income is recognized only upon actual receipt.

Interest income on CMBS is recognized using the effective interest method as required by EITF 99-20. Under EITF 99-20 management estimates, at the time of purchase, the future expected cash flows and determines the effective interest rate based on these estimated cash flows and the purchase price. In estimating these cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including the rate and timing of principal payments (including prepayments, repurchases, defaults and liquidations), the pass through or coupon rate and interest rate fluctuations. In addition, interest payment shortfalls due to delinquencies on the underlying mortgage loans, and the timing of and magnitude of credit losses on the mortgage loans underlying the securities have to be estimated. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact management’s estimates and the amount of interest income recognized.

If the current period cash flow estimates are lower than the previous period, and fair value is less than the carrying value of CMBS, we will write down the CMBS to fair market value and record the impairment charge in the current period earnings. After taking into account the effect of the impairment charge, income is recognized using the market yield for the security used in establishing the write down.

Loan Loss Reserves

The expenses for possible credit losses in connection with debt investments represents the increase in the allowances for possible credit losses to the level that management estimates to be adequate considering delinquencies, loss experience and collateral quality. Other factors considered relate to geographic trends and project diversification, the size of the portfolio and current economic conditions.

We must periodically evaluate loans for possible impairment. Loans and other investments are considered impaired, for financial reporting purposes, when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the original agreement, or, for loans acquired at a discount credit quality when it is deemed probable that we will be unable to collect as anticipated.

Specific valuation allowances are established for impaired loans based on the fair value of collateral on an individual loan basis. The fair value of the collateral may be determined by (i) independent appraisal, (ii) internal company models, (iii) market bids or (iv) a combination of these methods. Valuation of collateral and the resulting loan loss reserve is based on assumptions such as expected operating cash flows, expected capitalization rates, estimated time the property will be held, discount rates and other factors. Significant judgment is required both in determining impairment and in estimating the resulting loss allowance. Changes in market conditions, as well as changes in the assumption or methodology used to determine fair value, could result in a significant change in the recorded amount in our investment. Further, if actual results are not consistent with the Company’s assumptions and judgments used in estimating future cash flows and asset fair values, the Company may be exposed to losses greater than those estimated and such differences could be material to the results of operations.

If upon completion of the valuation, the fair value of the underlying collateral securing the impaired loan is less than the net carrying value of the loan, an allowance is created with a corresponding charge to the provision for loan losses. As of December 31, 2008, we have a loan loss reserve of $141.1 million. If our estimate of the fair value of collateral for collateral dependent loans increased or decreased by 5% at December 31, 2008, our net loss for the year ended December 31, 2008 would change by approximately $0.3 million.

Impairment of Long-Lived Assets

We evaluate potential impairments of long-lived assets, including assets held for development and real estate, in accordance with FASB Statement of Financial Accounting Standards 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” or SFAS 144. SFAS 144 establishes procedures for the review of recoverability and measurement of impairment, if necessary, of long-lived assets held and used by an entity. SFAS 144 requires that assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. We would be required to recognize an impairment loss if the carrying amount of long-lived assets is not recoverable based on their undiscounted cash flows. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to impairment losses that could be material to the results of operations.

In the third quarter of 2008, management made a decision to market the Springhouse property for sale, resulting in classification of assets and liabilities as “held for sale” as of December 31, 2008 and results from operations classified as “discontinued operations” for all periods presented. Based on management’s commitment to sell the property and the resulting held for sale classification, we have recorded the long-lived assets of Springhouse at estimated fair value less costs to sell, which resulted in an impairment loss of $6,057 for the year ended December 31, 2008.

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recoverable. Based on our current estimate of undiscounted cash flows over the expected life of the investment, we determined that the carrying value of the Loch Raven long-lived assets was not fully recoverable. As a result of this assessment, we recorded an impairment loss of $6 million for the year ended December 31, 2008 based on the difference between the carrying value of the long-lived assets and their estimated fair value.

Manager Compensation

The former management agreement provided for the payment of a base management fee to our Manager and an incentive fee if our financial performance exceeds certain benchmarks. The base management fee and the incentive fee are accrued and expensed during the period for which they are calculated and earned.

Stock-Based Payment

We have issued restricted shares of common stock and options to purchase common stock, or equity awards, to our directors, our Manager, employees of our Manager and other related persons. We account for stock-based compensation related to these equity awards using the fair value based methodology under FASB Statement No. 123(R), or SFAS 123(R), “Share Based Payment” and EITF 96-18 “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.” Compensation cost for restricted stock and stock options issued is initially measured at fair value at the grant date, remeasured at subsequent dates to the extent the awards are unvested, and amortized into expense over the vesting period on a straight-line basis.

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and real estate values. The primary market risks that we are exposed to are real estate risk, interest rate risk, market value risk and prepayment risk.

Real Estate Risk

Commercial mortgage assets, commercial property values and net operating income derived from such properties are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors), local real estate conditions (such as an oversupply of housing, retail, industrial, office or other commercial space); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; and increases in operating expenses (such as energy costs). In the event that net operating income from such properties decreases, a borrower may have difficulty repaying our loans, which could result in losses to us. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses. Even when the net operating income is sufficient to cover the related property’s debt service, there can be no assurance that this will continue to be the case in the future.

Interest Rate Risk

Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.

A hypothetical 100 basis point increase in interest rates along the entire interest rate curve for the year ended December 31, 2008 would have increased our net interest expense by approximately $4.8 million, and increased our investment income by approximately $6.8 million. In 2008, due primarily to the uncertainty in the credit markets, there was significant volatility in interest rates and we expect this volatility to continue in 2009.

Our operating results will depend in large part on differences between the income from our loans and our borrowing costs. We generally match the interest rates on our loans with like-kind debt, so that fixed rate loans are financed with fixed rate debt and floating rate loans are financed with floating rate debt, directly or through the use of interest rate swaps or other financial instruments. The objective of this strategy is to minimize the impact of interest rate changes on our net interest income. Currently most of our borrowings, with the exception of the two most junior classes of our CDO bonds (aggregating $44.25 million) and one of our consolidated joint venture mortgages payable of $25.8 million are variable-rate instruments, based on 30-day LIBOR.

In the event of a significant rising interest rate environment and/or economic downturn, defaults could increase and result in credit losses to us, which could adversely affect our liquidity and operating results. Further, such delinquencies or defaults could have an adverse effect on the spreads between interest-earning assets and interest-bearing liabilities.

We invest in CMBS, which are designated as trading on our balance sheet. The majority of our CMBS investments is fixed rate securities and is partially financed with floating rate debt. In order to minimize the exposure to interest rate risk we utilize interest rate swaps to convert the floating rate debt to fixed rate debt, which matches the fixed interest rate of the CMBS.

As of December 31, 2008, we have 21 interest rate swap agreements and three basis swap agreements outstanding with an aggregate current notional value of $909.9 million and $89.8 million, respectively, to hedge our exposure on forecasted outstanding LIBOR-based debt. The market value of these interest rate swaps and basis swaps is dependent upon existing market interest rates and swap spreads, which change over time. If there were a 100 basis point decrease in forward interest rates at December 31, 2008, the fair value of these interest rate swaps and basis swaps and our net income for the year ended December 31, 2008 would have decreased by approximately $41.0 million. If there were a 100 basis point increase in forward interest rates at December 31, 2008, the fair value of these interest rate swaps and basis swaps and our net income for the year ended December 31, 2008 would have increased by approximately $38.4 million.

Our hedging transactions using derivative instruments also involve certain additional risks such as counterparty credit risk, the enforceability of hedging contracts and the risk that unanticipated and significant changes in interest rates will cause a significant loss of basis in the contract. The counterparty to our derivative arrangements are Deutsche Bank AG, and Wachovia. The severe issues in the credit markets have significantly raised concerns over counter party credit risk, even with those counter parties long thought to be safe due to their size, history and reputation. As of December 31, 2008, we believe our counterparty credit risk is minimal given that we are in a net liability position for each counterparty that we have open hedging transactions with. As a result, we do not anticipate that any counterparty will fail to meet their obligations. We will continue to closely monitor our hedge positions and consider counterparty credit risk, however, there can be no assurance that we will be able to adequately protect against the foregoing risks and will ultimately realize an economic benefit that exceeds the related amounts incurred in connection with engaging in such hedging strategies.

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We utilize interest rate swaps to limit interest rate risk. Derivatives are used for hedging purposes rather than speculation. We do not enter into financial instruments for trading purposes. The following table sets forth our derivative instruments as of December 31, 2008:


Type of Hedge	Notional Amount		Swap Rate		Trade Date	Maturity Date	Termination Value at December 31, 2008
Pay-Fixed Swap	$	149,541,563	5.055	%	03/16/06	10/25/11	$	(10,164,355	)
Pay-Fixed Swap		44,736,359	5.663	%	05/12/06	02/25/18		(9,961,142	)
Pay-Fixed Swap		35,975,485	5.171	%	09/19/06	09/25/11		(3,543,512	)
Pay-Fixed Swap		28,151,274	4.947	%	12/15/06	10/25/11		(2,700,876	)
Pay-Fixed Swap		15,300,000	5.466	%	06/20/07	06/18/12		(2,014,434	)
Pay-Fixed Swap		9,100,000	5.182	%	03/04/08	02/25/12		(1,160,009	)
Pay-Fixed Swap		26,950,500	5.242	%	03/04/08	04/25/16		(5,493,710	)
Pay-Fixed Swap		4,250,000	5.574	%	03/04/08	07/25/11		(457,314	)
Pay-Fixed Swap		336,238,700	4.909	%	03/02/07	04/07/21		(41,648,864	)
Pay-Fixed Swap		28,272,430	4.842	%	03/02/07	10/07/11		(2,238,196
Pay-Fixed Swap		13,500,000	4.842	%	03/02/07	04/09/12		(1,223,076
Pay-Fixed Swap		25,000,000	4.842	%	03/02/07	10/07/11		(1,949,647
Pay-Fixed Swap		25,000,000	4.842	%	03/02/07	01/09/12		(2,150,002	)
Pay-Fixed Swap		16,200,000	4.842	%	03/02/07	07/07/15		(2,457,114	)
Pay-Fixed Swap		11,990,391	4.842	%	03/02/07	01/09/12		(971,426	)
Pay-Fixed Swap		2,835,372	4.842	%	03/02/07	10/07/11		(227,570	)
Pay-Fixed Swap		23,610,000	4.842	%	03/02/07	04/09/12		(2,165,943	)
Basis Swap		58,112,000	0.454	%	03/02/07	01/07/10		679,062
Basis Swap		3,028,516	0.449	%	03/02/07	09/15/11		50,320
Basis Swap		28,650,000	0.451	%	03/02/07	04/07/10		417,839
Pay-Fixed Swap		28,700,000	5.600	%	06/28/07	10/07/17		(7,160,775	)
Pay-Fixed Swap		8,500,000	5.654	%	08/16/07	06/07/17		(2,091,303	)
Pay-Fixed Swap		26,400,000	5.390	%	09/28/07	10/07/17		(3,646,451	)
Pay-Fixed Swap		49,679,400	5.510	%	02/04/08	10/07/17		(7,126,471	)

	$	999,721,989					$	(109,404,969	)

Prepayment Risk

As we receive repayments of principal on loans and other lending investments or CMBS, premiums paid on such investments are amortized against interest income using the effective yield method through the expected maturity dates of the investments. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the investments. Conversely discounts received on such investments are accreted into interest income using the effective yield method through the expected maturity dates of the investments. In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the interest income earned on the investments.

