TARRAGON REALTY INVESTORS INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the quarterly period ended SEPTEMBER 30, 2002
------------------

OR

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

For the transition period from to
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Commission File Number 0-22999
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TARRAGON REALTY INVESTORS, INC.
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(Exact name of registrant as specified in its charter)

Nevada 94-2432628
- --------------------------------------------- -------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)

1775 Broadway, 23rd Floor, New York, NY 10019
---------------------------------------------------
(Address of principal executive offices) (Zip Code)

(212) 949-5000
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(Registrant's telephone number, including area code)

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

Common Stock, $.01 per value 7,932,971
- ----------------------------- --------------------------------
(Class) (Outstanding at November 4, 2002)

1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements for the period ended
September 30, 2002, have not been audited by independent certified public
accountants, but, in our opinion, all adjustments (consisting of normal
recurring accruals) necessary for a fair presentation of consolidated financial
position, consolidated results of operations, and consolidated cash flows at the
dates and for the periods indicated have been included.

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)

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

2

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
(Unaudited)

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

3

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(Dollars in thousands, except per share data)
(Unaudited)

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

4

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

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

5

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

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

6

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

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

7

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying Consolidated Financial Statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America (GAAP) for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by GAAP for complete financial
statements. Operating results for the nine month period ended September 30,
2002, are not necessarily indicative of the results that may be expected for the
year ending December 31, 2002. For further information, refer to the
Consolidated Financial Statements and Notes included in our Annual Report on
Form 10-K for the year ended December 31, 2001. Dollar amounts in tables are in
thousands. Certain 2001 balances have been reclassified to conform to the 2002
presentation.

NOTE 2. REAL ESTATE

In March 2002, we sold Collegewood Apartments for $5.2 million, receiving net
cash proceeds of $3 million after payoff of the mortgage and closing costs. We
recognized a gain on the sale of $2.3 million. In accordance with Statement of
Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," the operations of this property prior to its
sale and the gain on sale are reported in discontinued operations in the
accompanying Consolidated Statements of Operations.

In April 2002, we purchased a 19-acre tract of land in Orlando, Florida, for
$2.8 million. Construction of a 296-unit apartment community on the land is
underway at a total estimated cost of $19.7 million, of which $17.2 million will
be funded by a construction loan.

In January 2002, a property with a net carrying value of $14.1 million was
reclassified from Real estate held for sale to For-sale housing inventory when
we began its conversion to condominiums. Also in January 2002, we reclassified a
property with a net carrying value of $6.3 million from Real estate held for
sale to Real estate held for investment when our contract of sale was terminated
and we ceased marketing the property for sale. The estimated fair values of
these properties exceeded their net carrying values at the date of
reclassification, so no loss was incurred upon their reclassification.

During the nine month period ended September 30, 2002, we sold 79 condominium
units at 5600 Collins Avenue in Miami Beach, Florida, for an aggregate sale
price of $20.4 million. After closing costs and release payments on the
mortgage, we received net cash proceeds of $9.1 million. Due to an increase in
estimated costs to complete the condominium conversion, we recorded For-sale
housing inventory write-downs in the second and third quarters of 2002 of $1.4
million and $900,000, respectively.

8

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS

Investments in and advances to partnerships, accounted for using the equity
method, consisted of the following at September 30, 2002:

601 Ninth Street Development, L.L.C ................. $ 231
801 Pennsylvania Avenue ............................. 14
Adams Street Development, L.L.C ..................... 502
Ansonia Apartments, L.P. ............................ --
Ansonia Liberty, L.L.C .............................. --
Danforth Apartment Owners, L.L.C .................... 247
Guardian-Jupiter Partners, Ltd. ..................... 4,178
Lake Sherwood Partners, L.L.C ....................... 67
Larchmont Associates, L.P. .......................... 2,224
Merritt 8 Acquisitions, L.L.C ....................... 2,320
Merritt Stratford, L.L.C ............................ 519
One Las Olas, Ltd. .................................. 6,824
100 East Las Olas, Ltd., and East Las Olas, Ltd. .... 4,318
Sacramento Nine ..................................... 553
Stone Creek Associates I, L.L.C ..................... 824
Summit/Tarragon Murfreesboro, L.L.C ................. 880
Tarragon Calistoga, L.L.C ........................... 221
Tarragon Savannah I & II, L.L.C ..................... 2,738
Thirteenth Street Development, L.L.C ................ 308
Vineyard at Eagle Harbor, L.L.C ..................... 401
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$27,369
=======

