SHELBOURNE PROPERTIES III INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from____________ to
____________.

Commission File Number: 0-16343

SHELBOURNE PROPERTIES III, INC.
(Exact name of registrant as specified in its charter)

Delaware 04-3502381
- ----------------------------------------- -------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

7 Bulfinch Place - Suite 500
Boston, MA 02114
- ----------------------------------------- -------------------------------------
(Address of principal executive offices) (Zip Code)

617-570-4600
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)

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

TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
Common Stock, $0.01 par value American Stock Exchange

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

TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
None None

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 and 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 at least 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 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 an accelerated filer (as
defined by Exchange Act Rule 12b-2). Yes [ ] No [X]

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement, to be filed with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year covered by this Form 10-K, with respect to the 2003 Annual Meeting of
Stockholders, are incorporated by reference into Part III of this Annual Report
on Form 10-K.

As of March 24, 2003, of the 788,772 shares of common stock outstanding, 460,278
shares with an aggregate market value of $14,913,007 were issued and outstanding
and held by non-affiliates.

This report consists of 67 sequentially numbered pages. The Exhibit Index is
located at sequentially numbered page 45.

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TABLE OF CONTENTS

Page
----

PART I............................................................................................................3

Item 1. Business........................................................................................3

Where Can You Find More Information About Us?....................................................................19

Item 2. Properties.....................................................................................19
Item 3. Legal Proceedings..............................................................................23
Item 4. Submission of Matters to a Vote of Security Holders............................................23

PART II..........................................................................................................24

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..........................24
Item 6. Selected Financial Data........................................................................26
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..........27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.....................................36
Item 8. Financial Statements and Supplementary Data.....................................................3
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............3

Part III..........................................................................................................3

Item 10. Directors and Executive Officers of the Registrant.............................................38
Item 11. Executive Compensation.........................................................................38
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................38
Item 13. Certain Relationships and Related Transactions.................................................38
Item 14. Controls and Procedures........................................................................38

Part IV...........................................................................................................3

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................3

Exhibit 99.1.....................................................................................................46

FORWARD-LOOKING STATEMENTS

This Form 10-K contains forward-looking statements relating to our
business and financial outlook, which are based on our current expectations,
estimates, forecasts and projections. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of these terms or other comparable
terminology. These forward-looking statements are not guarantees of future
performance and involve risks, uncertainties, estimates and assumptions that are
difficult to predict. Therefore, actual outcomes and results may differ
materially from those expressed in these forward-looking statements. You should
not place undue reliance on any of these forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which it is made,
and we undertake no obligation to update any such statement to reflect new
information, the occurrence of future events or circumstances or otherwise.

A number of important factors could cause actual results to differ
materially from those indicated by the forward-looking statements, including,
but not limited to, the risks described under "Item 1. Business - Risk Factors"
in this Form 10-K.

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PART I

ITEM 1. BUSINESS

In this Form 10-K, the terms "we," "us," "our" and "our company" refer
either to the combined operations of all of Shelbourne Properties III, Inc.,
Shelbourne Properties III GP LLC and Shelbourne Properties III L.P. or to
Shelbourne Properties III, Inc. independently, as the context requires.

OVERVIEW

Our company, Shelbourne Properties III, Inc., a Delaware corporation
(the "Corporation"), was formed on February 8, 2001 and is engaged in the
business of operating and holding for investment previously acquired
income-producing properties. As of March 24, 2003, we operate and hold one
shopping center, one retail store and two industrial warehouses. In addition,
the Corporation owns an interest in 20 motel properties that are triple-net
leased to an affiliate of Accor S.A. See "Corporate History- The Accotel
Transaction" and "Item 2. Properties" for a description of our properties.

We own our property portfolio through our directly and indirectly
wholly owned subsidiary, Shelbourne Properties III L.P. (the "Operating
Partnership"), a Delaware limited partnership. The Operating Partnership owns
our property portfolio directly, through joint ventures with affiliated entities
(Shelbourne Properties I L.P. and/or Shelbourne Properties II L.P.) or through
wholly-owned subsidiaries. The general partner of the Operating Partnership is
Shelbourne Properties III GP Inc., a Delaware corporation that is wholly owned
by the Corporation.

Our primary business objective is to maximize the value of our common
stock. Prior to October 29, 2002, we sought to achieve this objective by
managing our existing properties, making capital improvements to and/or selling
properties and by making additional real estate-related investments. On October
29, 2002, the stockholders of the Corporation adopted a plan of liquidation.
Accordingly, on such date the Corporation was dissolved and has been seeking to
liquidate its assets. Since October 29, 2002, the Corporation has sold its
properties located in Livonia, Michigan; New York, New York; Hilliard, Ohio and
Melrose Park, Illinois. It is expected that the remaining properties will be
sold at such time as market conditions enable the Corporation to maximize the
sale price. See "Corporate History-The HX Transaction; The Plan of Liquidation"
below.

Our Board of Directors currently consists of six directors. Two
director's terms expire in each of 2003, 2004 and 2005. See "Employees" below
for information relating to the provision by affiliates of property management
services, asset management services, investor relation services and accounting
services to us.

The Corporation is operating with the intention of qualifying as a real
estate investment trust for U.S. Federal Income Tax purposes ("REIT") under
Sections 856-860 of the Internal Revenue Code of 1986 as amended. Under those
sections, a REIT which pays at least 90% of its ordinary taxable income as a
dividend to its stockholders each year and which meets certain other conditions
will not be taxed on that portion of its taxable income which is distributed to
its stockholders.

We have adopted a plan of liquidation that requires us to liquidate all
of our assets and liabilities by October 29, 2004. Dividends paid during our
liquidation generally will not be taxable to you until the distributions exceed
your adjusted tax basis in your shares, and then will be taxable to you as
long-term capital gain assuming you hold your shares as capital assets and have
held them for more than 12 months when you receive the distribution as a result
of the adoption of the plan of liquidation. If our assets are not completely
liquidated by October 29, 2004, our assets will be transferred to a liquidating
trust on such date and in lieu of owning shares, you will own a beneficial
interest in the liquidating trust of an equivalent percentage. The
transferability of interests in the trust will be significantly restricted as
compared to the shares in the Corporation, and you will be required to include
in your own income your pro rata share of the trust's taxable income whether or
not that amount is actually distributed by the trust to you in that year.

The Predecessor Partnership (as defined below) invested all of the net
proceeds of its offering of Units (as defined below) in real estate. Revenues
from the following properties owned wholly and/or through joint venture,
represented 10% or more of our gross revenues during the fiscal year ended
December 31, 2002 and, the

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Predecessor Partnership's and, subsequently, our gross revenues during each of
the fiscal years ended December 31, 2001 and 2000: during 2002, 568 Broadway,
Tri-Columbus, Sunrise, and Livonia represented 26%, 24%, 24%, and 17% of gross
revenues, respectively; during 2001, Tri-Columbus, Sunrise, Livonia and 568
Broadway represented 27%, 25%, 18% and 24% of gross revenues, respectively;
during 2000, Tri-Columbus, Sunrise, Livonia and 568 Broadway represented 25%,
26%, 19% and 23% of gross revenues, respectively. See "Item 2. Properties" for a
description of the Predecessor Partnership's and our properties.

CORPORATE HISTORY

Predecessor Partnership. Prior to the merger described below, the owner
of the Corporation's properties was High Equity Partners L.P. - Series 88, a
Delaware limited partnership (the "Predecessor Partnership"). The Predecessor
Partnership was formed as of February 24, 1987. Prior to November 3, 1994 the
Predecessor Partnership's General Partners ("Predecessor General Partners") were
owned and controlled by Integrated Resources, Inc. On November 3, 1994, Presidio
Capital Corporation ("Presidio") acquired the Predecessor General Partners.
Effective July 31, 1998, NorthStar Capital Investment Corp., a Maryland
corporation, acquired control of Presidio.