Geographic Concentration Risk

As of December 31, 2008, approximately 29%, 10%, 48% and 7% of the outstanding balance of our loan investments had underlying properties in the East, the South, the West, and the Midwest, respectively, as defined by the National Council of Real Estate Investment Fiduciaries, or NCREIF, while the remaining 6.0% of the outstanding loan investments had underlying properties that are located throughout the United States.

Inflation

Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Further, our financial statements are prepared in accordance with GAAP and our distributions are determined by our board of directors based primarily by our net income as calculated for tax purposes, in each case, our activities and balance sheet are measured with reference to historical cost and or fair market value without considering inflation.

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ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements and Schedule


		PAGE
REALTY FINANCE CORPORATION

Reports of Independent Registered Public Accounting Firm		54
Consolidated Balance Sheets as of December 31, 2008 and 2007		56
Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006		57
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2008, 2007 and 2006		58
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006		59
Notes to Consolidated Financial Statements		60

Schedules

Schedule IV Mortgage Loans on Real Estate as of December 31, 2008		85

All other schedules are omitted because they are not required or the required information is shown in the financial statements or notes thereto.

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Realty Finance Corporation

We have audited the accompanying consolidated balance sheets of Realty Finance Corporation, formerly known as CBRE Realty Finance, Inc., (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index to Financial Statements and Schedule under Item 8. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note 3 to the consolidated financial statements, in 2008 the Company adopted Financial Accounting Standards Board Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2009 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Hartford, Connecticut

March 13, 2009

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Realty Finance Corporation

We have audited Realty Finance Corporation’s, formerly known as CBRE Realty Finance, Inc. (the “Company”), internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting, under Item 9A. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2008 and our report dated March 13, 2009 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Hartford, Connecticut

March 13, 2009

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Realty Finance Corporation

Consolidated Balance Sheets

(Amounts in thousands, except share and per share data)


	December 31, 2008			December 31, 2007
Assets:
Cash and cash equivalents	$	23,133		$	25,954
Restricted cash		67,252			137,004
Loans and other lending investments, net ($6,402 and $75,129 at fair value, respectively)		1,168,733			1,362,054
Commercial mortgage-backed securities, at fair value		54,620			236,134
Real estate, net		33,441			65,495
Investment in unconsolidated joint ventures		11,352			53,145
Derivative assets, at fair value		260			125
Accrued interest		6,707			9,304
Other assets		11,509			25,658
Assets held for sale		25,936			154,426

Total assets	$	1,402,943		$	2,069,299

Liabilities and Stockholders’ Equity:
Liabilities:
Collateralized debt obligations ($124,292 and $0 at fair value, respectively)	$	949,292		$	1,339,500
Repurchase obligations		—			144,183
Mortgage notes payable		54,964			54,899
Note Payable		19,199			21,736
Derivative liabilities, at fair value		109,508			40,403
Management fees payable		243			566
Dividends payable		—			6,493
Accounts payable and accrued expenses		11,714			8,439
Other liabilities		31,087			39,732
Junior subordinated deferrable interest debentures held by trust that issued trust preferred securities ($8,375 and $0 at fair value, respectively)		8,375			50,000
Liabilities held for sale		153			149,869

Total liabilities		1,184,535			1,855,820

Commitments and contingencies		—			—
Minority interest		(21	)		663
Stockholders’ Equity:
Preferred stock, par value $.01 per share; 50,000,000 shares authorized, no shares issued or outstanding at December 31, 2008 and December 31, 2007, respectively		—			—
Common stock par value $.01 per share; 100,000,000 shares authorized, 30,823,200 and 30,920,225 shares issued and outstanding at December 31, 2008 and December 31, 2007, respectively		308			309
Additional paid-in-capital		423,046			422,275
Accumulated other comprehensive loss		(37,826	)		(106,406	)
Accumulated deficit		(167,099	)		(103,362	)

Total stockholders’ equity		218,429			212,816

Total liabilities and stockholders’ equity	$	1,402,943		$	2,069,299

The accompanying notes are an integral part of these financial statements.

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Realty Finance Corporation

Consolidated Statements of Operations

(Amounts in thousands, except per share data)


	For the year ended December 31, 2008			For the year ended December 31, 2007			For the year ended December 31, 2006
Revenues
Investment income	$	100,522		$	129,416		$	64,631
Property operating income		4,439			4,005			3,076
Other income		976			4,609			3,322

Total revenues		105,937			138,030			71,029

Expenses
Interest expense		82,036			92,157			40,546
Management fees		5,059			7,695			6,515
Property operating expenses		3,270			2,662			1,685
Other general and administrative (including $770, $1,292 and $3,867, respectively, of stock-based compensation)		16,478			9,351			10,404
Depreciation and amortization		1,121			1,398			529
Provision for loan losses		126,504			19,650			—
Loss on impairment of assets		5,966			7,764			—

Total expenses		240,434			140,677			59,679

Gain (loss) on sale of investment		(2,021	)		(500	)		258
Gain (loss) on financial instruments		20,834			(1,668	)		3,634

Income (loss) from continuing operations before equity in net loss of unconsolidated joint ventures, minority interest and discontinued operations		(115,684	)		(4,815	)		15,242
Equity in net loss of unconsolidated joint ventures		(39,863	)		(5,721	)		(453	)

Income (loss) before minority interest and discontinued operations		(155,547	)		(10,536	)		14,789
Minority interest		(689	)		(132	)		(75	)

Income (loss) from continuing operations		(154,858	)		(10,404	)		14,864

Discontinued Operations:
Operating results from discontinued operations		(2,896	)		(5,633	)		(1,121	)
Loss on impairment of assets held for sale		(6,057	)		(54,729	)		—
Gain on sale of investment		6,780			—			—

Loss from discontinued operations		(2,173	)		(60,362	)		(1,121	)

Net income (loss)	$	(157,031	)	$	(70,766	)	$	13,743

Weighted-average shares outstanding:
Basic weighted average common shares outstanding		30,553			30,287			22,688

Diluted weighted average common shares and common share equivalents outstanding		30,553			30,287			22,837

Basic earnings per share:
Income (loss) from continuing operations	$	(5.07	)	$	(0.34	)	$	0.66
Loss from discontinued operations		(0.07	)		(1.99	)		(0.05	)

Net income (loss)	$	(5.14	)	$	(2.33	)	$	0.61

Diluted earnings per share:
Income (loss) from continuing operations	$	(5.07	)	$	(0.34	)	$	0.65
Loss from discontinued operations		(0.07	)		(1.99	)		(0.05	)

Net income (loss)	$	(5.14	)		(2.33	)		0.60

Dividends per common share	$	0.30		$	0.80		$	0.82

The accompanying notes are an integral part of these financial statements.

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Realty Finance Corporation

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

(Amounts in thousands, except per share and share data)


	Common Stock					Additional			Accumulated			Accumulated Deficit			Total			Comprehensive Income (loss)
	Shares		Par Value			Paid- In-Capital			Other Comprehensive			Accumulated Deficit			Total			Comprehensive Income (loss)
Balance at December 31, 2005	20,567,755		$	206		$	284,029		$	(1,748	)	$	(2,856	)	$	279,631		$	(696	)
Issuance of restricted shares of common stock	134,000			1			—			—			—			1			—
Net proceeds from common stock offering	9,945,020			99			133,090			—			—			133,189			—
Stock-based compensation	—			—			3,867			—			—			3,867			—
Net income													13,743			13,743			13,743
Net unrealized gain on CMBS										5,959						5,959			5,959
Net unrealized loss on derivative instruments										(5,680	)					(5,680	)		(5,680	)
Cash dividends declared or paid													(18,840	)		(18,840	)
Forfeitures of common stock awards	(45,633	)		—			—			—			—			—			—

Balance at December 31, 2006	30,601,142			306			420,986			(1,469	)		(7,953	)		411,870			14,022
Issuance of restricted shares of common stock	357,700			3			(3	)		—			—			—			—
Stock-based compensation	—			—			1,292			—			—			1,292			—
Net loss													(70,766	)		(70,766	)		(70,766	)
Net unrealized loss on CMBS										(64,775	)					(64,775	)		(64,775	)
Net unrealized loss on derivative instruments										(40,162	)					(40,162	)		(40,162	)
Cash dividends declared or paid													(24,643	)		(24,643	)
Forfeitures of common stock awards	(38,617	)		—			—			—			—			—			—

Balance at December 31, 2007	30,920,225			309			422,275			(106,406	)		(103,362	)		212,816			(175,703	)
Cumulative effect of the adoption of SFAS 159										61,231			102,563			163,794
Stock-based compensation							770									770
Net loss													(157,031	)		(157,031	)		(157,031	)
Amortization of unrealized loss on derivatives										7,349						7,349			7,349
Cash dividends declared or paid													(9,269	)		(9,269	)
Forfeitures of common stock awards	(97,025	)		(1	)		1

Balance at December 31, 2008	30,823,200		$	308		$	423,046		$	(37,826	)	$	(167,099	)	$	218,429		$	(149,682	)

The accompanying notes are an integral part of these financial statements.

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Realty Finance Corporation

Consolidated Statements of Cash Flows

(Amounts in thousands)


	For the year ended December 31, 2008			For the year ended December 31, 2007			For the year ended December 31, 2006
Operating Activities
Net income (loss)	$	(157,031	)	$	(70,766	)	$	13,743
Loss from discontinued operations		2,173			60,362			1,121
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Equity in net loss of unconsolidated joint ventures		39,863			5,665			453
Premium (discount) amortization, net		2,793			(413	)		1,200
Other amortization		3,871			2,963			757
Depreciation		1,098			915			529
Stock-based compensation		770			1,292			3,867
Loss on impairment of assets		5,966			7,764			—
Provision for loan losses		126,504			19,650			—
Realized (gain) loss on sale of investment		2,021			500			(258	)
(Gain) loss on financial instruments		(20,834	)		1,668			(3,634	)
Changes in operating assets and liabilities:
Restricted cash		104			551			(151	)
Accrued interest		2,596			(3,858	)		(3,204	)
Other assets		724			3,862			(4,927	)
Management fees payable		(304	)		(148	)		227
Accounts payable and accrued expenses		4,637			5,002			518
Other liabilities		(317	)		738			(1,742	)

Net cash provided by operating activities, continuing operations		14,634			35,747			8,499
Net cash used in operating activities, discontinued operations		(1,986	)		(6,340	)		(574	)

Net cash provided by operating activities		12,648			29,407			7,925

Investing Activities
Purchase of CMBS		—			(91,238	)		(140,210	)
Repayment of CMBS principal		301			10,095			2,022
Proceeds from sale of CMBS		—			4,085			4,807
Origination and purchase of loans		(14,929	)		(673,341	)		(854,491	)
Repayment of loan principal		44,539			205,435			165,153
Proceeds from sale of loans		25,979			116,715			44,642
Real estate acquisition		(56	)		(1,043	)		(34,747	)
Investment in unconsolidated joint ventures		(644	)		(17,763	)		(41,499	)
Distributions from unconsolidated joint ventures		2,574			—			—
Cash and cash equivalents from acquired investments		32			73			—
Restricted cash		66,257			(81,891	)		(47,812	)
Other liabilities		(8,881	)		(7,920	)		42,982