We hold noncontrolling interests in each of the above partnerships or joint
ventures or our outside partners have significant participating rights, as
defined in the Financial Accounting Standard Board's Emerging Issues Task
Force's 96-16 Abstract. Therefore, we account for our investments in these
partnerships using the equity method.

In the first and second quarters of 2002, Ansonia Apartments sold three
properties, for an aggregate sale price of $14.7 million and recognized gains
totaling $2.1 million. These properties were held for sale at December 31, 2001.
Tarragon's proportionate share of the gains was $1.5 million. Aggregate net cash
proceeds of $3.9 million were distributed to the partners, with Tarragon
receiving $2.8 million. In the second and third quarters of 2002, Ansonia
refinanced the mortgages on four of its properties and placed supplemental
mortgages on two properties, receiving aggregate net cash proceeds of $8.7
million of which $6 million was distributed to Tarragon. Tarragon has guaranteed
50%, or $925,000, of one of the mortgages. From the cash proceeds of the
property sales, the mortgage refinancings, and the supplemental mortgages,
distributions were made for the accounts of the outside partners which were used
first to pay off their notes payable to Tarragon, with cash in excess of the
note balances paid to the partners. The cash distributed to Tarragon was in
excess of our investment balance, and $5.2 million is included in equity in
income of partnerships in the accompanying Consolidated Statements of Operations
for the three and nine months ended September 30, 2002.

9

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

In February 2002, Devonshire sold its only property, Villages at Gateway, a
768-unit apartment community, for $33.2 million and recognized a gain of $25.2
million. This property was also held for sale at December 31, 2001. Net cash
proceeds of $8.35 million were distributed to the partners, with Tarragon
receiving $8 million. Tarragon's share of the gain was $8.3 million, which is
reduced by income recognized in 2000 resulting from distributions from
Devonshire in excess of our investment.

In March 2002, Tarragon Savannah I & II placed a supplemental mortgage of
$250,000 on the first phase of Links at Georgetown and replaced the construction
loan on the second phase with a permanent mortgage of $5.5 million. Payoff of
the construction loan and closing costs of the new loans required cash of
$732,000 which was advanced by Tarragon.

In March 2002, One Las Olas closed a $90 million construction loan and a $25
million mezzanine loan on its Las Olas River House condominium project. Tarragon
has guaranteed the $90 million construction loan, which had a balance at
September 30, 2002, of $5 million.

Tarragon formed a new joint venture, 100 East Las Olas and East Las Olas, with
our partners in One Las Olas in February 2002 and has contributed $4.3 million
to this joint venture in connection with its purchase of approximately one acre
of land adjacent to the Las Olas River House condominium development. This joint
venture plans to build a second phase of the Las Olas River House project on the
land. Tarragon has a 70% interest in this joint venture, and its investment will
be repaid from operation, financing, or sales of the planned development or from
sale of the land.

In April 2002, Tarragon Calistoga acquired a 25% interest in CR Tarragon Palm
Springs, which will develop a golf course and club house, hotel, fractional
ownership units, whole ownership condominium units, and single family detached
residences and lots on 892 acres to be acquired in Palm Springs, California.
Tarragon Calistoga has agreed to make contributions of up to $1 million, of
which Tarragon has committed to fund $800,000.