In 1989, the Predecessor Partnership made a public offering of 400,000
units of limited partnership interest (the "Units"). Upon final admission of
limited partners, the Predecessor Partnership had accepted subscriptions for
371,766 units for an aggregate of $92,941,500 in gross proceeds, resulting in
net proceeds from the offering of $90,153,255 (gross proceeds of $92,941,500
less organization and offering costs of $2,788,245). Subsequent to the
conversion discussed below, the Units were converted into shares of the
Corporation on a three for one basis. Throughout the rest of this document,
rather than referring to Units, we will refer to shares on an as converted
basis. In August of 1990, $6,305,151.36 in uninvested gross proceeds was
returned to the limited partners as a special distribution of $5.65 per Unit,
resulting in net proceeds from the offering of $83,848,104 (gross proceeds of
$86,636,349 less organization and offering costs of $2,788,245). The Predecessor
Partnership invested substantially all of its total adjusted net proceeds, after
establishing a working capital reserve, in real estate.

In April 1999, the California Superior Court approved the terms of the
settlement of a class action and derivative litigation involving the Predecessor
Partnership. Under the terms of the settlement, the Predecessor General Partners
agreed to take the actions described below subject to first obtaining the
consent of limited partners to amendments to the Agreement of Limited
Partnership of the Predecessor Partnership (the "Predecessor Partnership
Agreement") summarized below. The settlement became effective in August 1999
following approval of the amendments.

As amended, the Predecessor Partnership Agreement (a) provided for a
Partnership Asset Management Fee payable to the Predecessor General Partners or
their affiliates commencing the year ended December 31, 2000 equal to 1.25% of
the Gross Asset Value of the Predecessor Partnership (as defined in that
agreement) and a fixed 1999 Partnership Asset Management Fee of $719,411
($160,993 less than the amount that would have been paid under the pre-amendment
formula) and (b) fixed the amount that the Predecessor General Partners would be
liable to pay to limited partners upon liquidation of the Predecessor
Partnership as repayment of fees previously received (the "Fee Give-Back
Amount"). As amended, the Predecessor Partnership Agreement provided that, upon
a reorganization of the Predecessor Partnership into a REIT or other public
entity, the Predecessor General Partners would have no further liability to pay
the Fee Give-Back Amount. As a result of the conversion of the Predecessor
Partnership into a REIT on April 17, 2001, as described below, the Predecessor
General Partners' liability to pay the Fee Give-Back Amount was extinguished.

As required by the settlement, an affiliate of the Predecessor General
Partners, Millennium Funding IV, LLC, made a tender offer to limited partners to
acquire up to 25,034 Units (representing approximately 6.7% of the outstanding
Units) at a price of $113.15 per Unit. The offer closed in January 2000 and all
25,034 Units were acquired in the offer. On a post conversion basis, the tender
offer was for the equivalent of 75,012 shares at a price of $37.71 per share.

The final requirement of the settlement obligated the Predecessor
General Partners to use their best efforts to reorganize the Predecessor
Partnership into a REIT or other entity whose shares were listed on a national
securities exchange or on the NASDAQ National Market System. A Registration
Statement was filed with the

5

Securities and Exchange Commission on February 11, 2000 with respect to the
restructuring of the Predecessor Partnership into a publicly traded REIT. On or
about February 15, 2001 a prospectus/consent solicitation statement was mailed
to the limited partners of the Predecessor Partnership seeking consent to the
reorganization of the Predecessor Partnership into a REIT.

The consent of limited partners was sought to approve the conversion of
the Predecessor Partnership into the Operating Partnership. The consent
solicitation expired April 16, 2001, and holders of a majority of the Units
approved the conversion.

On April 17, 2001, the conversion was accomplished by merging the
Predecessor Partnership into the Operating Partnership. Pursuant to the merger,
each limited partner of the Predecessor Partnership received three shares of
stock of the Corporation for each Unit they owned and the Predecessor General
Partners received an aggregate of 58,701 shares of stock in the Corporation in
exchange for their general partner interests in the Predecessor Partnership. In
connection with the merger, the Company entered into an advisory agreement (the
"Advisory Agreement") with Shelbourne Management, LLC ("Shelbourne Management")
to provide accounting, asset management, treasury, cash management and investor
related services management to the Company. Shelbourne Management is a
wholly-owned subsidiary of Presidio Capital Investment Company, LLC ("PCIC"),
which was also the sole shareholder of Presidio. The Advisory Agreement has a
term of 10 years and provides for fees payable to Shelbourne Management of (1)
the Asset Management Fee previously payable to the Predecessor General Partners
or their affiliates, (2) $200,000 for non-accountable expenses and (3)
reimbursement of expenses incurred in connection with performance of its
services. In addition, Shelbourne Management was entitled to receive a property
management fee equal to up to 6% of property revenues.

The Presidio Transaction. On February 14, 2002, the Corporation,
Shelbourne Properties I, Inc. and Shelbourne Properties II, Inc. (together the
"Companies") announced the consummation of a transaction (the "Transaction")
whereby the Companies (i) purchased their respective Advisory Agreements and
(ii) repurchased all of the shares of capital stock in the Companies held by
subsidiaries of PCIC (the "PCIC Shares").

Pursuant to the Transaction, for the Advisory Agreements and the PCIC
Shares, the Companies paid PCIC an aggregate of $44,000,000 in cash, issued
preferred partnership interests in their respective operating partnerships with
a liquidation preference of $2,500,000, and issued notes with a stated amount
between approximately $54,300,000 and $58,300,000, depending upon the timing of
the repayment of the notes. These notes were subsequently satisfied for
$54,300,000 from the proceeds of the Hypo Loan described below.

Pursuant to the Transaction, the Corporation paid PCIC approximately
$11,800,000 in cash and the Operating Partnership issued preferred partnership
interests (the "Class A Units") with an aggregate liquidation preference of
$672,178 and a note with an aggregate stated amount between approximately
$14,600,000 and $15,700,000, depending upon the timing of the repayment of the
note. This note was subsequently satisfied for approximately $14,600,000 from
the proceeds of the Hypo Loan described below.

The Transaction was unanimously approved by the Boards of Directors of
each of the Companies at such time after recommendation by their respective
Special Committees comprised of the Companies' three independent directors.

Houlihan Lokey Howard & Zukin Capital served as financial advisor to
the Special Committees of the Companies and rendered a fairness opinion to the
Special Committees with respect to the Transaction.

The foregoing description of the Transaction does not purport to be
complete, and it is qualified in its entirety by reference to the Purchase and
Contribution Agreement, dated as of February 14, 2002, the Secured Promissory
Note, dated February 14, 2002 and the Partnership Unit Designations of Class A
Preferred Partnership Units of Shelbourne Properties III L.P., copies of which
are attached as exhibits to our current report on form 8-K filed on February 14,
2002, and are incorporated by reference herein.

The HX Transaction; The Plan of Liquidation. On July 1, 2002, the
Corporation entered into a settlement agreement with respect to certain
outstanding litigation brought by HX Investors, L.P. ("HX Investors") in the
Chancery Court of Delaware against the Companies. At the same time, the
Companies entered into a letter

6

agreement settling other outstanding litigation brought by stockholders against
the Companies, subject to approval by the court of a stipulation of settlement.
In connection with the settlements, the Corporation entered into a stock
purchase agreement (the "Stock Purchase Agreement") with HX Investors and Exeter
Capital Corporation ("Exeter"), the general partner of HX Investors, pursuant to
which HX Investors, the then owner of approximately 12% of the outstanding
common stock of the Corporation, was granted a waiver by the Corporation from
the stock ownership limitation (8% of the outstanding shares) set forth in the
Corporation's Certificate of Incorporation to permit HX Investors to acquire up
to 42% of the outstanding shares of the Corporation's common stock and HX
Investors agreed to conduct a tender offer for up to an additional 30% of the
Corporation's outstanding stock at a price per share of $49.00 (the "HX
Investors Offer"). The tender offer commenced on July 5, 2002 following the
filing of the required tender offer documents with the Securities and Exchange
Commission by HX Investors. In addition, pursuant to the terms of the
settlement, Shelbourne Management agreed to pay to HX Investors 42% of the
amounts paid to Shelbourne Management with respect to the Class A Units.

Pursuant to the Stock Purchase Agreement, the board of directors of the
Corporation approved a plan of liquidation for the Corporation (the "Plan of
Liquidation") and agreed to submit the Plan of Liquidation to its stockholders
for approval. HX Investors agreed to vote all of its shares in favor of the Plan
of Liquidation. Under the Plan of Liquidation, HX Investors was to receive an
incentive payment (the "Incentive Fee") of 25% of gross proceeds after the
payment of a priority return of approximately $52.25 per share was made to the
stockholders of the Corporation.