Net cash provided by (used in) investing activities, continuing operations		115,172			(536,793	)		(859,153	)
Net cash provided by (used in) investing activities, discontinued operations		8,691			(5,297	)		(1,038	)

Net cash provided by (used in) investing activities		123,863			(542,090	)		(860,191	)

Financing Activities
Proceeds from issuance of common stock, net of offering costs		—			—			133,190
Proceeds from issuance of CDOs		22,200			831,000			508,500
Proceeds from borrowings under repurchase agreements		—			481,194			869,973
Repayments of borrowings under repurchase agreements		(144,183	)		(770,449	)		(741,360	)
Proceeds from issuance of trust preferred securities		—			—			50,000
Proceeds from mortgage loans		138			2,741			26,583
Proceeds from note payable		—			23,000			—
Repayments of note payable		(2,537	)		(1,264	)		—
Proceeds from settlement of derivatives		—			—			6,501
Payments from settlement of derivatives		(1,973	)		(9,525	)		—
Deferred financing and acquisition costs paid		(780	)		(15,417	)		(10,649	)
Restricted cash		4,251			3,999			(8,250	)
Minority interest		(684	)		(150	)		376
Dividends paid to common stockholders		(15,763	)		(23,964	)		(15,699	)

Net cash provided by (used in) financing activities, continuing operations		(139,331	)		521,165			819,165
Net cash provided by (used in) financing activities, discontinued operations		—			—			1,657
Net cash provided by (used in) financing activities		(139,331	)		521,165			820,822

Net increase (decrease) in cash and cash equivalents		(2,820	)		8,482			(31,444	)
Cash and cash equivalents at beginning of period		25,954			17,933			49,377

Cash and cash equivalents at end of period		23,134			26,415			17,933
Less: cash and cash equivalents from discontinued operations at end of period		1			461			—

Cash and cash equivalents from continuing operations at end of period	$	23,133		$	25,954		$	17,933

Supplemental cash flow disclosures
Interest paid	$	81,968		$	87,855		$	41,486
Income taxes paid	$	—		$	—		$	—
Interest capitalized	$	—		$	1,163		$	494
Foreclosed assets assumed	$	7,378		$	203,142		$	—
Foreclosed liabilities assumed	$	518		$	151,542		$	—

The accompanying notes are an integral part of these financial statements.

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Realty Finance Corporation

Notes To Consolidated Financial Statements

(Amounts in thousands, except share and per share data)

December 31, 2008

NOTE 1—ORGANIZATION

Realty Finance Corporation, formerly known as CBRE Realty Finance, Inc. was organized as a commercial real estate specialty finance company focused on originating and acquiring whole loans, bridge loans, subordinate interests in whole loans, or B Notes, commercial mortgage-backed securities (“CMBS”), and mezzanine loans, primarily in the United States. Unless the context requires otherwise, all references to “we,” “our,” and “us” in this annual report on Form 10-K mean Realty Finance Corporation, a Maryland corporation, our wholly-owned and majority-owned subsidiaries and our ownership in joint venture assets. As of December 31, 2008, we also own interests in seven joint venture assets, two of which are consolidated in the consolidated financial statements. We commenced operations on June 9, 2005. We are a holding company and conduct our business through wholly-owned or majority-owned subsidiaries.

Historically, we have been externally managed and advised by CBRE Realty Finance Management, LLC, our Manager, an indirect subsidiary of CB Richard Ellis Group, Inc., or CBRE, and a direct subsidiary of CBRE Melody & Company, or CBRE|Melody. As of December 31, 2008, CBRE|Melody also owned an approximately 4.5% interest in the outstanding shares of our common stock. In addition, certain of our executive officers and directors owned an approximately 2.5% interest in the outstanding shares of our common stock. The management agreement expired by its terms on December 31, 2008. The expiration of the management agreement ended our affiliation with CBRE and its affiliates. As a result, subsequent to December 31, 2008, we have internalized the operations historically performed by our Manager into our company through the direct hiring of the employees previously employed by our Manager and replacing other functions previously performed or facilitated by CBRE|Melody such as payroll and other back office functions and obtaining standalone insurance coverage. As a result of the termination of the management agreement, we will no longer pay any management fees. However, such fees will generally be replaced by costs that had historically been absorbed by our Manager, primarily compensation and benefit costs. No fees were paid by us in connection with the expiration of the management agreement.

We have elected to qualify to be taxed as a real estate investment trust (“REIT”) for U. S. federal income tax purposes. As a REIT, we generally will not be subject to federal income tax on that portion of income that is distributed to stockholders if at least 90% of our REIT taxable income is distributed to our stockholders. We conduct our operations so as to not be regulated as an investment company under the Investment Company Act of 1940, as amended (the “1940 Act”).

As of December 31, 2008, the net carrying value of investments held by us was approximately $1,234,584, including origination costs and fees and net of repayments and sales of partial interests in loans and CMBS, with a weighted average spread to 30-day LIBOR of 311 basis points for our floating rate investments and a weighted average yield of 7.13% for our fixed rate investments.

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund loans and other investments, pay dividends, fund debt service and for other general corporate purposes. On December 31, 2008, we had approximately $23.1 million of unrestricted cash and cash equivalents. We have long-term financing for 100% of our encumbered portfolio in place through our existing CDOs and mortgage loans. Our primary sources of funds for short-term liquidity requirements, including working capital, distributions, if any, debt service and additional investments, if any, consist of (i) cash flow from operations; (ii) proceeds from our existing collateralized debt obligations, or CDOs; (iii) proceeds from principal and interest payments on our unencumbered investments; (iv) proceeds from potential loan and asset sales; and, to a lesser extent; (v) new financings or additional securitization or CDO offerings and (vi) proceeds from additional common or preferred equity offerings. We believe these sources of funds will be sufficient to meet our short-term liquidity requirements.

The majority of our investments are pledged as collateral for our CDO bonds and the income generated from these investments is used to fund interest obligations of our CDO bonds and the remaining income, if any, is retained by us. Our CDO bonds contain interest coverage and asset overcollateralization covenants that must be met in order for us to receive such payments. If we fail our interest coverage or asset overcollateralization covenants in either of our CDOs, all cash flows from the CDO (including interest on the bonds we own, distribution of our common and preferred equity and our subordinate management fees) would be diverted to repay principal and interest on the outstanding CDO bonds and we would not receive any residual payments until the CDO was back in compliance with such tests. We were in compliance with all such covenants as of December 31, 2008. In the event of a breach of our CDO covenants that we could not cure in the near term, we would be required to fund interest on trust preferred securities and other expenses (including compensation expenses) through (i) cash on hand, (ii) income from any CDO not in default, (iii) sale of unencumbered assets or (iv) accessing debt or equity capital markets, if available. We have the ability to cure defaults, which would resume normal payments to us, by purchasing non-performing loans out of our CDOs. However, we may not have sufficient liquidity available to do so at such time. In some cases, collateral may be continuing to pay interest but may be considered a defaulted interest for the purpose of the covenant calculations, such as our CMBS in our 2006 CDO, or CDO I, which are considered defaulted interests for the purpose of covenant calculation if any rating agency downgrade occurs. To the extent noncompliance continues for an extended period of time, our ability to continue as a going concern may be jeopardized. At December 31 2008, our most restrictive covenants on our CDOs had an interest coverage ratio of 2.21x and 1.22x for CDO I and CDO II, respectively, compared to minimum requirements of 1.21x and 1.09x. At December 31, 2008, our most restrictive covenants on our CDOs had an asset overcollateralization ratio of 1.15x and 1.10x for CDO I and our 2007 CDO, or CDO II, respectively, compared to minimum requirements of 1.12x and 1.10x. If we experience an additional $15,050 or $500 in reductions of collateral in CDO I or CDO II, respectively, due to further investment losses or other factors, we will fail the overcollateralization test for the respective CDO.

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the overcollateralization test, however, if an additional $.5 million in defaults occur, CDO II will also breach the overcollateralization covenant. Management believes it is likely that CDO II will fail the overcollateralization test at some point in 2009, which will result in the cash flows of CDO II being diverted to pay down principal of senior bond holders, eliminating residual cash inflows paid to us. With both CDOs out of compliance with overcollateralization covenants, we will have minimal incoming cash flows from our primary business and there is no assurance when or if we will be able to regain compliance with these covenants. As discussed further in Note 14, the breach of the overcollateralization covenant in either CDO provides MBIA Insurance Corporation, or MBIA, the controlling class of CDO II bondholders, the ability to terminate the existing collateral management agreement, as amended, and to remove us as the collateral manager of CDO II. We have incurred significant losses since our inception and may incur additional losses in the future as we continue to navigate the difficult issues in the credit and real estate markets. With minimal incoming cash flows, management’s plans to fulfill short-term capital requirements include (i) use of $23.1 million of cash on hand as of December 31, 2008 to fund operating expenses, (ii) senior collateral management fees, (iii) reduction in administrative costs, as a result of becoming a non-reporting company, (iv) reduction in employee headcount, and (v) sale of our unencumbered 1515 Market Street LLC joint venture interest, if possible under current market conditions.

We have incurred significant losses since our inception, may incur additional losses in the future as we continue to navigate the difficult issues in the credit and real estate markets and expect minimal incoming cash flows from our CDOs. We believe our $23.1 million of cash on hand as of December 31, 2008 and a combination of our ability to collect senior collateral management fees, and reduce administrative costs, as a result of becoming a non-reporting company, reduce employee headcount, and potential sales of our joint venture interests, if possible under current market conditions, will be sufficient to meet our liquidity requirements for at least the next 12 months. We continue to seek and explore partnerships and new business opportunities; however, there is no assurance that such partnerships or business opportunities will be available on favorable terms or at all.

NOTE 2—BASIS OF PRESENTATION

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The consolidated financial statements include our accounts and those of our subsidiaries, which are wholly-owned or controlled by us or entities which are variable interest entities (“VIE”) in which we are the primary beneficiary under Financial Accounting Standards Board, or FASB, Interpretation No. 46R “Consolidation of Variable Interest Entities”, or FIN 46R. All significant intercompany transactions and balances have been eliminated in consolidation.

NOTE 3—SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates and assumptions. Significant estimates in the consolidated financial statements include the valuation of our commercial mortgage backed securities, valuation of our CDOs, valuation of our junior subordinated debentures, valuation of derivatives, estimation of loan loss reserves and estimation of impairment of long-lived assets.

Cash and Cash Equivalents

We consider all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.

Restricted Cash

Restricted cash consists of tax and insurance escrows, margin amounts on derivative positions, cash held by the trustee of our CDOs transaction and leasehold improvement reserves held on behalf of certain borrowers.

Loans and Other Lending Investments

Variable Interest Entities

In December 2003, the FASB issued FIN 46R as a modification of Interpretation No. 46 “Consolidation of Variable Interest Entities”, or FIN 46. FIN 46R, which became effective in the first quarter of 2004, clarified the methodology for determining whether an entity is a Variable Interest Entity, or VIE and the methodology for assessing who is the primary beneficiary of a VIE. VIEs are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. If an entity is determined to be a VIE, it must be consolidated by the primary beneficiary. The primary beneficiary is the enterprise that absorbs the majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both. Generally, expected losses and expected residual returns are the expected negative and positive variability, respectively, in the fair value of the variable interest entities’ net assets.