In January, March, and July 2002, Tarragon formed a series of joint ventures to
develop up to 1,100 residential units in Hoboken, New Jersey, for sale or
rental. Tarragon has committed to contribute to the capital of 601 Ninth Street
Development, Adams Street Development, and Thirteenth Street Development 90% of
the amounts in excess of construction loans as may be required to complete the
construction of the projects and to fund any operating shortfalls up to the
dates of substantial completion and stabilization of the projects. Our
contributions will be repaid from 90% of cash from operations, refinancings, or
sales until we have received an internal rate of return of 12% on our
contributions, after which our share of cash distributions will be reduced to
50% for 601 Ninth Street Development and Thirteenth Street Development and 40%
for Adams Street Development.

10

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

In August 2002, Ansonia Liberty refinanced the mortgage on The Liberty Building
Apartments, receiving net cash proceeds of $1.2 million, of which $1.1 million
was distributed to Tarragon. The cash distributed to Tarragon was in excess of
our investment balance, and $365,000 is included in equity in income of
partnerships in the accompanying Consolidated Statements of Operations for the
three and nine months ended September 30, 2002.

The accompanying Consolidated Financial Statements as of September 30, 2002, and
for the six months then ended reflect two partnerships, Antelope Pines Estates,
L.P., and Woodcreek Garden Apartments, L.P., on the consolidation method of
accounting because we now have a controlling interest in each. Total assets of
these partnerships were approximately $40 million at September 30, 2002.

Below are summarized financial data for Ansonia, Devonshire, and all other
partnerships as of and for the three and nine months ended September 30, 2002
(unaudited):

11

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

NOTE 4. NOTES AND INTEREST PAYABLE

In the first nine months of 2002, we obtained variable rate first mortgage
financing on four apartment communities totaling $45.6 million, receiving net
cash proceeds of $9.2 million after the payoff of $35.2 million in existing
debt, funding escrows for taxes, insurance, replacements, and repairs, and
paying the associated closing costs. In September 2002, we placed a variable
rate supplemental mortgage of $2.8 million on a property and received net cash
proceeds of $2.7 million after closing costs.

In connection with one of the financings, we purchased an interest rate cap (as
required by the lender) with a notional value of $8.3 million that caps the
30-day LIBOR at 5.72% and matures in May 2005. In accordance with SFAS 133, the
$79,000 cost of the cap was recorded as an asset, and the carrying value of the
cap has been reduced to its fair value at September 30, 2002, with a charge of
$53,000 to interest expense.

In connection with the 2001 refinancing of the mortgage debt of Antelope Pines
and Woodcreek Garden, we purchased interest rate caps as required by the
lenders. The cap purchased for Antelope Pines for $74,000 has a notional value
of $11.7 million, caps the Bond Market Association Municipal Swap Index (the
"BMA Index") at 6.34%, and matures in November 2006. The cap purchased for
Woodcreek Garden for $89,000 has a notional value of $13.3 million, caps the BMA
Index at 6.28%, and matures in December 2006. In accordance with SFAS 133, the
caps were recorded at cost as assets, with the carrying values of the caps
adjusted to their fair values quarterly. During the nine months ended September
30, 2002, the fair values of the caps decreased by $81,000 and $91,000,
respectively, with charges to interest expense in these amounts.

During the first nine months of 2002, we also closed two construction loans
totaling $31.6 million to fund the construction of a 216-unit apartment
community in Charleston, South Carolina, and a 296-unit apartment community in
Orlando, Florida.

12

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 4. NOTES AND INTEREST PAYABLE (Continued)

In May 2002, we obtained a $2 million revolving line of credit secured by shares
of Tarragon treasury stock. Advances under the line of credit bear interest at
LIBOR plus 2% per annum, and payments of interest only monthly are due, with the
principal due at maturity of May 2004. There were no outstanding advances under
the line of credit at September 30, 2002.

Also during the first nine months of 2002, we made net repayments totaling $7.9
million of advances from affiliates of William S. Friedman, our President and
Chief Executive Officer and Chairman of our Board of Directors, pursuant to a
$20 million revolving line of credit arrangement. Advances under the line of
credit, totaling $3.9 million as of September 30, 2002, bear interest at LIBOR
plus 1% per annum, and the line of credit matures in January 2004. In October
2002, the remaining balance was repaid.