Subsequently, on July 29, 2002, Longacre Corp. ("Longacre"), commenced
a lawsuit individually and derivatively against the Companies, their boards, HX
Investors, and Exeter seeking preliminary and permanent injunctive relief and
monetary damages based on purported violations of the securities laws and
mismanagement related to the tender offer by HX Investors, the Stock Purchase
Agreement, and the Plan of Liquidation. The suit was filed in federal district
court in New York, New York. On August 1, 2002, the court denied Longacre's
motion for a preliminary injunction, and the court dismissed the lawsuit on
September 30, 2002, at the request of Longacre.

Contemporaneous with filing its July 29, 2002 lawsuit, Longacre
publicly announced that its related companies, together with outside investors,
were prepared to initiate a competing tender offer for the same number of shares
of common stock of the Corporation as were tendered for under the HX Investors
Offer, at a price per share of $53.90. Over the course of the next several days,
Longacre and HX Investors submitted competing proposals to the board of
directors of the Corporation and made those proposals public. On August 4, 2002,
Longacre notified the Corporation that it was no longer interested in proceeding
with its proposed offer.

On August 5, 2002, the Corporation entered into an amendment to the
Stock Purchase Agreement. Pursuant to the terms of the amendment, the purchase
price per share offered under the HX Investors Offer was increased from $49.00
to $58.30. The amendment also reduced the Incentive Fee payable to HX Investors
under the Plan of Liquidation from 25% to 15% of gross proceeds after payment of
the approximately $52.25 per share priority return to stockholders of the
Corporation plus interest thereon compounded quarterly at 6% per annum, and
included certain corporate governance provisions. After giving effect to
dividends paid from August 19, 2002 to March 24, 2003, the remaining unpaid per
share priority return to stockholders is $7.13.

On August 16, 2002, the HX Investors Offer expired and HX Investors
acquired 236,631 shares representing 30% of the outstanding shares.

On August 19, 2002, as contemplated by the Stock Purchase Agreement,
the existing Board of Directors and executive officer of the Corporation
resigned, and the Board was reconstituted to consist of six members, four of
whom are independent directors. In addition, new executive officers were
appointed.

Also on August 19, 2002, the Board of Directors of the Corporation
authorized the issuance by the Operating Partnership of Class B Units to HX
Investors which Class B Units were to be issued in full satisfaction of the
Incentive Fee. The Class B Units provide distribution rights to HX Investors
consistent with the intent and financial terms of the incentive payment provided
for in Stock Purchase Agreement described above. On August 19, 2002, the
Operating Partnership issued the Class B Units to HX Investors in full
satisfaction of the Incentive Fee otherwise required under the Plan of
Liquidation.

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On October 29, 2002, the stockholders of the Corporation approved the
Plan of Liquidation. As a result, the Operating Partnership has been seeking,
and will seek to, sell its remaining properties at such time as it is believed
that the sale price for such property can be maximized. Since the adoption of
the Plan of Liquidation, the Corporation has sold its properties located in
Livonia, Michigan; Hilliard, Ohio; Melrose Park, Illinois, and New York, New
York and has paid dividends of $8.25 per share on November 21, 2002, $2.50 per
share on January 31, 2003 and $36.00 per share on March 18, 2003. Pursuant to
the Plan of Liquidation, if all of the assets of the Corporation are not
disposed of prior to October 29, 2004, the remaining assets will be placed in a
liquidating trust and the stockholders of the Corporation will receive a
beneficial interest in such trust in total redemption of their shares in the
Corporation.

The foregoing description of Stock Purchase Agreement is qualified in
its entirety by reference to such agreement, a copy of which is attached as an
exhibit to the Corporation's Current Reports on Form 8-K filed on July 2, 2002
and August 5, 2002, which is incorporated herein by reference. The foregoing
description of Plan of Liquidation is qualified in its entirety by reference to
the Plan of Liquidation, a copy of which is attached as an exhibit to the
Corporation's Definitive Proxy Statement filed on September 29, 2002, which is
incorporated herein by reference.

FINANCINGS

The Hypo Loan. On May 1, 2002, the operating partnerships of the
Companies and certain of the operating partnerships' subsidiaries entered into a
$75,000,000 revolving credit facility with Bayerische Hypo-Und Vereinsbank AG,
New York Branch, as agent for itself and other lenders (the "Credit Facility" or
"Hypo Loan"). The Credit Facility was subsequently satisfied on February 20,
2003 from proceeds of the Fleet Loan. See "Fleet Loan" below.

The Credit Facility had a term of three years and was prepayable in
whole or in part at any time without penalty or premium. The Companies initially
borrowed $73,330,073 under the Credit Facility. The Corporation's share of the
proceeds amounted to $19,718,457, of which $14,589,936 was used to repay the
note issued in the Transaction, $142,871 to pay associated accrued interest and
$556,712 to pay costs associated with the Credit Facility. The excess proceeds
of $4,428,938 were deposited into the Corporation's operating cash account. The
Companies had the right, from time to time, to elect an annual interest rate
equal to (i) LIBOR plus 1.5% for the portion of the Note Payable secured by
mortgages on certain real properties (Conversion rate) (ii) LIBOR plus 2.5% for
the portion of the Note Payable secured by a pledge of partnership interests
(LIBOR rate) or (iii) the greater of (a) agent's prime rate or (b) the federal
funds rate plus 1.5% (Base rate). The Companies were required to pay the
lenders, from time to time, a commitment fee equal to .25% of the unborrowed
portion of the Credit Facility. Such fee paid during the term of the Credit
Facility amounted to $992. Interest was payable monthly in arrears. The interest
rate at December 31, 2002 was approximately 3.8%.

The Credit Facility was secured by (i) a pledge by the operating
partnerships of their membership interest in their wholly-owned subsidiaries
that hold their interests in joint ventures with the other Companies and (ii)
mortgages on certain real properties owned directly or indirectly by the
operating partnerships. All of the properties of the Corporation were security
for the Credit Facility.

Under the terms of the Credit Facility, the Companies were permitted to
sell the pledged property only if certain conditions were met. If properties
were sold, the Companies were required to pay a fixed release amount to the
lenders except in the case of core properties, which were defined as 568
Broadway, Century Park, Seattle Tower and Southport, in which case the Companies
were required to pay the lenders the greater of the net proceeds or the release
amount. In addition, the Companies were required to maintain certain debt yield
maintenance ratios and comply with restrictions relating to engaging in certain
equity financings, business combinations and other transactions that might
result in a change of control (as defined under the Credit Facility).

The Companies were joint and severally liable under the Credit Facility
but had entered into a Contribution and Cross-Indemnification Agreement. Such
agreement provided for the allocation of the Credit Facility and payments
thereunder among the operating partnerships in proportion to their interest in
the Credit Facility.

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The foregoing description of the Credit Facility is qualified in its
entirety by reference to such agreement, a copy of which is attached as exhibits
to the Corporation's Current Report on Form 8-K filed on May 14, 2002, which is
incorporated herein by reference.

The Fleet Loan. Under the terms of the Credit Facility, upon the sale
of the New York, New York property which was sold on February 28, 2003, the
proceeds from such sale would first have been required to satisfy the Credit
Facility. As a result, upon the sale of the New York property, the Corporation
risked not being able to satisfy the requirements to maintain its REIT status as
it was likely that dividends in 2003, absent unforeseeable occurrences, would
not have been equal to at least 90% of the Corporation's ordinary taxable
income. Accordingly, on February 20, 2003, in a transaction designed to
alleviate this problem as well as provide flexibility to the Companies in
implementing their respective plans of liquidation, direct and indirect
subsidiaries (the "Borrowers") of each of the Companies entered into a Loan
Agreement with Fleet National Bank, as agent for itself and other lenders
("Fleet") pursuant to which the Borrowers obtained a $55,000,000 loan (the
"Loan"). The entering into of this Loan transaction enabled 100% of the net
proceeds from the sale of its 568 Broadway Joint Venture (the New York property)
to be paid as a dividend by the Corporation as the New York property was not
security for the Loan.