We have evaluated our investments in CMBS, loans and other lending investments, and joint venture interests to determine whether they are variable interests in VIEs. For each of the investments, we have evaluated the sufficiency of the entities’ equity investment at risk to absorb expected losses, and whether as a group, the equity has the characteristics of a controlling financial interest.

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a QSPE. To maintain the QSPE exception, the entity must continue to meet the QSPE criteria both initially and in subsequent periods. An entity’s QSPE status can be impacted in future periods by activities by its transferor(s) or other involved parties, including the manner in which certain servicing activities are performed. To the extent our CMBS investments were issued by an entity that meets the requirements to be considered a QSPE, we record the investments at purchase price paid. To the extent the underlying entities are not QSPEs, we follow the guidance set forth in FIN 46R as the entities would be considered VIEs.

We have identified one mezzanine loan as a variable interest in a VIE and have determined that we are not the primary beneficiary of this VIE and as such the VIE should not be consolidated in our consolidated financial statements. The loan is for a mixed use development project. Our maximum exposure to loss would not exceed the carrying amount of this investment of $0.

Our maximum exposure to loss as a result of our investments in these VIEs was $54,620 and $278,964 as of December 31, 2008 and 2007, respectively.

The financing structures, including loans and other lending investments, that we offer to borrowers on certain of its loans involve the creation of entities that could be deemed VIEs and, therefore, could be subject to FIN 46R. Management has evaluated these entities and has concluded that none of them are VIEs that are subject to consolidation under FIN 46R.

Commercial Mortgage-Backed Securities (“CMBS”)

CMBS are classified as trading securities as of December 31, 2008, in connection with the adoption of Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, or SFAS 159, discussed further below, and available-for-sale securities at December 31, 2007 and are carried on our balance sheet at fair value. Prior to the adoption of SFAS 159 on January 1, 2008, when CMBS were classified as available for sale, in accordance with Statement of Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” or SFAS 115, and Emerging Issues Task Force Issue 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” or EITF 99-20, we assessed whether unrealized losses on securities, if any, reflect a decline in value which was other than temporary and, accordingly, wrote the impaired security down to its value through earnings. For example, a decline in value is deemed to be other than temporary if it is probable that we will be unable to collect all amounts due according to the contractual terms of a security which was not impaired at acquisition. Temporary declines in value generally result from changes in market factors, such as market interest rates, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly impact our ability to collect amounts contractually due. Additionally, for an impairment to be temporary, we must demonstrate the intent and ability to hold the investments through at least their anticipated recovery period. Significant judgment is required in this analysis. No such write-downs were made through December 31, 2007.

Real Estate, Net

Real estate properties are stated at cost less accumulated depreciation. Costs directly related to the acquisition and building improvements are capitalized. Ordinary repairs and maintenance are expensed as incurred.

Real estate properties are depreciated using the straight-line method over the estimated useful lives of the assets. The estimated useful lives are as follows:


Category		Term
Building (fee simple ownership)		40 years
Building improvements		shorter of remaining life of the building or useful life

Depreciation expense for the years ended December 31, 2008, 2007 and 2006 was $1,098, 915 and 529, respectively.

Impairment of Long-Lived Assets

We evaluate potential impairments of long-lived assets, including assets held for development and real estate, in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, or SFAS 144. SFAS 144 establishes procedures for the review of recoverability and measurement of impairment, if necessary, of long-lived assets held and used by an entity. SFAS 144 requires that assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. We would be required to recognize an impairment loss if the carrying amount of long-lived assets is not recoverable based on their undiscounted cash flows. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to impairment losses that could be material to the results of operations.

In the third quarter of 2008, management made a decision to no longer fund operating deficits at the Loch Raven property based on (i) the property’s current and forecasted operating performance, (ii) lack of liquidity in the credit markets that make refinancing more difficult, (iii) declines and expected declines in commercial real estate valuations and (iv) the general expectation of a prolonged economic slow down that would adversely impact the performance and value of the property. The decision to no longer fund operating deficits put us in default with the non-recourse first mortgage on the property, which will likely result in the senior lender foreclosing on our position. Management determined that the change in strategy indicated that the carrying amount of Loch Raven long-lived assets may not be fully recoverable. Based on our current estimate of undiscounted cash flows over the expected life of the investment, we determined that the carrying value of the Loch Raven long-lived assets was not fully recoverable. As a result of this assessment, we recorded an impairment loss of $5,966 for the year ended December 31, 2008 based on the difference between the carrying value of the long-lived assets and their estimated fair value.

Revenue Recognition

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Impairment of Loans

We periodically evaluate loans for possible impairment. Loans and other investments are considered impaired, for financial reporting purposes, when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the original agreement, or, for loans acquired at a discount for credit quality when it is deemed probable that we will be unable to collect as anticipated.

The provision for loan losses represents the increase in the allowance for possible credit losses to the level that management estimates to be adequate considering delinquencies, loss experience, estimated fair market value of underlying collateral and other factors.

A summary of the change in the provision for loan losses for the years ended December 31, 2008 and 2007 is as follows:


Loan loss reserve at December 31, 2006	$	—
Increase in loan loss reserves		19,650

Loan loss reserve at December 31, 2007		19,650
Increases in loan loss reserves		126,504
Realized losses		(5,089	)

Loan loss reserve at December 31, 2008	$	141,065

Fair Value of Financial Instruments

On January 1, 2008, we adopted Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” or SFAS 159. SFAS 159 permits entities to elect to measure many financial instruments at fair value. We elected the fair value option under SFAS 159 for all CMBS with a rating below AAA at the date of acquisition, all CDO bonds with a rating below AAA at the date of issuance and $50 million of our junior subordinated debentures in order to more appropriately reflect the operations of our business which is investing in commercial real estate financial assets and to match fund those investments through securitized debt financing instruments. We typically hold all assets and liabilities to maturity and we believe recording certain assets and corresponding liabilities at fair value provides a more accurate reflection of our book value under generally accepted accounting principles. Our financial assets primarily include loans and CMBS. Our loans are recorded on the balance sheet at historical cost, net of loan loss reserves, and CMBS are recorded at fair value, giving an appropriate depiction of changes in fair value throughout the holding periods. In addition, compared to our CMBS, CDO bonds and junior subordinated debentures, our loans have significantly shorter terms, are unique in nature and lack an open market, thus ascertaining and recording an estimate of fair value will not be reflective of the distinct nature of these loans. To adequately match the changes in fair value of our assets that are recorded at fair value, where there is often significant volatility due to company specific circumstances as well as external market factors, we believe it is preferable to also reflect changes in the fair value of the corresponding liabilities for CDO bonds and junior subordinated debentures. Since our senior AAA rated CDO bonds are less volatile in nature, similar to our loans which are not recorded at fair value, we did not elect the fair value option for our senior CDO bonds that were AAA rated at the date of issuance in order to more appropriately match these instruments with our loans. Similarly, we have not elected the fair value option on CMBS securities that have AAA rating at the date of acquisition. To address matching on the statement of operations, we elected the fair value option on CMBS with a rating below AAA since the changes in fair value of these instruments generally correlate with the change in fair value of our CDO bonds and junior subordinated debentures, therefore we believe it is most representative to reflect changes in fair value of all of these instruments through the statement of operations. While we did not elect to adopt SFAS 159 for derivative instruments, because CDOs are recorded at fair value, all interest rate swaps outstanding at January 1, 2008 no longer qualify for hedge accounting and subsequent changes in fair value are recorded as a component of income from continuing operations.

On January 1, 2008, we adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” or SFAS 157. SFAS 157 clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing the asset or liability and establishes a fair value hierarchy, giving the highest priority to quoted prices in active markets and the lowest priority to unobservable data. SFAS 157 applies whenever other standards require assets or liabilities to be measured at fair value. SFAS 157 requires, with limited exceptions, that changes in fair value estimates resulting from the adoption of SFAS 157 be recorded prospectively as changes in estimates.

A summary of the methods used to estimate fair value is as follows:

Loans and other investments

Specific valuation allowances are established for certain impaired loans based on the estimated fair value of collateral on an individual loan basis. The estimated fair value of the collateral may be determined based on (i) independent appraisal, (ii) internal company models, (iii) market bids, (iv) credit and capital market conditions or (v) a combination of these factors. If the estimated fair value of the collateral of an impaired loan is less than our carrying value of the loan, a loan loss provision is recorded for the difference at the measurement date, resulting in our loan being recorded at estimated fair value. Valuation of collateral and the resulting loan loss reserve is based on assumptions such as expected operating cash flows, expected capitalization rates, estimated time the property will be held, discount rates, ability to obtain financing and other factors. Significant judgment is involved in valuations and different judgments and assumptions used in management’s valuation could result in different valuations.

CMBS

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unable to obtain any quotes from market participants or if in our judgment we believe quotes received are inaccurate, we estimate fair value using internal models that consider, among other things, the CMBX index, expected cash flows, known and expected defaults and rating agency reports. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in the recorded amount of our investment. As of December 31, 2008 and 2007 $4,304 and $0 CMBS investments were valued using internal models, respectively. Significant judgment is involved in valuations and different judgments and assumptions used in management’s valuation could result in different valuations. As the severe dislocation in the real estate and credit markets continues and worsens, resulting in illiquidity, our estimates of fair value will continue to have significant volatility. Since there are no active markets for our CMBS investments, we classify the investment as Level 3 under the SFAS 157 fair value hierarchy.

CDO Bonds and Junior Subordinated Debentures

Estimated fair values for CDO bonds and junior subordinated debentures are based on independent valuations. Currently, there is not an active market for our CDO bonds or our junior subordinated debentures and the independent appraiser estimates fair value using valuation models that consider, among other things, (i) anticipated cash flows (ii) current market credit spreads, such as CMBX, (iii) known and anticipated credit issues of underlying collateral (iv) term and reinvestment period and (v) market transactions of similar securities. When available, management will compare fair values estimated by the independent appraiser to third party quotes and transactions of identical or similar securities, however, such information is not available on a consistent basis. Estimates of fair value are subject to significant variability based on market conditions, such as interest rates and credit spreads. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in the recorded amount of our fair value. Significant judgment is involved in valuations and different judgments and assumptions used in management’s valuation could result in different valuations.

During the year ended December 31, 2008, the CMBS and CDO markets experienced widening of credit spreads, resulting in a decrease in the fair value of our liabilities related to CDO bonds and our junior subordinated debentures, resulting in unrealized gains of $260,993 and $18,080, respectively, for the year ended December 31, 2008. The decreases in value are due primarily to increases in market credit spreads and increases in expected default rate assumptions resulting from an increase in the amount of our non-performing loans and watch list assets that are collateral for our CDO bonds. During the year ended December 31, 2008, the average spread for the AA CMBX.3 index increased from 256 basis points at December 31, 2007 to 1,837 basis points at December 31, 2008.

Derivative Instruments

Springhouse and Loch Raven Long-Lived Assets

In estimating the fair value of long-lived assets for Springhouse and Loch Raven used to calculate impairment losses, we considered a variety of factors, including (i) discussion with local brokers and possible buyers of the property, (ii) status of current credit markets, (iii) ability to finance the properties and (iv) recent independent third party appraisals. Given the recent state of the credit and capital markets and uncertainty in the commercial real estate markets, estimated fair value is a significant estimate. The ultimate value realized upon a sale of these assets could be less than our current estimate of fair value, due to use of different market assumptions, lack of liquidity in the credit markets, further declines in the value of commercial real estate, insufficient time to market the property for sale, insufficient time or inability to refinance the property and other factors, which could result in differences from our estimates and those differences could be significant.