NOTE 5. EARNINGS PER COMMON SHARE

Income (loss) per common share has been computed based on the weighted average
number of shares of common stock outstanding for the three and nine month
periods ended September 30, 2002 and 2001. The information presented for 2001
has been restated to give effect to the stock dividend declared in December 2001
and recorded in March 2002. The effect of stock options on weighted average
shares of common stock outstanding - assuming dilution for the three and nine
month periods ended September 30, 2001, and the three month period ended
September 30, 2002, is not reflected because their effect is anti-dilutive due
to net losses in those periods.

NOTE 6. COMMITMENTS AND CONTINGENCIES

Tarragon is party to various claims and routine litigation arising in the
ordinary course of business. We do not believe that the results of such claims
and litigation, individually or in the aggregate, will have a material adverse
effect on our business, financial position, or results of operations.

Tarragon is not aware of any liability relating to federal, state, and local
environmental laws, ordinances, and regulations that would have a material
adverse effect on our business, financial position, or results of operations.

13

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING

Our business is divided into three principal segments - the operation of our
investment portfolio, property development, and for-sale housing (formerly
referred to as homebuilding). The operation of our investment portfolio of
stabilized apartment communities and commercial properties is the largest
segment and the one whose operation most resembles that of traditional real
estate investment trusts. Funds generated by the operation, sale, or refinancing
of properties in the investment portfolio support our overhead and finance our
development activities. The second segment is property development through which
we create new investment properties, primarily multifamily apartment
communities, which, upon stabilization, become part of our investment portfolio.
Our activities in the third segment, for-sale housing, encompass condominium
conversions of existing apartment properties and the development of town homes
and new, high-rise condominiums for sale to resident owners. In 2001, assets in
the for-sale housing group were included in our development group. In 2002, we
have begun to report on the assets in the for-sale housing category in a third
segment because we have expanded development of housing for sale. We will
reclassify properties from the development division to the investment division
once they have achieved stabilized operations (as defined below). We will
reclassify properties for which we have initiated renovation or reposition
activities from the investment division to the development division. We will
reclassify properties for which we have initiated condominium conversion
activities from the investment division to the for-sale housing division.

o Development. Assets in this division are under development or in
initial lease-up, under renovation, or land held for construction
development or sale. In 2001, this segment also included 5600 Collins
Avenue, an apartment property under renovation and sale as
condominiums, and Las Olas River House in Ft. Lauderdale, a 42-story
luxury condominium development. In 2002, these properties are reported
in the for-sale housing division.

o Investment. This division includes properties with stabilized
operations. We consider a property "stabilized" when development or
renovation is complete and recurring operating income exceeds
operating expenses and debt service.

o For-Sale Housing. Assets in this division include luxury high-rise
condominiums, senior housing communities, and townhouses under
development and existing apartment properties under conversion to
condominiums.

The following table summarizes apartment units and commercial square footage in
the development and investment divisions. The for-sale housing division includes
two consolidated apartment properties with 373 units which are scheduled for
renovation and sale as condominiums, a 42-story luxury condominium project under
development and a mixed-use retail and residential condominium project owned
through unconsolidated joint ventures.

14

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

The following tables summarize operating data through income (loss) from
continuing operations and identifiable assets of our real estate and investments
in partnerships for the three divisions and funds from operations for our
investment division. We use funds from operations to measure the performance of
our investment division. We measure the performance of our development and
for-sale housing divisions primarily by net profit from third party and
intercompany sales. Intercompany sales for 2002 include transfers on January 1,
2002, from the development division to the investment division of properties
with 2,970 apartment units and 355,737 square feet of commercial space that were
stabilized during 2001, and transfers on April 1, 2002, from the development
division to the investment division of properties with 737 apartment units and
34,381 square feet of commercial space that were stabilized in the first quarter
of 2002. Intercompany sales for 2001 include transfers on January 1, 2001, from
the development division to the investment division of properties with 2,172
apartment units that were stabilized during 2000. The sale prices for these
properties are their estimated fair market values as of the date of transfer,
and the cost of sales is their net carrying values as of the same date. Three
commercial properties with 253,460 square feet were targeted for reposition in
2001. The January 1, 2001, transfer of these properties from the investment
division to the development division is shown as an intercompany sale in the
operating data for the nine months ended September 30, 2001. The gain to the
investment division is the excess of the properties' aggregate estimated fair
market values over their aggregate net carrying values as of December 31, 2000.
Gains on transfers of assets between segments do not represent gains
recognizable in accordance with GAAP and, accordingly, are eliminated for
purposes of consolidated reporting.