The Loan bears interest at the election of the Borrowers at a rate of
either (i) LIBOR plus 2.75% or (ii) 1% plus the greater of Fleet's prime rate or
5%. At present the Borrowers have elected that the Loan bear interest at LIBOR
plus 2.75% which, at March 24, 2003 was 4.09%. The Loan matures on February 19,
2006, subject to two one-year extensions. The Loan is pre-payable in whole or in
part at anytime without penalty or premium.

The Borrowers are jointly and severally liable for the repayment of the
amounts due under the Loan and the Operating Partnership and the Corporation (as
well as the other operating partnerships and Companies) have guaranteed the
repayment of the Loan. The proceeds of the Loan were used to satisfy the Credit
Facility that had a balance due of $37,417,249. The Credit Facility was
satisfied by delivery of $27,417,249 in cash and a $10,000,000 note from 568
Broadway Joint Venture (the "568 Note"), which note was then acquired by
Manufacturers Traders and Trust Company. In connection with the assignment of
the 568 Note, the purchase agreement with respect to the property held by 568
Joint Venture was amended to provide that the buyer would acquire the property
subject to the 568 Note and would receive a credit of $10,000,000 at closing.
After satisfying the Credit Facility, establishing a capital improvements
reserve of $5,000,000 in the aggregate ($1,000,000 of which is allocable to the
Corporation), a $10,000,000 reserve ($2,215,000 of which is allocable to the
Corporation) to be released upon the earlier of the sale of the 568 Property or
the satisfaction of the 568 Note and costs associated with consummating the
Loan, the net proceeds received by the Companies was approximately $11,000,000
in the aggregate, which proceeds, together with the $10,000,000 reserve that was
released from escrow on March 3, 2003, were distributed to stockholders as part
of the March dividend.

The Loan is secured by mortgages on certain real properties owned
directly and indirectly by the operating partnerships. The Corporation's
properties located in Las Vegas, Nevada; Westerville, Ohio, and Grove City, Ohio
(the "Collateral Properties") secure the Loan. Pursuant to the Loan, the
Collateral Properties may be sold if, among other things, the purchase price
provides net proceeds which are in an amount equal to a minimum release price
for such property, which amount would be applied as a prepayment of the Loan.
The Corporation's other properties may be sold at any time and, so long as there
is no event of default, none of the net proceeds of the sales of such other
properties is required to be applied towards the Loan.

Under the Loan, the Companies are required to maintain a certain debt
yield maintenance ratio and have certain restrictions with respect to engaging
in certain equity financings, business combinations and other transactions that
may result in a "change of control" (as defined under the Loan documents),
incurring additional indebtedness, acquiring additional properties, and selling
properties without achieving certain minimum sale prices. In addition, the
occurrence of certain events over which the Companies may have no control and
which constitute a "change of control" will cause a default under the Loan.

Since the Borrowers are jointly and severally liable for the repayment
of the entire principal, interest and other amounts due under the Loan, the
Borrowers, the Companies and the operating partnerships have entered into
Indemnity, Contribution and Subrogation Agreements, the purpose and intent of
which was to place the operating partnerships in the same position (as among
each other) as each would have been had the lender made three separate loans,
one to each of the operating partnerships; each of which loans would have been
in a smaller amount than the

9

Loan, would have been the obligation/liability only of the operating partnership
to which it was made and would have been secured only by certain of such
operating partnership's assets.

The foregoing description of the Fleet Loan is qualified in its
entirety by reference to Loan Agreement and other documents entered into in
connection therewith, copies of which are attached as exhibits to the
Corporation's Current Report on Form 8-K filed on February 24, 2003, which are
incorporated herein by reference.

PROPERTY SALES/ACQUISITIONS

The Accotel Transaction. As discussed above, in connection with the
Transaction, the Operating Partnership issued the Class A Units to Shelbourne
Management. Pursuant to the terms of the Purchase and Contribution Agreement
pursuant to which the Class A Units were issued, the holder of the Class A Units
had the right to cause the Operating Partnership to purchase the Class A Units
at a substantial premium to their liquidation value ($4,374,000 at the January
15, 2003) unless the Operating Partnership, together with the operating
partnerships of Shelbourne Properties I, Inc. and Shelbourne Properties II, Inc.
(together with the Operating Partnership, the "Shelbourne OPs") maintained at
least approximately $54,200,000 of aggregate indebtedness ($14,574,000 in the
case of the Operating Partnership) guaranteed by the holder of the Class A Units
and secured by assets having an aggregate market value of at least approximately
$74,800,000 ($20,100,000 in the case of the Operating Partnership) (the "Debt
and Asset Covenant"). These requirements significantly impaired the ability of
the Corporation to sell its properties and pay dividends in accordance with the
Plan of Liquidation.

Accordingly, in a transaction (the "Accotel Transaction") designed to
facilitate the liquidation of the Corporation and provide dividends to
stockholders, on January 15, 2003, a joint venture owned by the Shelbourne OPs
acquired from Realty Holdings of America, LLC, an unaffiliated third party, a
100% interest in an entity that owns 20 motel properties triple net leased to an
affiliate of Accor S.A. The cash purchase price, which was provided from working
capital, was approximately $2,700,000, of which approximately $878,000,
$1,096,000 and $726,000 was paid by Shelbourne Properties I L.P., Shelbourne
Properties II L.P. and the Operating Partnership, respectively. The properties
were also subject to existing mortgage indebtedness in the principal amount of
approximately $74,220,000.

The Accor S.A. properties were acquired for the benefit of the holder
of the Class A Units as they provide sufficient debt to be guaranteed by the
holder of the Class A Units. Except as indicated below, the Class A Unitholder
will ultimately be the sole owner of the joint venture. In connection with the
Accotel Transaction, the terms of the Class A Units were amended to (i)
eliminate the liquidation preferences (as the cost of the interest in the Accor
S.A. properties which was borne by the Shelbourne OPs satisfied the liquidation
preference) and (ii) eliminate the Debt and Asset Covenant. The holder of the
Class A Units does, however, continue to have the right, under certain limited
circumstances which the Companies do not anticipate will occur, to cause the
Shelbourne OPs to purchase their respective Class A Units at the premium
described above. These circumstances include the occurrence of the following
while any of the Class A Units are outstanding; (i) the filing of bankruptcy by
a Shelbourne OP; (ii) the failure of a Shelbourne OP to be taxed as a
partnership; (iii) the termination of the Advisory Agreement; (iv) the issuing
of a guaranty by any of the Companies on the debt securing the Accor S.A.
properties; or (v) the taking of any action with respect to the Accor S.A.
properties without the consent of the Class A Unitholder.

The holder of the Class A Units has the right, which right must be
exercised by no later than July 28, 2004, to require that the Shelbourne OPs
acquire other properties for the Class A Unitholder's benefit at an aggregate
cash cost to the Shelbourne OPs of not more than $2,500,000 (approximately
$672,000 of which would be paid by the Operating Partnership). In that event,
the Accor S.A. properties would not be held for the benefit of the holder of the
Class A Units and the Companies would seek to dispose of these properties as
part of the liquidation of the Companies. Accordingly, if the Class A Unitholder
were to exercise this option, there is a risk that the Companies interest in the
Accor S.A. properties could not be sold for their original purchase price.

The foregoing description of the transaction does not purport to be
complete, and is qualified in its entirety by reference to the Purchase
Agreement (and all exhibits thereto) dated as of January 15, 2003, the
Modification Agreement, dated as of January 15, 2003 and the Amended and
Restated Partnership Unit Designation, copies of

10

which are attached as exhibits to the Corporation's Current Report on Form 8-K
filed on January 16, 2003, which are incorporated herein by reference.

Property Sales. On January 29, 2003, Livonia Shopping Plaza was sold
for $12,969,000. After all expenses, prorations, adjustments, and settlement
charges, the Company received net proceeds in the amount of approximately
$7,865,000.

On January 31, 2003, the Hilliard, Ohio property was sold to an
unaffiliated third party for a gross sales price of $4,600,000. After satisfying
the debt encumbering the property, closing adjustments and other closing costs,
net proceeds were approximately $2,063,000, $1,636,784 of which is attributable
to the Company's interest.