SFAS 157 Definitions

The fair value hierarchy introduced in SFAS 157 provides the following classifications of fair value:

Level 1

Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2

Inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability.

Level 3

Inputs are unobservable inputs for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability. Therefore, unobservable inputs shall reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity’s own data. In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. Therefore, the reporting entity’s own data used to develop unobservable inputs shall be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.

Deferred Financing Costs

Deferred financing costs represent commitment fees, legal and other third party costs associated with obtaining commitments for financing which result in a closing of such financing. These costs are amortized over the terms of the respective agreements and the amortization is reflected in interest expense. Unamortized deferred financing costs are expensed when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financing transactions which do not close, are expensed in the period in which it is determined that the financing will not close. These costs are included in other assets at December 31, 2008 and 2007.

As a result of the adoption of SFAS 159 on CDO notes payable and junior subordinated debentures, the Company recorded a charge against cumulative earnings for unamortized deferred financing costs related to such notes payable as of January 1, 2008 and any future costs will be expensed as incurred.

Borrowings

We financed the acquisition of our investments, including loans and CMBS, primarily through the use of secured borrowings in the form of repurchase agreements, warehouse facilities, junior subordinated debentures and other structured debt. We recognize interest expense on all borrowings on an accrual basis.

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Manager Compensation

The former management agreement between us and the Manager (the “Management Agreement”) provided for the payment of a base management fee to the Manager and an incentive fee if our financial performance exceeded certain benchmarks. The base management fee and the incentive fee were accrued and expensed during the period for which they are calculated and earned. See Note 14 for further discussion of the specific terms of the computation and payment of the base management fee and the incentive fee.

Derivative Instruments

We recognize all derivatives on the balance sheet at fair value. While we did not elect to adopt SFAS 159 for derivative instruments, because CDOs are recorded at fair value, all interest rate swaps outstanding at January 1, 2008 no longer qualify for hedge accounting and subsequent changes in fair value are recorded as a component of income from continuing operations. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or liability. Prior to January 1, 2008, to the extent hedges were effective, a corresponding amount, adjusted for swap payments, was recorded in accumulated other comprehensive income within stockholders’ equity. Amounts were then reclassified from accumulated other comprehensive income to the income statement in the period or periods the hedged forecasted transaction affected earnings. Ineffectiveness, if any, was recorded in the income statement. We periodically reviewed the effectiveness of each hedging transaction, which involved estimating future cash flows, at least quarterly. Fair values of derivatives are subject to significant variability based on changes in interest rates. The results of such variability could be a significant increase or decrease in our derivative assets, derivative liabilities, book equity, and/or earnings.

Income Taxes

We have elected to qualify to be taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code, beginning with our taxable year ended December 31, 2005. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our ordinary REIT taxable income to stockholders. As a REIT, we generally will not be subject to U.S. federal income tax on taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to U.S. federal income taxes on our taxable income at regular corporate rates and we will not be permitted to qualify for treatment as a REIT for U.S. federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distributions to stockholders. Management believes that we will be organized and will operate in such a manner as to qualify for treatment as a REIT; however, we may be subject to certain state and local taxes.

One of our wholly-owned subsidiaries, RFC TRS, Inc. (“TRS”), is intended to be taxed as a corporation. We account for income taxes related to TRS in accordance with the provisions of Statement of Financial Standards No. 109, “Accounting for Income Taxes.”, or SFAS 109. Under SFAS 109, we account for income taxes using the asset and liability method. For financial reporting purposes, current and deferred taxes are provided for on the portion of earnings recognized by us with respect to its interest in TRS. Deferred income tax assets and liabilities are computed based on temporary differences between the financial statement and income tax bases of assets and liabilities that existed on the balance sheet date. As of December 31, 2008, TRS has net operating loss carry forward for U.S. federal income tax purposes of approximately $76,299 ($62,319, $12,496, $818 and $666 for the tax periods ended December 31, 2008, 2007, 2006 and 2005, respectively, which are available to offset future taxable income, if any, through 2025 and 2028, respectively).

The characterization of the distributions paid to our common stockholders in 2008 was 16.4% ordinary income and 83.6% return of capital. The characterization of distributions paid to our common stockholders in 2007 and 2006 was 100% ordinary income.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, or FIN 48. This interpretation, among other things, creates a two-step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements. FIN 48 is effective for fiscal years beginning after December 15, 2006, in which the impact of adoption should be accounted for as a cumulative-effect adjustment to the beginning balance of retained earnings. We adopted FIN 48 effective January 1, 2007 and it had no material effect on our financial statements. Upon adoption of FIN 48, we elected an accounting policy to classify accrued interest and penalties related to unrecognized tax benefits in our income tax provision. We have no accrued interest and penalties recorded as of December 31, 2008.

Comprehensive Income (Loss)

Comprehensive income (loss) is recorded in accordance with the provisions of Statement on Financial Standards No. 130, “Reporting Comprehensive Income”, or SFAS 130. SFAS 130 establishes standards for reporting comprehensive income and its components in the financial statements. Comprehensive income (loss), is comprised of net income, as presented in the consolidated statements of operations, adjusted for changes in unrealized gains or losses on available for sale securities and changes in the fair value of derivative financial instruments accounted for as cash flow hedges. The reconciliation of the components of accumulated other comprehensive loss is as follows:


	Unrealized Gain (Loss) on Commercial Mortgage Backed Securities			Unrealized Gain (Loss) Gain on Derivatives			Total
Balance as of December 31, 2005	$	(2,415	)	$	667		$	(1,748	)
Net unrealized gain on commercial mortgage backed securities		5,959			—			5,959
Net unrealized loss on derivative instruments		—			(5,680	)		(5,680	)

Balance as of December 31, 2006	$	3,544		$	(5,013	)	$	(1,469	)
Net unrealized loss on commercial mortgage backed securities		(64,775	)		—			(64,775	)
Net unrealized loss on derivative instruments		—			(40,162	)		(40,162	)

Balance as of December 31, 2007	$	(61,231	)	$	(45,175	)	$	(106,406	)
Adoption of SFAS 159		61,231			—			61,231
Amortization of deferred loss on derivatives		—			7,349			7,349

Balance as of December 31, 2008	$	—		$	(37,826	)	$	(37,826	)

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Earnings Per Share

We present both basic and diluted earnings per share, (“EPS”). Basic EPS excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, where such exercise or conversion would result in a lower EPS amount. In accordance with Statement of Accounting Standards No. 128 “Earnings Per Share”, or SFAS 128, certain nonvested restricted shares are not included in the calculation of basic EPS (even though nonvested shares are legally outstanding).

Stock-Based Payment

We have issued restricted shares of common stock and options to purchase common stock (collectively “equity awards”) to our directors, the Manager, employees of the Manager and other related persons of the Manager. We account for stock-based compensation related to these equity awards using the fair value based methodology under Statement of Financial Standards No. 123(R), “Share Based Payment”, or SFAS 123(R) and EITF 96-18 “Accounting for Equity Investments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.” Compensation cost for restricted stock and stock options issued is initially measured at fair value at the grant date, remeasured at subsequent dates to the extent the awards are unvested, and amortized into expense over the vesting period on a straight-line basis.

New Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, “Business Combinations”, or SFAS 141R. SFAS 141R broadens the guidance of SFAS 141, extending its applicability to all transactions and other events in which one entity obtains control over one or more other businesses. It broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations and stipulates that acquisition related costs be expensed rather than included as part of the basis of the acquisition. SFAS 141R expands required disclosures to improve the ability to evaluate the nature and financial effects of business combinations. SFAS 141R is effective for all transactions entered into on or after January 1, 2009. We anticipate that the adoption of SFAS 141R will only have a significant impact on our financial statements if we enter into a business combination after the adoption date.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51”, or SFAS 160. SFAS 160 requires a noncontrolling interest in a subsidiary to be reported as equity and the amount of consolidated net income specifically attributable to the noncontrolling interest to be identified in the consolidated financial statements. SFAS 160 also provides for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling equity investment retained in a deconsolidation. SFAS 160 is effective on January 1, 2009. We do not expect the adoption of SFAS 160 to have a significant impact on our financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities—An Amendment of FASB Statement No. 133”, or SFAS 161. SFAS 161 expands the disclosure requirements for derivative instruments and hedging activities. SFAS 161 specifically requires entities to provide enhanced disclosures addressing (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 will be effective for us on January 1, 2009. We do not expect the adoption of SFAS 161 to have a significant impact on our financial statements.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles”, or SFAS 162. SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted accounting principles in the United States for non-governmental entities. SFAS 162 is effective 60 days following approval by the U.S. Securities and Exchange Commission (“SEC”) of the Public Company Accounting Oversight Board’s amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles”. We do not expect the adoption of SFAS 162 to have a significant impact on our financial statements.

In October 2008, the FASB issued Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active”, or FSP 157-3. FSP 157-3 clarifies the application of SFAS 157, which we adopted as of January 1, 2008, in cases where a market is not active. We considered the guidance provided by FSP 157-3 in our determination of estimated fair values as of December 31, 2008 for our CMBS investments, CDO bonds and Junior Subordinated Debentures, and the impact was not significant.

NOTE 4—FAIR VALUE OF FINANCIAL INSTRUMENTS

A summary of the cumulative effect of the adoption of SFAS 159 is as follows:


	Balance at January 1, 2008 prior to Adoption			Increase to Retained Earnings upon Adoption			Balance at January 1, 2008 after Adoption
CDO bonds (below AAA)	$	(514,500	)	$	151,415		$	(363,085	)
CDO financing fees		10,098			(10,098	)		—
Junior subordinated debentures		(50,000	)		23,545			(26,455	)
Junior subordinated debentures financing fees		1,068			(1,068	)		—

Total	$	(553,334	)	$	163,794		$	(389,540	)

As a result of the adoption of SFAS 159, an adjustment of $163,794 was made to the balance of retained earnings on January 1, 2008. In addition, the $61,231 of unrealized losses related to CMBS securities as of January 1, 2008 was reclassified from accumulated other comprehensive loss to retained earnings.

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At December 31, 2008, all of our recurring fair value measurements under SFAS 157 are classified as Level 3 measurements, as earlier defined. A reconciliation of the change in fair value for financial instruments for the year ended December 31, 2008 with unobservable inputs (Level 3) is as follows:


	Fair Value Measurements at Reporting Date Using Significant Unobservable Inputs (Level 3)
	Loans and other Lending Investments⁽¹⁾			CMBS			CDO Bonds			Derivatives, net			Junior Subordinated Debentures			Total
Balance at January 1, 2008	$	75,129		$	236,134		$	(363,085	)	$	(40,278	)	$	(26,455	)	$	(118,555	)
Issuances, settlements and amortization		(194,035	)		(301	)		(22,200	)		1,972						(214,564	)
Increase in loan loss reserve		125,129															125,129
Unrealized gain (loss)					(181,213	)		260,993			(68,970	)		18,080			28,890
Realized loss											(1,972	)					(1,972	)

Balance at December 31, 2008	$	6,223		$	54,620		$	(124,292	)	$	(109,248	)	$	(8,375	)	$	(181,072	)

⁽¹⁾	Consists only of our non-performing loans, discussed further in Note 6, which are “collateral dependent” and are therefore valued based on the fair value of the underlying collateral.