15

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

Dollar amounts in the following tables are in thousands. Operating data for 2001
has been restated to present the For-Sale Housing Division separately from the
Development Division consistent with the 2002 presentation.

16

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

17

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

18

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

19

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

20

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

(1) Tarragon considers funds from operations ("FFO") to be an appropriate
measure of the performance of our investment portfolio but not of our other
assets. FFO, as defined by the National Association of Real Estate
Investment Trusts ("NAREIT"), equals net income (loss), computed in
accordance with GAAP, excluding gains (or losses) from debt restructuring
and sales of property, plus depreciation and amortization of real estate
assets, and after adjustments for unconsolidated partnerships and joint
ventures. Adjustments for unconsolidated partnerships and joint ventures
are calculated to reflect FFO on the same basis. Effective January 1, 2002,
NAREIT clarified that FFO related to assets held for sale, sold, or
otherwise transferred and included in results of discontinued operations
should continue to be included in consolidated FFO. FFO reported above has
been computed in accordance with this clarification. We believe that a
clear understanding of the operating results of our investment portfolio
requires examining FFO along with net income (loss) as shown in the
Consolidated Financial Statements and Notes. FFO does not represent cash
generated from operating activities in accordance with GAAP and is not an
alternative to net income as an indication of our operating performance or
to cash flow as a measure of liquidity, nor is it necessarily indicative of
cash available to fund cash needs and cash dividends. Our calculation of
FFO may be different from the methods used by other companies and,
therefore, may not be comparable to other companies.

21

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

NOTE 8. GOODWILL

Goodwill was recorded in connection with the acquisitions of Tarragon Realty
Advisors and Accord Properties Associates and, until December 31, 2001, was
amortized on the straight-line method. We adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," on January 1, 2002. SFAS No. 142 requires that
goodwill and other intangible assets with indefinite useful lives no longer be
amortized as expenses of operations but rather carried on the balance sheet as
permanent assets. These assets are subject to at least annual assessment for
impairment by applying a fair-value-based test. We have determined there is no
transitional impairment loss at January 1, 2002.

Following is a presentation of income (loss) from continuing operations, net
income (loss), earnings per common share, and earnings per common share -
assuming dilution adjusted to exclude amortization expense related to goodwill
and intangible assets that are no longer being amortized.

22

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 8. GOODWILL (Continued)

23

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 9. ASSETS HELD FOR SALE

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which, among
other things, requires operating results for assets held for sale or sold to be
presented as discontinued operations for current and all prior years presented.
SFAS No. 144 also changes the rules for impairment testing of real estate held
for investment and requires the use of a probability weighted approach to
determine the holding period for purposes of estimating undiscounted cash flows.
We adopted this statement effective January 1, 2002. The adoption had no effect
on our reported net income (loss).

Assets held for sale and liabilities related to assets held for sale in the
accompanying Consolidated Balance Sheets include the following:

The operations of properties for which a plan of disposal was implemented after
the adoption of SFAS 144 have been reported in discontinued operations. Total
revenues included in discontinued operations were $218,000 for the nine month
period ended September 30, 2002, and $148,000 and $510,000 for the three and
nine month periods ended September 30, 2001. These operations were previously
reported in the investment segment.