On February 28, 2003, 568 Broadway Joint Venture, a partnership in
which the Operating Partnership indirectly holds a 22.15% interest, sold its
property located in New York, New York for a gross purchase price of
$87,500,000. The property was sold to 568 Broadway Holding LLC, an unaffiliated
third party. After assumption of the debt encumbering the property
($10,000,000), closing adjustments and other closing costs, net proceeds were
approximately $73,000,000, and approximately $16,169,500 was allocated to the
Operating Partnership.

Also on February 28, 2003, the Operating Partnership sold its property
located in Melrose Park, Illinois for a gross purchase price of $2,164,800. The
property was sold to Antonio Francesco Ingraffia, as trustee of the Antonio
Francesco Ingraffia Living Trust, under Trust Agreement dated April 29, 1993, as
to an undivided 1/2 interest and Domenico Gambino, as trustee of the Domenico
Gambino Living Trust, under Trust Agreement dated April 28, 1993, as to an
undivided 1/2 interest. After closing adjustments and other closing costs, net
proceeds were approximately $1,970,000.

COMPETITION

The leasing and sale of real estate is highly competitive. We compete
for tenants with lessors and developers of similar properties located in our
respective markets primarily on the basis of location, rent charged, services
provided, and the design and condition of our buildings. In addition, we compete
for purchasers with sellers of similar properties in the area in which our
properties are located. These factors are discussed more particularly in "Item
2. Properties" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Real Estate Market".

INDUSTRY SEGMENTS AND SEASONALITY

Our primary business is the ownership of office, retail and industrial
properties. Our long-term tenants are in a variety of businesses, and no single
tenant is significant to our business. Our business is not seasonal.

EMPLOYEES

Since the Corporation's inception, property management services, asset
management services, investor relation services and accounting services have
been provided to us by affiliates. See "Item 8. Financial Statements and
Supplementary Data - Note 3" for additional information.

Asset Management Services. Prior to the Transaction, all asset
management services, investor relation services and accounting services (the
"Asset Management Services") were provided by Shelbourne Management pursuant to
the terms of the Advisory Agreement. Under the terms of the Advisory Agreement,
which agreement was approved by the stockholders of the Corporation in
connection with the merger of the Predecessor Partnership with and into the
Operating Partnership, Shelbourne Management received (1) an annual asset
management fee, payable quarterly, equal to 1.25% of the gross asset value of
the Corporation as of the last day of each year, (2) $150,000 for
non-accountable expenses and (3) reimbursement of expenses incurred in
connection with performance of its services. See "The Predecessor Partnership"
above.

Effective February 14, 2002, the Advisory Agreement was contributed by
Shelbourne Management to the Operating Partnership (see "The Presidio
Transaction" above), Shelbourne Management ceased providing the Asset

11

Management Services, and the Corporation retained PCIC to provide the Asset
Management Services to the Corporation on a transitional basis at a reduced cost
of $333,333 per annum.

Effective September 30, 2002, as contemplated by the Plan of
Liquidation, the agreement with PCIC was terminated and Kestrel Management, L.P.
("Kestrel") began providing the Asset Management Services for an annual cost of
$200,000. Kestrel is an affiliate of our current Chief Executive Officer.

Property Management Services. During the years ended December 31, 2001
and 2002, property management services have been provided by Kestrel. For
providing property management services, as approved by the stockholders of the
Corporation in connection with the merger of the Predecessor Partnership with
and into the Operating Partnership, Kestrel is entitled to receive a fee of up
to 6% of the applicable property's revenues. Personnel at the properties perform
services for the Corporation at the properties. Salaries for such on-site
personnel are reimbursed by the Corporation.

12

RISK FACTORS

You should carefully consider the risks described below. These risks
are not the only ones that our company may face. Additional risks not presently
known to us or that we currently consider immaterial may also impair our
business operations and hinder our ability to make expected distributions to our
stockholders.

This Form 10-K also contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including the risks faced by us described below or elsewhere in this Form 10-K.

OUR ECONOMIC PERFORMANCE AND THE VALUE OF OUR REAL ESTATE ASSETS ARE SUBJECT TO
THE RISKS INCIDENTAL TO THE OWNERSHIP AND OPERATION OF REAL ESTATE PROPERTIES.

Our economic performance, the value of our real estate assets and,
therefore, the value of your investment are subject to the risks normally
associated with the ownership, operation and disposal of real estate properties,
including:

o changes in the general and local economic o the attractiveness of our properties
climate; to tenants and purchasers;

o the cyclical nature of the real estate o changes in market rental rates and our
industry and possible oversupply of, or ability to rent space on favorable terms;
reduced demand for, space in our core
markets;

o trends in the retail industry, in o the bankruptcy or insolvency of
employment levels and in consumer spending tenants;
patterns;

o changes in household disposable income; o the need to periodically renovate,
repair and re-lease space and the costs
thereof;

o changes in interest rates and the o increases in maintenance, insurance
availability of financing; and operating costs; and

o competition from other properties; o civil unrest, acts of terrorism,
earthquakes and other natural disasters or
acts of God that may result in uninsured
losses.

In addition, applicable federal, state and local regulations, zoning
and tax laws and potential liability under environmental and other laws may
affect real estate values. Further, throughout the period that we own real
property regardless of whether the property is producing any income, we must
make significant expenditures, including property taxes, maintenance costs,
insurance costs and related charges and debt service. The risks associated with
real estate investments may adversely affect our operating results and financial
position, and therefore the funds available for distribution to you as
dividends.

13

WE CANNOT ASSURE THE AMOUNTS OR TIMING OF LIQUIDATING DISTRIBUTIONS.

If values of our assets decline, or if the costs and expenses related
to selling our assets, including the costs of improvements to be made to our
assets, exceed our current estimates, then the Plan of Liquidation may not yield
liquidating distributions equal to or greater than the recent market prices of
the shares of common stock of the Corporation. In addition, the ability to sell
real estate assets depends, in some cases, on the availability of financing to
buyers on favorable terms. If such financing is not available, it may take
longer than expected to sell our assets at desirable prices, and this may delay
our ability to make liquidating distributions. There can be no assurance that we
will be successful in disposing of our remaining assets for values approximating
those currently estimated by us or that related liquidating distributions will
occur within the currently estimated timetable.

THE AMOUNTS AND TIMING OF THE LIQUIDATING DISTRIBUTIONS MAY BE ADVERSELY
AFFECTED BY LIABILITIES AND INDEMNIFICATION OBLIGATIONS FOLLOWING ASSET SALES.

In selling our assets, we may be unable to negotiate agreements that
provide for the buyers to assume all of the known and unknown liabilities
relating to the assets, including, without limitation, environmental and
structural liabilities. In addition, if we agree to indemnify the buyers for
such liabilities, we may be unable to limit the scope or duration of such
indemnification obligations to desirable levels or time periods. As a result, we
have from time to time determined, and we may in the future determine, that it
is necessary or appropriate to reserve cash amounts or obtain insurance in order
to attempt to cover the liabilities not assumed by the buyers and to cover
potential indemnifiable losses. There can be no assurance that such reserves and
insurance will be sufficient to satisfy all liabilities and indemnification
obligations arising after the sale of our assets, and any such insufficiencies
may have a material adverse affect on the amounts and timing of the liquidating
distributions made to our stockholders.

IF A SIGNIFICANT NUMBER OF OUR TENANTS DEFAULTED OR SOUGHT BANKRUPTCY
PROTECTION, OUR CASH FLOWS, OPERATING RESULTS AND SALE PRICES WOULD SUFFER.

A tenant may experience a downturn in its business, which could cause
the loss of that tenant or weaken its financial condition and result in the
tenant's inability to make rental payments when due. In addition, a tenant of
any of our properties may seek the protection of bankruptcy, insolvency or
similar laws, which could result in the rejection and termination of such
tenant's lease and cause a reduction in our cash flows, and, accordingly, sale
prices.

We cannot evict a tenant solely because of its bankruptcy. A court,
however, may authorize a tenant to reject and terminate its lease with us. In
such a case, our claim against the tenant for unpaid, future rent would be
subject to a statutory cap that might be substantially less than the remaining
rent owed under the lease. In any event, it is unlikely that a bankrupt tenant
will pay in full amounts it owes us under a lease. The loss of rental payments
from tenants could adversely affect our cash flows and operating results and,
accordingly, sale prices.