During the year ended December 31, 2008, we had non-recurring fair value measurements of the long-lived assets of Springhouse and Loch Raven as a result of impairments of these assets necessitating a fair value measurement. We estimated the fair value of the long-lived asset groups of Springhouse and Loch Raven of $26,200 and $27,811, respectively. Since each property is unique is nature, with no active markets or observable inputs, the fair value estimate for each of these long-lived assets group represents a Level 3 fair value estimate under SFAS 157.

The components of gains and losses on financial instruments recorded in the statement of operations are as follows:


	For the year ended December 31, 2008			For the year ended December 31, 2007			For the year ended December 31, 2006
Unrealized loss on CMBS	$	(181,213	)	$	—		$	—
Unrealized loss on derivatives		(68,970	)		(1,668	)		3,634
Realized loss on derivative		(1,972	)
Unrealized gain on CDO bonds (below AAA)		260,993			—			—
Unrealized gain on junior subordinated debentures		18,080			—			—
Amortization of unrealized loss on derivatives		(6,084	)		—			—

Total gains (losses) on financial instruments	$	20,834		$	(1,668	)	$	3,634

NOTE 5—FORECLOSED ASSETS

Accounting for Foreclosed Assets

On November 11, 2008, we foreclosed on the Granite Center office property located in Schaumburg, Illinois. As a result of the foreclosure, we assumed $7,377 in assets and $518 in liabilities.

During the year ended December 31, 2007, we foreclosed on the Monterey property, a 434-unit condominium conversion project, on May 9, 2007 and took immediate control. We also foreclosed on Rodgers Forge, a 508-unit condominium conversion project, on May 4, 2007 and took control on June 19, 2007 after court ratification awarded us legal control of the property.

The following table sets forth the estimated fair values of the assets and the liabilities assumed:


	Estimated Fair Market Value
Assets acquired:
Cash, cash equivalents and restricted cash	$	1,309
Assets under development and real estate		201,318
Other assets		514
Liabilities assumed:
Accounts payable and accrued liabilities		(10,462	)
Mortgages payable		(140,188	)
Other liabilities		(892	)

Total net assets acquired	$	51,599

The results of operations of the properties from the date of foreclosure in May 2007 through December 31, 2007 are included as discontinued operations in the consolidated statement of operations. Had the acquisitions occurred on May 10, 2005 (inception), there would not have been a material impact on the results of operations on a pro forma basis. No material intangible assets were identified in the foreclosures.

Impairment of Foreclosed Assets

On November 11, 2008, we foreclosed on the Granite Center office property located in Schaumburg, Illinois after a series of defaults that the borrower was not able to resolve. Management estimated the fair value of net assets assumed in the foreclosure of $6,859, based on (i) a recent independent third party appraisal, (ii) an offer to purchase the property and (iii) management’s assessment of current market conditions. We recorded an impairment of $5,089 on Granite Center for the year ended December 31, 2008, which is included in the provision for loan losses in the consolidated statement of operations.

In May 2007, we foreclosed on our subordinated mortgage on the Rodgers Forge property. Rodgers Forge was an apartment to condominium conversion project that was under development at the time of foreclosure. After taking control and possession of Rodgers Forge, management evaluated which use of the underlying property would, in its estimate, maximize returns to stockholders and performed studies on the cost to complete development efforts and the demand for rental property and completed condominium units. Based on the results of these studies and analysis, management concluded that it believed the highest and best use for the project was both as an apartment and condominium conversion and estimated the fair market value of the development project using a discounted cash flow analysis.

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Management’s decision at the time of foreclosure, with construction of the project already underway, was based on a relatively strong market for condominiums at the time. The results of the valuation indicated that the estimated fair market value of the Rodgers Forge property on the date of foreclosure approximated the carrying value of $58,653.

Also in May 2007, we foreclosed on a 100% interest in Montrose Investment Holdings, LLC (“Montrose”) which was held as collateral for one of our mezzanine loans. Montrose had title to the Monterey property, an apartment to condominium conversion project that was under development at the time of foreclosure. At the time of foreclosure, with construction of the project already underway and a relatively strong market for condominiums at the time, management’s belief was that completion of the project as a condominium conversion was the most appropriate course of action at the time. After taking control and possession of the Monterey property, management determined the fair value of the Monterey property based on various factors, including the use of the underlying property that management thought would maximize returns to stockholders, the delay in development activities as a result of a claim by the Montgomery County Housing Authority and studies on the cost to complete development efforts and the demand for completed condominium units and a redeveloped rental property. Based on the results of this analysis, management concluded that it believed the highest and best use of the project was as a condominium conversion and estimated that the fair market value of the net assets received on the date of foreclosure was approximately $133,200, which was less than the carrying value on the date of foreclosure of $141,000. The deficit was driven by various factors, including the delay in development due to the Montgomery County Housing Authority issue and sales efforts on the project, an increase in secured liens assumed by the previous owner and an increase in the estimated costs to complete the project. As a result, we concluded that the foreclosure event triggered an impairment of $7,800 which was recorded in the consolidated statements of income for the year ended December 31, 2007.

During the second half of 2007, there was significant deterioration in the Baltimore area and metropolitan DC area condominium markets as well as a severe dislocation of the capital markets precipitated by the sub prime lending crisis. As a result of these events, management determined that their original business plans to convert the Rodgers Forge and Monterey properties to condominiums were no longer viable and that the properties may be impaired. Based on our estimate of future undiscounted cash flows as apartment properties, the carrying amounts of the Rodgers Forge and Monterey properties were no longer fully recoverable. Impairment losses of $17,700 and $37,000, respectively, on the Rodgers Forge and Monterey properties were determined based on the difference between the carrying values of the assets and their estimated fair market values. The estimated fair market values were based on discounted cash flow projections which assumed the properties are sold when stabilized and are supported by third party offers to purchase the Rodgers Forge property and an independent third party appraisal for the Monterey property.

NOTE 6—DISCONTINUED OPERATIONS

In January 2008, we sold our Rodgers Forge property and in March 2008 we sold our Monterey property. In the third quarter of 2008, we began marketing the Springhouse property for sale and expect a sale to close within one year. The consolidated financial statements reflect the operations, assets and liabilities of our Rodgers Forge, Monterey and Springhouse operations as discontinued under the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” or SFAS 144, for all periods presented.

The following table presents summarized information for our Rodgers Forge, Monterey and Springhouse operations included in historical results:


	For the year ended December 31, 2008			For the year ended December 31, 2007			For the year ended December 31, 2006
Property operating income	$	3,872		$	5,026		$	3,024
Interest expense		(3,391	)		(5,001	)		(1,635	)
Property operating expenses		(2,474	)		(4,030	)		(1,425	)
Depreciation and amortization		(903	)		(1,373	)		(1,003	)
Loss on impairment of asset		(6,057	)		(54,729	)		—
Loss on financial instruments		—			(255	)		(82	)
Gain on sale of investments		6,780			—			—

Net loss	$	(2,173	)	$	(60,362	)	$	(1,121	)

The carrying amounts of assets and liabilities of Springhouse as of December 31, 2008 and Rodgers Forge and Monterey as of December 31, 2007 are presented on our balance sheet as “held for sale” under the provisions of SFAS 144, are as follows:


	December 31, 2008		December 31, 2007
Cash and cash equivalents	$	1	$	461
Restricted cash		130		—
Land, building, improvements and other long-lived assets		25,404		152,232
Other assets		401		1,733

Total assets held for sale	$	25,936	$	154,426

Accounts payable and accrued liabilities	$	42	$	9,253
Mortgage payable		—		140,225
Other liabilities		111		391

Total liabilities held for sale	$	153	$	149,869

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NOTE 7—LOANS AND OTHER LENDING INVESTMENTS, NET

The aggregate carrying values allocated by product type and weighted average coupons of our loans and other lending investments as of December 31, 2008 and 2007, were as follows:


	Carrying Value⁽¹⁾						Allocation by Investment Type				Fixed Rate: Average Yield				Floating Rate: Average Spread Over LIBOR⁽²⁾
	2008			2007			2008		2007		2008		2007		2008	2007
Whole loans fixed rate⁽³⁾	$	544,639		$	576,493		41	%	42	%	6.48	%	6.49	%
Whole loans floating rate⁽³⁾		299,294			304,596		23	%	22	%	—		—		208bps	210bps
Mezzanine loans, fixed rate		62,011			74,751		5	%	5	%	9.97	%	9.53	%	—	—
Mezzanine loans, floating rate		185,427			207,547		14	%	15	%	—		—		474bps	475bps
Subordinate interests in whole loans, fixed rate		85,429			85,319		7	%	6	%	9.12	%	9.12	%	—	—
Subordinate interests in whole loans, floating rate		132,998			132,998		10	%	10	%	—		—		316bps	316bps

Total / Average		1,309,798			1,381,704		100	%	100	%	7.12	%	7.10	%	311bps	317bps
Loan loss reserve		(141,065	)		(19,650	)

Total loans and lending investments, net	$	1,168,733		$	1,362,054

(1)	Loans and other lending investments are presented after scheduled amortization payments and prepayments, and are gross of premiums, discounts and unamortized fees.

(2)	Benchmark rate is 30-day LIBOR.

(3)	Includes originated whole loans, acquired whole loans and bridge loans.

The carrying value of our loans and other lending investments is gross of premiums, unamortized fees, and discounts of $2,608 and $351 at December 31, 2008 and 2007, respectively.

We have identified one mezzanine loan as of December 31, 2008, as a variable interest in a VIE and have determined that we are not the primary beneficiary of this VIE and as such the VIE should not be consolidated in our financial statements. As of December 31, 2008, our maximum exposure to loss would not exceed the carrying amount of this investment or $0.

As of December 31, 2008, our loans and other lending investments had the following maturity characteristics:


Year of Maturity	Number of Investments Maturing	Current Carrying Value (In thousands)		% of Total
Loans in maturity default	3	$	84,953	6	%
2009	14		349,371	27	%
2010	14		244,169	19	%
2011	12		294,041	22	%
2012	8		187,245	14	%
2013	2		33,737	3	%
Thereafter	8		116,282	9	%

Total	61	$	1,309,798	100	%

Weighted average maturity			2.2

For year ended December 31, 2008 and 2007, our investment income from debt investments was generated by the following investment types:


	For the Year Ended December 31, 2008				For the Year Ended December 31, 2007				For the Year Ended December 31, 2006
Investment Type	Investment Income		% of Total		Investment Income		% of Total		Investment Income		% of Total
Whole loans	$	50,878	51	%	$	62,758	48	%	$	25,294	39	%
Mezzanine loans		19,498	19	%		26,567	21	%		14,822	23	%
Subordinate interests in whole loans		12,773	13	%		19,514	15	%		13,894	22	%
CMBS		17,373	17	%		20,560	16	%		10,584	16	%
Miscellaneous		—	—	%		17	—	%		37	—	%

Total	$	100,522	100	%	$	129,416	100	%	$	64,631	100	%

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Non-Performing Loans and Watch List Assets

As of December 31, 2008, we had the following watch list and non-performing loans:


Investment Type	Classification	Net Loan Balance⁽¹⁾		% of Total Assets
Whole Loan	Watch⁽²⁾	$	10,500	0.7	%
Whole Loan	Watch	$	47,000	3.3	%
Mezzanine Loan	Watch	$	18,000	1.3	%
B-Note	Non-Performing⁽⁴⁾	$	42,830	3.0	%
Mezzanine Loan	Non-Performing⁽⁴⁾	$	40,000	2.8	%
Whole Loan	Non-Performing	$	11,000	0.8	%
Bridge Loan	Non-Performing⁽³⁾	$	7,500	0.5	%
Mezzanine Loan	Non-Performing	$	25,000	1.8	%
Bridge Loan	Non-Performing⁽³⁾	$	2,123	0.2	%

Total		$	203,953	14.4	%

(1)	At December 31, 2008, we had loan loss reserves of $139,690 against these assets out of our total loan loss reserves of $141,065.