NOTE 10. ACCOUNTING CHANGE

Effective July 1, 2002, we adopted the fair value method defined in SFAS No 123,
"Accounting for Stock-Based Compensation," in accounting for our stock option
plans, where previously we applied APB No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. SFAS 123 indicates that the fair value
method is the preferable method of accounting, and we have elected to apply it
prospectively for all options granted since the beginning of 2002. For the three
and nine month periods ended September 30, 2002, we have recognized expense of
$32,000 and $141,000 related to stock options granted in 2002.

NOTE 11. SUBSEQUENT EVENTS

In October 2002, a land parcel located in Dallas, Texas was sold for $420,000.
We received net cash proceeds of $382,000 and recognized a gain of $269,000.

Also in October 2002, we closed an $8.3 million mortgage secured by a recently
completed shopping center in Paramus, New Jersey. After paying off the existing
loan, establishing required escrows, and paying closing costs, we received net
cash proceeds of $1.2 million.

24

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

Please read this discussion along with the Consolidated Financial Statements and
Notes included elsewhere in this report.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of cash are property operations, borrowings, and proceeds
from the sale of properties. We believe these sources will continue to meet our
cash requirements, including debt service payments, property maintenance and
improvements, development costs for properties under construction, projected
purchases of existing properties, dividends on preferred stock, and planned
repurchases of common stock. Although we expect these sources of cash to be
sufficient to fund planned uses of cash, we make no assurance that the expected
sales and refinancings of properties will be completed as planned.

In the first nine months of 2002, borrowings generated net proceeds of $43.7
million from the refinancing of mortgages on consolidated and unconsolidated
properties (after existing loan payoffs) and construction loan fundings. We also
repaid $8.9 million of borrowings under line of credit facilities (including
$7.9 million repaid to affiliates of William S. Friedman, President, Chief
Executive Officer, and Chairman of the Board of Directors of Tarragon).

Principal payments on notes payable totaling $48.7 million come due during the
remainder of 2002, including $43.1 million of balloon payments. Of this amount,
$7.5 million has been paid off since the end of the third quarter, and a $14
million construction loan has three one-year extension options. We intend to pay
off or extend the loans as they come due largely through refinancings. We
estimate that refinancing will generate $4.8 million in net cash proceeds during
the remainder of 2002. We believe we can arrange such new financing as may be
needed to repay maturing notes.

We have guaranteed $3.7 million of mortgages on two unconsolidated properties.
We have also guaranteed construction loans totaling $167.2 million on four
unconsolidated properties, including the $90 million construction loan for the
Las Olas River House condominium development. This construction loan was closed
in March 2002 and has a September 30, 2002, balance of $5 million. The aggregate
balance of the other construction loans at September 30, 2002, is $66 million.

In the first nine months of 2002, we received $3 million in net cash proceeds
from the sale of an apartment property with a net carrying amount of $2.7
million after paying off a mortgage of $1.9 million. Additionally, we received
distributions of $10.7 million of proceeds from the sale of four joint venture
properties. We estimate proceeds from the projected sale of real estate will
provide approximately $10 million during the remainder of 2002.

As of September 30, 2002, we had entered into contracts for the sale of 26 of
the remaining 47 apartments at the 5600 Collins condominium conversion for a
total of $7.9 million. During the first nine months of 2002, we closed the sale
of 79 condominium units for $20.4 million. After closing costs and payoff of the
project mortgage, we received net cash proceeds of $9.1 million. During the
first nine months of 2002, Tarragon spent $6.2 million on capital improvements
and unit renovations in connection with the condominium conversion.

In April 2002, we purchased a tract of land for development for $2.8 million.

In the first nine months of 2002, Tarragon made capital improvements to its
consolidated real estate of $32 million, (excluding expenditures at 5600 Collins
discussed above). Of this amount, $21.3 million was spent on construction at our
development properties. We expect to spend approximately $23.1 million on
construction of

25

three consolidated apartment communities under development during the remainder
of 2002, $17.4 million of which will be funded by construction loans. We plan to
invest approximately $1.7 million in capital improvements to our consolidated
operating properties during the remainder of 2002.