OUR BUSINESS IS SUBSTANTIALLY DEPENDENT ON THE ECONOMIC CLIMATES OF THREE
MARKETS.

As of March 24, 2003, our real estate portfolio consists of retail
properties in two markets (Las Vegas, Nevada and Indianapolis, Indiana) and
industrial properties in a single market (Columbus, Ohio). As a result, our
business is substantially dependent on the economies of these markets. A
material downturn in demand for office, industrial or retail space in any one of
these markets could have a material impact on our ability to lease the office,
industrial or retail space in our portfolio and may adversely impact our cash
flows operating results and, accordingly, sale prices.

OUR COMPETITORS MAY ADVERSELY AFFECT OUR ABILITY TO LEASE OUR PROPERTIES, WHICH
MAY CAUSE OUR CASH FLOWS, OPERATING RESULTS AND SALE PRICES TO SUFFER.

We face significant competition from developers, managers and owners of
office, retail and mixed-use properties in seeking tenants for our properties.
Substantially all of our properties face competition from similar properties in
the same markets. These competing properties may have vacancy rates higher than
our properties, which may result in their owners being willing to make space
available at lower prices than the space in our properties. Competition for
tenants could have a material adverse affect on our ability to lease our
properties and on

14

the rents that we may charge or concessions that we must grant. If our
competitors adversely impact our ability to lease our properties, our cash
flows, operating results and sale prices may suffer.

OUR DEGREE OF LEVERAGE MAY ADVERSELY AFFECT OUR BUSINESS AND THE MARKET PRICE OF
OUR COMMON STOCK.

Our level of debt could adversely affect our ability to obtain
additional financing for working capital, capital expenditures, developments or
other general corporate purposes. Our degree of leverage could also make us more
vulnerable to a downturn in our business or the economy generally. The Loan
contains financial and operating covenants limiting our ability under certain
circumstances to incur additional secured and unsecured indebtedness.

ENVIRONMENTAL PROBLEMS AT OUR PROPERTIES ARE POSSIBLE, MAY BE COSTLY AND MAY
ADVERSELY AFFECT OUR OPERATING RESULTS, FINANCIAL CONDITION AND SALE PRICES.

We are subject to various federal, state and local laws and regulations
relating to environmental matters. Under these laws, we are exposed to liability
primarily as an owner or operator of real property and, as such, we may be
responsible for the cleanup or other remediation of contaminated property.
Contamination for which we may be liable could include historic contamination,
spills of hazardous materials in the course of our tenants' regular business
operations and spills or releases of hydraulic or other toxic oils. An owner or
operator can be liable for contamination or hazardous or toxic substances in
some circumstances whether or not the owner or operator knew of, or was
responsible for, the presence of such contamination or hazardous or toxic
substances. In addition, the presence of contamination or hazardous or toxic
substances on property, or the failure to properly clean up or remediate such
contamination or hazardous or toxic substances when present, may materially and
adversely affect our ability to sell or rent such contaminated property or to
borrow using such property as collateral.

Environmental laws and regulations can change rapidly, and we may
become subject to more stringent environmental laws and regulations in the
future. Compliance with more stringent environmental laws and regulations could
have a material adverse effect on our operating results or financial condition.
We believe that our exposure to environmental liabilities under currently
applicable laws is not material. We cannot assure you, however, that we
currently know of all circumstances that may give rise to such exposure. In this
regard, tetraclhoroethane ("PCE") is present in the soil and ground water at the
Corporation's property located in Las Vegas, Nevada. The PCE contamination
appears to be from the dry cleaner that previously was a tenant at the property.
The levels of PCE contamination in the soil are below The United States
Environmental Protection Agency Preliminary Remedial Goals for residence and
industrial uses. Further, the ground water is not used for consumption and there
is a 30 to 40 foot thick layer of confining clay between the shallow groundwater
and the deeper aquifer. Accordingly, the Corporation does not believe that any
remediation is required at the property and has requested a "no further action"
status from the Nevada Department of Environmental Protection-Bureau of
Corrective Actions. There can be no assurance that such a "no further action"
status will be received. Further, the existence of the environmental situation
may have an adverse effect on the Corporation's ability to sell this property,
or, if sold, the ultimate sale price received.

IF WE WERE REQUIRED TO ACCELERATE OUR EFFORTS TO COMPLY WITH THE AMERICANS WITH
DISABILITIES ACT, OUR CASH FLOWS, OPERATING RESULTS AND SALE PRICES COULD
SUFFER.

All of our properties must comply with the Americans with Disabilities
Act, or the ADA. The ADA has separate compliance requirements for "public
accommodations" and "commercial facilities," but generally requires that
buildings be made accessible to people with disabilities. Compliance with ADA
requirements could require us to remove access barriers, and non-compliance
could result in the imposition of fines by the U.S. Government or an award of
damages to private litigants. We believe that the costs of compliance with the
ADA will not have a material adverse affect on our cash flows or operating
results. However, if we must make changes to our properties on a more
accelerated basis than we anticipate, our cash flows, operating results and sale
prices could suffer.

15

ADDITIONAL REGULATIONS APPLICABLE TO OUR PROPERTIES MAY REQUIRE US TO MAKE
SUBSTANTIAL EXPENDITURES TO ENSURE COMPLIANCE, WHICH COULD ADVERSELY AFFECT OUR
CASH FLOWS, OPERATING RESULTS AND SALE PRICES.

Our properties are subject to various federal, state and local
regulatory requirements such as local building codes and other similar
regulations. If we fail to comply with these requirements, governmental
authorities may impose fines on us or private litigants may be awarded damages
against us.

We believe that our properties are currently in substantial compliance
with all applicable regulatory requirements. New regulations or changes in
existing regulations applicable to our properties, however, may require us to
make substantial expenditures to ensure regulatory compliance, which would
adversely affect our cash flows, operating results and sale prices.

OUR INSURANCE MAY NOT COVER SOME POTENTIAL LOSSES.

We carry comprehensive general liability, fire, flood, extended
coverage and rental loss insurance with policy specifications, limits and
deductibles customarily carried for similar properties. Some types of risks,
generally of a catastrophic nature such as from war or environmental
contamination, however, are either uninsurable or not economically insurable.

We currently have insurance for earthquake risks, subject to certain
policy limits and deductibles, and will continue to carry such insurance if it
is economical to do so. We cannot assure you that earthquakes may not seriously
damage our properties and that the recoverable amount of insurance proceeds will
be sufficient to fully cover reconstruction costs and losses suffered. Should an
uninsured or underinsured loss occur, we could lose our investment in, and
anticipated income and cash flows from, one or more of our properties, but we
would continue to be obligated to repay any recourse mortgage indebtedness on
such properties.

Additionally, although we generally obtain owner's title insurance
policies with respect to our properties, the amount of coverage under such
policies may be less than the full value of such properties. If a loss occurs
resulting from a title defect with respect to a property where there is no title
insurance or the loss is in excess of insured limits, we could lose all or part
of our investment in, and anticipated income and cash flows from, that property.

OUR FAILURE TO QUALIFY AS A REIT WOULD DECREASE THE FUNDS AVAILABLE FOR
DISTRIBUTION TO OUR STOCKHOLDERS AND ADVERSELY AFFECT THE MARKET PRICE OF OUR
COMMON STOCK.

Determination of REIT status is highly technical and complex. Even a
technical or inadvertent mistake could endanger our REIT status. The
determination that we qualify as a REIT requires an analysis of various factual
matters and circumstances that may not be within our control. For example, the
Internal Revenue Service, or IRS, could change tax laws and regulations or the
courts may issue new rulings that make it impossible for us to maintain REIT
status. We do not believe that any pending or proposed law changes would change
our REIT status.

If we fail to qualify for taxation as a REIT in any taxable year:

o we would be subject to tax on our taxable income at regular
corporate rates;

o we would not be able to deduct, and would not be required to pay,
dividends to stockholders in any year in which we fail to qualify
as a REIT;

o unless we are entitled to relief under specific statutory
provisions, we would be disqualified from taxation as a REIT for
the four taxable years following the year during which we lost
our qualification; and

o dividends paid by us during our liquidation would be fully
taxable to our stockholders as ordinary dividend income, even if
such distributions did not exceed their adjusted tax basis in
their shares.