(2)	Subsequent to December 31, 2008 this loan became non-performing.

(3)	Investments are with the same sponsor.

(4)	Investments are with the same sponsor.

Watch List Assets

We conduct a quarterly comprehensive credit review, resulting in an individual risk classification being assigned to each asset.

The first watch list asset is a $10,500 whole loan secured by a mixed use industrial and commercial facility located in Windsor, Connecticut. The borrower determined that the primary business occupying the facility was not economically feasible and has engaged a broker to sell the building. In June 2008, we received payment of $2,000 from the borrower, which included a $1,500 reduction of principal to $10,500 and $500 to replenish interest reserves, in exchange for the removal of a personal guaranty. The borrower has since triggered personal recourse pursuant to the exculpation provisions in the loan documents. In November 2008, the interest reserve balance was fully depleted. Management concluded that no loan loss reserve was necessary at this time based on the estimated fair market value of the underlying collateral from a recent third party appraisal. If the borrower is not successful in locating a buyer for the building at an adequate price, or at all, such an adverse event could have an adverse impact on our ability to recover our loan balance. In December 2008, we initiated foreclosure proceedings.

The second watch list asset is a $47,000 whole loan secured by an office building located in San Francisco, California. The building has a below market occupancy rate and does not fully cover debt service obligations, requiring the borrower to contribute significant capital. The loan was current as of December 31, 2008 and January and February 2009 interest payments were received. The loan matured on March 9, 2009 without payment and therefore is in default. If we foreclose on the property, given current market conditions where it is difficult to sell and finance commercial real estate properties at reasonable levels, we may not be able to fully recover the loan balance. Based on the Company’s internal valuation of the collateral, at this time the range of potential losses is between $0 and $11,000.

The third watch list asset is a $18,000 mezzanine loan for a specialty retail development located in Tennessee. Our loan originally matured on December 1, 2008 and the senior construction loan matured on December 24, 2008 and both were extended until January 24, 2009, at which time they went into maturity default. Construction on the project has halted as the lending group and borrower negotiate long-term financing and capitalization for the project. We believe it will be difficult for the borrower to find permanent financing given current credit market conditions. Currently, the project has a construction funding budget deficit that will be required to complete tenant improvements and the borrower is working closely with the lending group to obtain the remaining funding requirements. Based on our consideration of the difficulty under current market conditions of (i) resuming and completing construction, (ii) obtaining additional capital required, (iii) negotiating an extension of the current capital structure at reasonable terms, (iv) obtaining permanent financing for the property and (v) operating an specialty retail property during a prolonged economic downturn that severely impacts leisure travel, we believe there is substantial doubt about our ability to recover our loan balance. Based on these uncertainties and management’s inability to reasonably predict recovery upon restructuring or assumption of the collateral, we recorded a loan loss reserve against the balance of this loan in the fourth quarter of 2008 to reduce the net carrying value to $0.

Subsequent to December 31, 2008, we added a $31,957 whole loan secured by seven office buildings in Albany, New York and Rochester, New York was added to the watch list. The buildings have been under-performing compared to original underwriting expectations, resulted in the borrower having to fund cash operating deficits. As a result of current and projected operating deficits, management expects it may have to restructure the loan to provide the borrower some relief on interest payments and concluded that a $1,375 reserve was necessary at this time.

Non-Performing Loans

The $42,830 B-Note investment classified as non-performing had a maturity default on December 1, 2007 and is secured by a class A parcel of land in New York City that is intended to be developed into a mixed use retail and residential site. The B-Note was originally due on October 1, 2007 and was extended for 60 days with the sponsor funding an additional $150,000 of cash equity. Interest on the loan has been paid through December 31, 2007 at the contractual rate. As of December 31, 2008, we have initiated foreclosure proceedings on the collateral of our loan. At the current time, the lending group is conducting an appraisal of the site and, if the appraisal indicates the value of the site does not support our position in the capital structure, we will lose our ability to control foreclosure and voting rights over major decisions. The value of the loan is dependent on several factors that are outside of our control, such as the ultimate use of the project, the timing of completion and negotiations with potential tenants, and adverse events not currently anticipated could have a material impact on the value of the underlying collateral and ultimate realization of our loan balance. Based on our consideration of (i) the current state of the credit and capital markets, (ii) the long duration of the maturity default and (iii) the time and expense associated with foreclosure proceedings, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

The $40,000 mezzanine loan had a maturity default on February 9, 2008 and is collateralized by four class A office properties located in New York City. The sponsor of this investment is also the sponsor of the $42,830 B-Note investment discussed above. In April 2008, the borrower and lending group for the properties reached a consensual sale agreement that will allow the properties to be sold in an orderly fashion. The consensual sale agreement expired in January 2009. Based on the negotiated sales prices of three of the four class A office properties prior to the expiration of the agreement, we will not recover any of our loan balance, therefore we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

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The $11,000 whole loan is secured by a mixed use office and industrial facility located in Phoenix, Arizona. The facility has been 100% vacant for greater than two years and interest reserves were fully depleted in April 2008. In November 2008, the borrower notified us that it will no longer be making interest payments and we expect to assume possession of the collateral from the borrower by deed-in-lieu of foreclosure. Management obtained an independent, third party appraisal of the collateral value of this property which indicated that the fair value of the collateral, net of expected selling costs, was less than our historical carrying value and, as a result, we have a loan loss reserve against the balance of this loan to reduce the net carrying value to the estimated net realizable value of $6,223.

The $7,500 bridge loan is secured by development rights to build an office building in the Washington, DC area. The loan matures in April 2009, interest reserves were depleted in April 2008 and subsequent interest payments have been deferred until the maturity date of the loan. The borrower is in the process of completing predevelopment activities and obtaining necessary regulatory approvals to start construction. The borrower is exploring alternative uses of the site, including student housing. At December 31, 2008, based on the continued decline of the credit markets, which we believe makes it very difficult to obtain financing on projects of this nature, combined with the growing concern of a prolonged economic slowdown that is making it more difficult to execute long-term lease commitments, we concluded that the significance of these uncertainties raises substantial doubt about our ability to recover our loan balance. Based on these uncertainties and management’s inability to reasonably predict recovery upon (i) pursuit of a personal guaranty from the borrower or (ii) assumption of the collateral, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

The $25,000 mezzanine loan is secured by an interest in an apartment complex in New York City. The borrower notified us in July 2008 that it will cease servicing the debt and has requested significant modifications to the outstanding loans in order to continue its involvement with the property. Management is currently in the process of negotiating with the borrower, however, the ultimate outcome remains uncertain. Given the continued adverse market conditions that have negatively impacted commercial real estate valuations and the ability to refinance and based on our assessment of the current fair value of the underlying collateral, we believe there is significant uncertainty about our ability to recoup our loan balance in the event of sale or foreclosure. As a result, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

The $2,123 bridge loan is secured by development rights to build a mixed use office, retail and hotel facility in the Miami, Florida area. The borrower is in the process of obtaining construction financing for the development and completing other predevelopment activities. The loan matured on November 2008 and the borrower has communicated to us that it is unable to repay the loan. At December 31, 2008, based on the continued decline of the credit markets, which we believe makes it very difficult to obtain financing on projects of this nature, combined with the growing concern of a prolonged economic slowdown that is making it more difficult to execute long-term lease commitments, management concluded that the significance of these uncertainties raises substantial doubt about our ability to recover our loan balance. Based on these uncertainties and management’s inability to reasonably predict recovery upon (i) pursuit of a personal guaranty from the sponsor or (ii) assumption of the collateral, we continue to carry a loan loss reserve against the balance of this loan to reduce the net carrying value to $0.

Loan Loss Reserve

As of December 31, 2008 and 2007, our loan loss reserve was $141,065 and $19,650, respectively. Management estimated the loan loss reserve based on consideration of current economic conditions and trends, the intent and wherewithal of the sponsors, the quality and estimated value of the underlying collateral and other factors.

Concentration Risk

At December 31, 2008 and 2007, our loan and other lending investments had the following geographic diversification:


	2008				2007
Region	Carrying Value		% of Total		Carrying Value		% of Total
West	$	624,793	48	%	$	650,173	47	%
East		381,074	29	%		415,292	30	%
South		135,390	10	%		131,293	9	%
Midwest		90,532	7	%		104,799	8	%
Nationwide		78,009	6	%		80,147	6	%

Total	$	1,309,798	100	%	$	1,381,704	100	%

At December 31, 2008 and 2007, the underlying collateral of loan and other lending investments consisted of the following property types:


	2008				2007
Region	Carrying Value		% of Total		Carrying Value		% of Total
Office	$	637,101	49	%	$	641,000	46	%
Hotel		256,418	19	%		276,418	20	%
Multifamily		221,099	17	%		249,629	18	%
Industrial		67,416	5	%		70,918	5	%
Other		127,764	10	%		143,739	11	%

Total	$	1,309,798	100	%	$	1,381,704	100	%

NOTE 8—CMBS

The following table summarizes our CMBS investments, aggregated by investment category, as of December 31, 2008, which are carried at estimated fair value:


Security Description	Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
CMBS Class A or Better	$	10,000	$	—	$	(6,962	)	$	3,038
CMBS Class BBB		179,354		—		(152,126	)		27,228
CMBS Class BB		92,271		—		(73,515	)		18,756
CMBS Class B		28,347		—		(23,175	)		5,172
CMBS Class NR		7,105		—		(6,679	)		426

Total	$	317,077	$	—	$	(262,457	)	$	54,620

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The following table summarizes our CMBS investments, aggregated by investment category, as of December 31, 2007, which are carried at estimated fair value:


Security Description	Amortized Cost		Unrealized Gains		Unrealized Losses			Estimated Fair Value
CMBS Class A or Better	$	10,006	$		$	(622	)	$	9,384
CMBS Class BBB		194,634		—		(48,444	)		146,190
CMBS Class BB		65,790		126		(8,865	)		57,051
CMBS Class B		24,114		1		(2,296	)		21,819
CMBS Class NR		2,821		—		(1,131	)		1,690

Total securities available-for-sale	$	297,365	$	127	$	(61,358	)	$	236,134

We had 67 CMBS investments that are in an unrealized loss position at December 31, 2008, 64 of which have been in a continuous unrealized loss position for greater than twelve months. The unrealized loss of the 64 CMBS investments in a continuous unrealized loss position for greater than twelve months is $233,428 and the unrealized loss of the three CMBS investments that have been in a continuous loss position for less than twelve months is $10,852, as of December 31, 2008. We had 65 CMBS investments that are in an unrealized loss position at December 31, 2007, eight of which have been in a continuous unrealized loss position for greater than twelve months. The unrealized loss of the eight CMBS investments in a continuous unrealized loss position for greater than twelve months is $3,353 and the unrealized loss of the 57 CMBS investments that have been in a continuous loss position for less than twelve months is $58,006, as of December 31, 2007.