During the first nine months of 2002, Tarragon advanced $4.3 million to a new
joint venture that purchased land in Fort Lauderdale, Florida, adjacent to the
Las Olas River House condominium development. The joint venture plans to build a
second phase of this project on the land. During the same period, Tarragon
received net repayment of advances of $6 million from One Las Olas, which owns
the Las Olas River House condominium development.

In December 2001, the Board of Directors declared a 10% common stock dividend
payable on April 26, 2002, to holders of record on April 15, 2002. This stock
dividend was recorded in March 2002.

We paid cash dividends of $513,000 to preferred stockholders in the first nine
months of 2002.

The Board of Directors has authorized a common stock repurchase program. We
intend to continue to repurchase shares of our common stock as long as we
believe the fair market value of our net assets per share is substantially
greater than the market price of our common stock. During the first nine months
of 2002, Tarragon repurchased 221,392 shares of its common stock in open market
and negotiated transactions at a cost of $3.2 million. Subject to market
conditions, we expect to repurchase shares of our common stock in 2002 at a rate
consistent with prior years. As of September 30, 2002, Tarragon had authority to
repurchase an additional 717,304 common shares.

RESULTS OF OPERATIONS

Equity in earnings of partnerships increased $2.9 million and $11.6 million for
the three and nine month periods ended September 30, 2002. For the nine month
period, Devonshire Apartment Owners, L.L.C., accounted for an increase of $7.6
million resulting from the sale of its only property in the first quarter of
2002 and distribution of net proceeds to its members. For the three month
period, the sale of Devonshire's property caused a $242,000 decrease. For both
periods, Ansonia Apartments, L.P., accounted for an increase of $5.2 million
resulting from the distribution of net proceeds from the mortgage refinancing of
several properties. This amount represents proceeds received in excess of
Tarragon's investment in the partnership. For the three month period, Ansonia
also accounted for a decrease of $1.2 million representing Tarragon's share of
the gain on one of its properties sold in the third quarter of 2001. Tarragon's
share of gains from the sale of three of its properties in the first and second
quarters of 2002 totaled $1.5 million, making the nine month period more
comparable. Decreases of $310,000 and $555,000 for the three and nine month
periods came from net losses of three partnerships with properties recently
completed or under construction that began lease-up in 2002.

In the second quarter of 2002, we began consolidating two partnerships because
we now have a controlling interest in each. The consolidation resulted in
increases in net rental income (rental revenue less property operating expenses)
of $929,000 and $1.8 million for the three and nine month periods. For the same
periods, interest expense increased $272,000 and $745,000, and depreciation
increased $297,000 and $553,000. For the three and nine month periods, $313,000
and $477,000 representing the outside partners' interest in the partnerships'
net income was recorded to minority interest.

In May 2001, we deconsolidated three properties in connection with a change in
control upon forming joint ventures with Aetna Life Insurance Company. We
experienced decreases in net operating results of $150,000 and $128,000 for the
three and nine month periods associated with these properties. For the nine
months ended September 30, 2002, the decrease in net operating results includes
a decrease in consolidated net rental income of $2 million, a decrease in
interest expense of $1.4 million, and a decrease in depreciation of $751,000.
Additionally, we recorded losses of $227,000 and $465,000 for the three and nine
month periods ended

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September 30, 2002, representing our equity in the losses of these joint
ventures for the periods. Our equity in the net losses of these joint ventures
for the comparable periods in 2001 was $77,000 and $130,000.