16

The consequences of failing to qualify as a REIT would adversely affect
the market price of our common stock. We cannot guarantee that we will be
qualified and taxed as a REIT because our qualification and taxation as a REIT
will depend upon our ability to meet the requirements imposed under the Internal
Revenue Code of 1986, as amended, on an ongoing basis.

IN ORDER TO MAINTAIN OUR STATUS AS A REIT, WE MAY BE FORCED TO BORROW
FUNDS DURING UNFAVORABLE MARKET CONDITIONS.

To qualify as a REIT, we generally must pay dividends to our
stockholders at least 90% of our net taxable income each year, excluding capital
gains. This requirement limits our ability to accumulate capital. We may not
have sufficient cash or other liquid assets to meet REIT dividend requirements.
As a result, we may need to incur debt to fund required dividends when
prevailing market conditions are not favorable. Difficulties in meeting dividend
requirements may arise as a result of:

o differences in timing between when we must recognize income for
U.S. federal income tax purposes and when we actually receive
income;

o the effect of non-deductible capital expenditures;

o the creation of reserves; or

o required debt or amortization payments.

If we are unable to borrow funds on favorable terms, our ability to pay
dividends to our stockholders and our ability to qualify as a REIT may suffer.

THE TRANSFER OF OUR REMAINING ASSETS TO A LIQUIDATING TRUST WILL AFFECT THE
LIQUIDITY OF YOUR OWNERSHIP INTERESTS, AND THE ANTICIPATION OF THAT TRANSFER MAY
REDUCE THE PRICE OF OUR COMMON STOCK.

The Corporation currently expects that not later than October 29, 2004
the Corporation will transfer and assign to a liquidating trust as designated by
the Board of Directors all of its then remaining assets (which may include
direct or indirect interests in real property) and liabilities, although there
can be no assurance in this regard. After such a transfer to a liquidating
trust, all stock certificates that represent outstanding shares of our common
stock will be automatically deemed to evidence ownership of beneficial interests
in the liquidating trust. Beneficial interests in the liquidating trust will be
non-certificated and non-transferable, except by will, intestate succession or
operation of law. As a result, the beneficial interests in the liquidating trust
will not be listed on any securities exchange or quoted on any automated
quotation system of a registered securities association. In anticipation of such
a transfer and the resulting illiquidity of the beneficial interests, some of
our stockholders may desire to sell their shares of common stock. In such case,
the number of shares of our common stock for which sell orders are placed is
high relative to the demand for such shares, there could be a material adverse
affect on the price of the Corporation's common stock.

OUR STOCKHOLDERS WILL FACE REDUCED LIQUIDITY AS OUR ASSETS ARE SOLD AND THE
PROCEEDS ARE DISTRIBUTED.

As our assets are sold and the proceeds are distributed to our
stockholders, the market capitalization, "public float" and the market interest
in our common stock by the investment community will diminish, thereby reducing
the market price, the market demand and liquidity for shares of the common
stock. Depending on the length of the liquidation process and our market
capitalization, the American Stock Exchange may cause the common stock to be
delisted at a later stage of the liquidation process.

17

OWNERSHIP LIMITATIONS IN OUR CERTIFICATE OF INCORPORATION MAY ADVERSELY AFFECT
THE MARKET PRICE OF OUR COMMON STOCK.

Our certificate of incorporation contains an ownership limitation that
is designed to prohibit any transfer that would result in our being
"closely-held" within the meaning of Section 856(h) of the Internal Revenue Code
of 1986, as amended. This ownership limitation, which may be waived by the
Corporation, generally prohibits ownership, directly or indirectly, by any
single stockholder of more than 8% of the value of outstanding shares of our
capital stock.

In addition, our certificate of incorporation prohibits transfers that
would result in our owning more than 10% of the ownership interest in one of our
tenants within the meaning of Section 856(d)(2)(B) of the Code; in shares of our
stock (both common and preferred) being beneficially owned by fewer than 100
persons within the meaning of Section 856(a)(5) of the Code; in our being a
"pension held REIT" within the meaning of Section 856(h)(3)(D) of the Code; in
our failing to qualify as a "domestically-controlled REIT" within the meaning of
Section 897(h)(4)(B) or in our failing to qualify for REIT status.

The inability of holders of our common stock to sell their shares to
persons other than qualifying U.S. persons, or the perception of this inability,
as well as the limitations on transfer, may adversely affect the market price of
our common stock.

LIMITS ON CHANGES OF CONTROL MAY DISCOURAGE TAKEOVER ATTEMPTS THAT MAY
BE BENEFICIAL TO HOLDERS OF OUR COMMON STOCK.

Provisions of our certificate of incorporation and bylaws, as well as
provisions of the Internal Revenue Code of 1986, as amended, and Delaware
corporate law, may:

o delay or prevent a change of control over us or a tender offer
for our common stock, even if those actions might be beneficial
to holders of our common stock; and

o limit our stockholders' opportunity to receive a potential
premium for their shares of common stock over then-prevailing
market prices.

Primarily to facilitate the maintenance of our qualification as a REIT,
our certificate of incorporation generally prohibits ownership, directly or
indirectly, by any single stockholder of more than 8% of the value of
outstanding shares of our capital stock. Our board of directors may modify or
waive the application of this ownership limit with respect to one or more
persons if it receives a ruling from the Internal Revenue Service or an opinion
of counsel concluding that ownership in excess of this limit will not jeopardize
our status as a REIT. HX Investors and the Operating Partnership have received
such a waiver and may hold in excess of that 8% ownership limit provided that
our REIT status will not be jeopardized and we will not be deemed to be
closely-held. The ownership limit, however, may nevertheless have the effect of
inhibiting or impeding a change of control over us or a tender offer for our
common stock.

In addition, the Board of Directors has been divided into three
classes, the current terms of which expire in 2003, 2004 and 2005 respectively,
with directors of a given class chosen for three-year terms upon expiration of
the terms of the members of that class. The staggered terms of the members of
Board of Directors may adversely affect the stockholders' ability to effect a
change in control of the Corporation, even if such a change in control were in
the best interests of some, or a majority, of the Corporation's stockholders.

Our certificate of incorporation authorized the Board of Directors to
issue shares of preferred stock in series and to establish the rights and
preferences of any series of preferred stock so issued. The issuance of
preferred stock could also have the effect of delaying or preventing a change in
control of the Corporation.

We have adopted a stockholder rights agreement that gives the current
stockholders the right to purchase securities from the Corporation at a discount
if a person or group acquires more than 15% of the outstanding shares of our
common stock, thereby diluting the acquiring person's holdings. In addition, the
Board of Directors can prevent the stockholder rights agreement from operating
in the event the Board approves of the acquiring person.

18

WHERE CAN YOU FIND MORE INFORMATION ABOUT US?

We are subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), which means that we file
periodic reports, including reports on Forms 10-K and 10-Q, and other
information with the Securities and Exchange Commission ("SEC"). As well, we
distribute proxy statements annually and file those reports with the SEC. You
can read and copy these reports, statements and other information at the public
reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, NW,
Washington, D.C. 20549, as well as the regional offices at the Woolworth
Building, 233 Broadway Ave., New York, New York 10279 and Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. You may obtain
copies of this material for a fee by writing to the SEC's Public Reference
Section of the SEC at 450 Fifth Street, NW, Washington, D.C. 20549. You may
obtain information about the operation of the Public Reference Room by calling
the SEC at 1-800-SEC-0330. You can also access some of this information
electronically by means of the SEC's website on the Internet at
http://www.sec.gov, which contains reports, proxy and information statements and
other information that the Corporation has filed electronically with the SEC. In
addition, you may inspect reports and other information concerning us at the
offices of the American Stock Exchange LLC, which are located at 86 Trinity
Place, New York, New York 10006 and can be contacted at (212) 306-1000.