On January 1, 2008, as a result of our adoption of SFAS 159, all changes in the fair value of our CMBS securities that are rated below AAA at the time of acquisition are recorded as a component of income from continuing operations. At December 31, 2007, prior to the adoption of SFAS 159, management concluded that our CMBS investments were not other-than-temporarily impaired at that time since (i) the unrealized losses were primarily the result of changes in market interest rates subsequent to the purchase of the CMBS investments, (ii) our portfolio had not experienced any increases in defaults and (iii) we had the ability and intent hold all the investments until their expected maturity as all securities are financed through our two CDOs.

During the year ended December 31, 2007, we sold one CMBS investment and received net proceeds of $4,085 that generated a realized loss of $287. During the year ended December 31, 2008, 2007 and 2006, respectively, we accreted $0, $1,804 and $1,084 of the net discount for these securities in interest income.

The actual maturities of CMBS are generally shorter than stated contractual maturities. Actual maturities of these investments are affected by the contractual lives of the underlying assets, periodic payments of principal, and prepayments of principal.

The following table summarizes the estimated maturities of our CMBS investments, as of December 31, 2008, according to their estimated weighted average life classifications:


Weighted Average Life	Estimated Fair Value		Amortized Cost		Weighted Average Coupon
Less than one year	$	14,728	$	55,333	4.83	%
Greater than one year and less than five years		9,724		43,713	5.45	%
Greater than five years and less than ten years		29,186		205,926	5.79	%
Greater than ten years		982		12,105	5.45	%

The following table summarizes the estimated maturities of our CMBS investments, as of December 31, 2007, according to their estimated weighted average life classifications:


Weighted Average Life	Estimated Fair Value		Amortized Cost		Weighted Average Coupon
Less than one year	$	30,056	$	31,718	7.26	%
Greater than one year and less than five years		55,568		60,976	6.67	%
Greater than five years and less than ten years		143,521		193,424	5.80	%
Greater than ten years		6,989		11,247	5.64	%

The weighted average lives of our CMBS investments at December 31, 2008 and 2007, respectively, in the tables above are based upon calculations assuming constant principal prepayment rates to the balloon or reset date for each security.

The following table summarizes our CMBS investments, aggregated by vintage, as of December 31, 2008, which are carried at estimated fair value:


Security Description	Amortized Cost		Unrealized Gains		Unrealized Losses			Market Value
CMBS 1998 Vintage	$	12,500	$	—	$	(8,771	)	$	3,729
CMBS 2000 Vintage		11,211		—		(9,070	)		2,141
CMBS 2001 Vintage		9,537		—		(6,583	)		2,954
CMBS 2002 Vintage		12,542		—		(9,475	)		3,067
CMBS 2005 Vintage		79,203		—		(63,046	)		16,157
CMBS 2006 Vintage		158,002		—		(134,586	)		23,416
CMBS 2007 Vintage		34,082		—		(30,926	)		3,156

Total	$	317,077	$	—	$	(262,457	)	$	54,620

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The following table summarizes our CMBS investments, aggregated by vintage, as of December 31, 2007, which are carried at estimated fair value:


Security Description	Amortized Cost		Unrealized Gains		Unrealized Losses			Market Value
CMBS 1998 Vintage	$	11,512	$	—	$	(786	)	$	10,726
CMBS 2000 Vintage		10,336		126		(224	)		10,238
CMBS 2001 Vintage		9,535		—		(146	)		9,389
CMBS 2002 Vintage		12,228		2		(1,928	)		10,302
CMBS 2005 Vintage		75,771		—		(13,026	)		62,745
CMBS 2006 Vintage		145,485		—		(37,698	)		107,787
CMBS 2007 Vintage		32,498		—		(7,551	)		24,947

Total	$	297,365	$	128	$	(61,359	)	$	236,134

NOTE 9—REAL ESTATE, NET

Springhouse Apartments LLC (“Springhouse”)

On December 15, 2005, we invested $8,289 for a 95% interest in Springhouse, a joint venture between us and The Bozzuto Group (“Bozzuto”). Springhouse acquired an existing garden-style apartment community consisting of 220 units located in Laurel, Maryland for $31,923. We determined that Springhouse is a VIE and that we are the primary beneficiary and have consolidated the entity from the date of investment. At December 31, 2008, Springhouse’s balance sheet was comprised of land of $8,191, buildings, net of accumulated depreciation of $1,814, of $17,415, other assets of $684, mortgage note payable of $25,794 and other liabilities of $235. At December 31, 2007, Springhouse’s balance sheet was comprised of land of $8,191, buildings, net of accumulated depreciation, of $23,434, other assets of $956, mortgage note payable of $25,729 and other liabilities of $332. Creditors of Springhouse do not have any recourse to the company.

Loch Raven Village Apartments-II, LLC (“Loch Raven”)

On March 28, 2006, we invested $8,980 for a 95% interest in Loch Raven, a joint venture between us and Bozzuto. Loch Raven acquired an existing garden-style apartment community consisting of 495 units located in Baltimore, Maryland for $32,733. We determined that Loch Raven was a VIE and that we are the primary beneficiary and have consolidated the entity from the date of investment. At December 31, 2008, Loch Raven’s balance sheet was comprised of land of $7,464, buildings, net of accumulated depreciation of $2,305, of $20,100, other assets of $2,167, mortgage note payable of $29,170 and other liabilities of $965. At December 31, 2007, Loch Raven’s balance sheet was comprised of land of $7,464, buildings, net of accumulated depreciation, of $25,046, other assets of $4,229, mortgage note payable of $29,170 and other liabilities of $547. Creditors of Loch Raven do not have any recourse to the company.

Minority interest on our consolidated balance sheet represents Bozzuto’s 5% interest in Springhouse and Loch Raven.

NOTE 10—UNCONSOLIDATED JOINT VENTURES

We have non-controlling, unconsolidated ownership interest in entities that are accounted for using the equity method. Capital contributions, distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated percentage interests, if any, in such entities as a result of preferred returns and allocation formulas as described in such agreements.

KS-CBRE Shiraz LLC (“Shiraz Portfolio”)

On March 17, 2006, we invested $16,840 for a 90% non-managing member interest in the Shiraz Portfolio, a joint venture between us and Everest Partners LLC (“Everest”). We contributed an additional $121 in 2007. The Shiraz Portfolio is a portfolio of eight office and industrial properties comprising approximately 680,300 square feet located in Route 128, Route 3 and Interstate 495 submarkets in Boston, Massachusetts. We determined that the Shiraz Portfolio was not a VIE and that as a result of our non-managing member interest is not consolidated in our financial statements.

Effective April 1, 2008, we restructured our joint venture investment in KS-CBRE Shiraz LLC. Under the terms of the restructured agreement, our original equity contributions have been converted into a preferred equity interest. Interest accrues at 12% per year, with 5% paid monthly and the remaining 7% being deferred until such time that the underlying properties are sold.

We continue to record our investment as an unconsolidated joint venture, however subsequent to the amendment, the historical carrying value of our investment is no longer adjusted for our share of the income and losses of the partnership due to the revised distribution preferences of the partnership where our interest is senior to that of our partner and we do not absorb operating losses. Since the payment of current and deferred interest is dependent upon the cash flows of the underlying properties, income from contractual payments will only be recorded upon cash receipt.

In the second quarter of 2008, we were notified that our joint venture partner for KS-CBRE Shiraz LLC believes the April 1, 2008 amendment to the joint venture agreement was contingent upon an event that did not occur and as a result the amendment was not valid and the terms of the original agreement continue to be in place. As a result of this assertion, our joint venture partner has not paid the first nine required payments. We have commenced a court action to pursue specific performance by our joint venture partner under the amendment to the joint venture agreement, which we believe does not contain any such contingencies. We have been awarded injunctive relief against our joint venture partner by the Superior Court in the Commonwealth of Massachusetts, restraining them from transferring our joint venture assets during the review of the dispute. Our joint venture partner has filed counterclaims against us seeking a declaratory judgment that the 2008 amendments are unenforceable and alleging a breach of fiduciary duty and other breaches by us.

In the fourth quarter of 2008, based on continued weakening of the credit and real estate markets that has resulted in significant declines in commercial real estate valuations that we anticipate will make it very difficult to sell or refinance the underlying properties at values in excess of the senior first mortgage obligation, we concluded that it is unlikely that we will recover any of the carrying value of our investment. As a result, we recorded an impairment of $15,065, which is included in equity in net loss of unconsolidated joint ventures in our consolidated statement of operations ,bringing the carrying value of our investment to zero at December 31, 2008.

At December 31, 2008, excluding the impairment described above, Shiraz Portfolio’s balance sheet was comprised of cash and cash equivalents of $219, land, and building of 74,134, net of accumulated depreciation, other assets of 3,378, mortgage payable of $60,171 and other liabilities of $730. At December 31, 2007, Shiraz Portfolio’s balance sheet was comprised of cash and cash equivalents of $406, land and building of 75,117, net of accumulated depreciation, other assets of $3,168, mortgage payable of $60,850 and other liabilities of $832. The first mortgage is due on January 1, 2010.

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For the year ended December 31, 2008, excluding the impairment described above, Shiraz Portfolio’s net revenues were $9,319, operating expenses were $7,021, depreciation and amortization was $2,537 and net loss was $238. For the year ended December 31, 2007, Shiraz Portfolio’s net revenues were $8,627, operating expenses were $6,976, depreciation and amortization was $3,738 and net loss was $2,088. For the period from March 17, 2006 through December 31, 2006, Shiraz Portfolio’s net revenues were $6,870, operating expenses were $5,320, depreciation and amortization was $1,299 and net loss was $251.

KS-CBRE GS LLC (“GS Portfolio”)

On March 17, 2006, we invested $9,268 for a 90% non-managing member interest in the GS Portfolio, a joint venture between us and Everest. We contributed an additional $456 in 2007. The GS Portfolio is a portfolio of nine office and industrial properties comprising approximately 526,355 square feet located in Route 128 and Route 3 submarkets in Boston, Massachusetts. We determined that the GS Portfolio was not a VIE and that as a result of our non-managing member interest is not consolidated in our financial statements.

Effective April 1, 2008, we restructured our joint venture investment in KS-CBRE GS LLC. Under the terms of the restructured agreement, our original equity contributions have been converted into a preferred equity interest. Interest accrues at 12% per year, with 5% paid monthly and the remaining 7% being deferred until such time that the underlying properties are sold.

In the second quarter of 2008, we were notified that our joint venture partners for KS-CBRE GS LLC believes the April 1, 2008 amendment to the joint venture agreement was contingent upon an event that did not occur and as a result the amendment was not valid and the terms of the original agreement continue to be in place. As a result of this assertion, our joint venture partner has not paid the first nine required payments. We have commenced a court action to pursue s

Realty Finance Corp 10-K