We purchased two apartment communities in 2001 that contributed increases of
$446,000 and $756,000 to net operating results for the three and nine month
periods. We sold a 10% interest in the Liberty Building to a third party in
October 2001, and, since that time, we have used the equity method to account
for our interest in this property. For the three and nine month periods ended
September 30, 2002, we recognized income of $64,000 and $275,000 representing
our equity in the income of the joint venture that owns this property. In
addition, in the three and nine month periods ended September 30, 2002, we
received distributions from operations and from proceeds of refinancing the
Liberty Building in amounts greater than the balance of our investment in the
joint venture, and $365,000 is included in equity in income of partnerships from
these sources. For the three and nine month periods ended September 30, 2001,
this property contributed $50,000 and $55,000 to net operating results. These
amounts were comprised of net rental income of $202,000 and $555,000, interest
expense of $113,000 and $385,000, and depreciation of $39,000 and $115,000. The
other property, Forest Park, was purchased in October 2001 and contributed
$67,000 and $171,000 to net operating results for the three and nine month
periods ended September 30, 2002. These amounts were comprised of net rental
income of $212,000 and $598,000, interest expense of $97,000 and $291,000, and
depreciation of $48,000 and $136,000.

The sale of two apartment communities, two commercial properties, and a portion
of another commercial property during 2001 reduced net operating results by
$59,000 and $271,000 for the three and nine month periods. These decreases are
comprised of decreases in net rental income of $131,000 and $739,000, decreases
in interest expense of $65,000 and $413,000, and decreases in depreciation of
$7,000 and $55,000.

The operations of five consolidated apartment communities under development or
recently completed and in lease-up and one recently completed consolidated
shopping center which began operations in 2001 or 2002 increased our net
operating results by $552,000 and $38,000 for the three and nine month periods.
These amounts are comprised of increases in net rental income of $1 million and
$2.8 million, increases in interest expense of $236,000 and $1.6 million, and
increases in depreciation of $222,000 and $1.1 million. As of November 1, 2002,
occupancy at the five apartment communities ranged from 17% to 94%, and the
retail property was fully leased.

At September 30, 2002, Tarragon's consolidated apartment properties accounted
for 88% of its real estate and included 10,257 operating units, and our
consolidated operating commercial properties had an aggregate 1.2 million square
feet.

The portfolio of 42 consolidated apartment properties with 8,451 units owned for
all of 2002 and 2001 reported net rental income of $6.9 million and $21.8
million for the three and nine month periods ended September 30, 2002, compared
with $6.7 million and $20.2 million reported in the corresponding periods in
2001. Net rental income as a percentage of rental revenue for the 8,451 units
was 43.5% and 45.8% for the three and nine month periods in 2002 compared to
42.5% and 44.4% in 2001. Rental revenue for the same store apartment properties
increased $249,000, or 1.6%, and $2 million, or 4.4%, chiefly due to generally
higher rental rates. Additionally, for the nine month period, increased
occupancy at several properties reduced vacancy losses. Average overall
occupancy for apartment communities held in both years increased slightly.
Average monthly rental revenue per unit for the same store properties increased
1.6% to $629 from $619 for the three month period and 4.4% to $625 from $599 for
the nine month period. Property operating expenses on a same store basis
decreased $8,000, or .1% for the three months, and increased $423,000, or 1.7%,
for the nine months. Higher property management fees (since changing to third
party management for certain of our properties in 2001) and property insurance
costs were offset (only partially for the nine month period) by lower utility
costs.

For properties held in both years, interest expense decreased $892,000 and $2.2
million primarily due to pay downs or pay offs of several mortgages and
decreases in interest rates on our variable rate debt.

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Corporate general and administrative expenses increased $608,000 and $1.1
million for the three and nine month periods in 2002 compared to the same
periods in 2001. Of these increases, $650,000 in both periods represents
expenses incurred in connection with potential acquisitions or development
projects that were not selected for further investment. In connection with our
adoption of the expense recognition provisions of Statement of Financial
Accounting Standards (SFAS) No. 123 effective July 1, 2002, we recognized
compensation expense for the three and nine month periods of $32,000 and
$141,000 for stock options granted in 2002. Additionally, in the second quarter
of 2002, in accordance with the Accounting Principles Board's Opinion No. 25, we
recognized expense of $144,000 in connection with stock options granted with
below market exercise prices.

Property general and administrative expenses decreased $59,000 and $551,000 for
the three and nine month periods in 2002 compared to the same periods in 2001,
primarily due to a change to third party property management for certain of our
properties and a related reduction in property management staff in March 2001.

In connection with the adoption