ITEM 2. PROPERTIES

PROPERTY PORTFOLIO

The Corporation owned or held in a Joint Venture interest in the
following properties as of December 31, 2002 and, unless otherwise indicated,
March 24, 2003:

(1) 568 BROADWAY

On December 2, 1986, a joint venture (the "Broadway Joint Venture")
comprised of the High Equity Partners L.P. - Series 86 ("HEP-86"), the
predecessor in interest to Shelbourne Properties II, L.P., and Integrated
Resources High Equity Partners L.P. - Series 85 ("HEP-85"), the predecessor in
interest to Shelbourne Properties I, L.P., acquired a fee simple interest in
568-578 Broadway ("568 Broadway"), a commercial building in New York City, New
York. Until February 1, 1990, the HEP-86 and HEP-85 each had a 50% interest in
the Broadway Joint Venture. On February 1, 1990, the Broadway Joint Venture
admitted a third joint venture partner, the Predecessor Partnership, which
contributed $10,000,000 for a 22.15% interest in the joint venture.

568 Broadway is located in the SoHo district of Manhattan on the
northeast corner of Broadway and Prince Street. 568 Broadway is a 12-story plus
basement and sub-basement building constructed in 1898. It is situated on a site
of approximately 23,600 square feet, has a rentable square footage of
approximately 300,000 square feet and a floor size of approximately 26,000
square feet. Formerly catering primarily to industrial light manufacturing, the
building has been converted to an office building and is currently being leased
to art galleries, photography studios, retail and office tenants. 568 Broadway
competes with several other buildings in the SoHo area.

On February 28, 2003, Broadway Joint Venture sold the property
to an unaffiliated third party for a gross purchase price of $87,500,000, which
consisted of the assumption of $10,000,000 loan encumbering the property and the
balance in cash. Net proceeds, after closing costs and adjustments, from the
sale were approximately $73,000,000, and approximately $16,169,500 of which is
attributable to the Operating Partnership's interest in the property.

(2) LIVONIA PLAZA

On June 28, 1989, the Predecessor Partnership purchased a fee simple
interest in Livonia Plaza, a shopping center that was completed in December
1989, located in Livonia, Michigan.

Livonia Plaza is a 133,198 square foot neighborhood shopping center
situated on a 13.9 acre site near the intersection of Five Mile Road and
Bainbridge Avenue in Livonia, a western suburb of Detroit. In October 1996, the
Predecessor Partnership signed an agreement to expand the Kroger store to 56,337
square feet and purchased

19

1.77 acre of land adjacent to the center to facilitate the Kroger expansion. The
expansion was completed in 1997 and Kroger incurred the costs of the building
and parking lot construction.

On January 29, 2003, Livonia Plaza was sold to an unaffiliated third
party for a gross sales price of $12,969,000. After satisfying the debt
encumbering the property, closing adjustments and other closing costs, net
proceeds were approximately $7,800,000.

(3) MELROSE CROSSING SHOPPING CENTER - PHASE II

On February 3, 1989, the Predecessor Partnership purchased the fee
simple interest in Phase II of the Melrose Crossing Shopping Center
("Melrose-Phase II"). Melrose-Phase II, located in Melrose Park, Illinois,
previously consisted of a 88,616 square foot retail store located on a parcel
totaling 7.02 acres.

Melrose-Phase II lies to the north of Melrose Crossing on which an
88,000 square foot department store is located as well as 138,355 square feet of
retail space that is owned by Shelbourne Properties II, L.P. Melrose-Phase II is
situated in Melrose Park, Illinois, an older working-class neighborhood near
O'Hare Airport at the intersection of Mannheim Road and North Avenue, less than
10 miles from Chicago's Loop.

On February 28, 2003, this property was sold to an unaffiliated third
party for a gross purchase price of $2,164,800. Net proceeds, after closing
costs and adjustments, from the sale were approximately $1,970,000.

(4) SUNRISE MARKETPLACE

On February 15, 1989, the Predecessor Partnership purchased the fee
simple interest in Sunrise Marketplace ("Sunrise"), a 176,661 square foot
neighborhood shopping center in Las Vegas, Nevada. The center is situated on
15.15 acres of land at the northeast corner of Nellis Boulevard and Stewart
Avenue.

Tetraclhoroethane ("PCE") is present in the soil and ground water at
Sunrise. The PCE contamination appears to be from the dry cleaner that
previously was a tenant at the property. The levels of PCE contamination in the
soil are below The United States Environmental Protection Agency Preliminary
Remedial Goals for residence and industrial uses. Further, the ground water is
not used for consumption and there is a 30 to 40 foot thick layer of confining
clay between the shallow groundwater and the deeper aquifer. Accordingly, the
Corporation does not believe that any remediation is required at the property
and has requested a "no further action" status from the Nevada Department of
Environmental Protection-Bureau of Corrective Actions. See "Item 1. Business.,
Risk Factors" above.

Further to the transaction described under "Item 1. Business-Recent
Developments-Fleet Loan", we granted a mortgage on Sunrise to Fleet as security
for the loan made by Fleet to the Operating Partnership. For more information
concerning this mortgage, please see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Overview" below.

(5) SUPER VALU STORES

On February 16, 1989, the Predecessor Partnership acquired joint
venture interests in four supermarkets (the "Properties") owned by Super Valu
Stores ("Super Valu") located in Edina, Minnesota; Toledo, Ohio; Norcross,
Georgia and Indianapolis, Indiana. A fee simple interest in the Predecessor
Properties was acquired pursuant to a contract of sale among the seller, the
Predecessor Partnership and American Real Estate Holdings Limited Partnership
("AREH"). AREH is 99% owned by American Real Estate Partners L.P., a public
partnership originally sponsored by Integrated. At the closing, AREH and the
Predecessor Partnership assigned their contract rights with respect to each of
the Properties to three joint venture entities each of which has AREH and the
Predecessor Partnership as a 50% owner. Cub Foods, a tenant Norcross, Georgia
and Indianapolis, Indiana, has declared bankruptcy. The lease in Norcross
Georgia was rejected as of January 31, 2002. The lease in Indianapolis has not
been rejected. In January 2002, two of the Super Valu properties, one in Edina,
Minnesota and one in Toledo, Ohio, were sold. In August 2002, the Super Valu
store located in Norcross, Georgia was sold, leaving Indianapolis, Indiana as
the only active property.

20

(6) TMR WAREHOUSES

On September 15, 1988, Tri-Columbus Associates ("Tri-Columbus"), a
joint venture comprised of the Predecessor Partnership, Shelbourne Properties
II, L.P. and IR Columbus Corp. ("Columbus Corp."), at the time a wholly-owned
subsidiary of Integrated, purchased the fee simple interest in three warehouses
(the "TMR Warehouses") located in Columbus, Ohio. The Predecessor Partnership
originally purchased a 58.68% interest in Tri-Columbus on September 15, 1988. On
June 29, 1990, the Predecessor Partnership closed in escrow on the purchase of
an additional 20.66% interest in Tri-Columbus. The Predecessor Partnership
purchased the additional joint venture interest from Columbus Corp. at
approximately 86% of Columbus Corp.'s original cost, pursuant to a right of
first refusal contained in the joint venture agreement. Due to Integrated's
bankruptcy, the transaction was submitted to the bankruptcy court for review,
the approval of the bankruptcy court was obtained on September 6, 1990 and the
funds were released from escrow. Purchase of this additional 20.66% interest
increased our interest in Tri-Columbus from 58.68% to 79.34%. The remaining
20.66% is held by Shelbourne Properties II, L.P.

We entered into an agreement with Volvo in late 2000 pursuant to which
Volvo agreed to extend its lease term until December 31, 2010. The rent through
December 31, 2002 remained at its then current rate of $1,418,825 and increased
to $1,533,290 per annum through December 31, 2005. Annual rent from 2006 through
2010 will be $1,614,910. We agreed to spend up to $2,000,000 for capital
improvements and to connect the property with an adjacent property. Any
expenditures made by us will be pro rated over the remaining term of the lease
and reimbursed by Volvo as additional rent. From January 1, 2001 through March
24, 2003, $212,759 has been spent for such capital improvements.

The TMR Warehouses are distribution and light manufacturing facilities
located in Orange, Grove City and Hilliard, all suburbs of Columbus, Ohio and
comprise 1,010,500 square feet of space in the aggregate, with individual square
footage of 583,000 square feet, 190,000 square feet and 237,500 square feet,
respectively.

On January 31, 2003, the Hilliard, Ohio property was sold to an
affiliated third party for sale price of for a gross sales price of $4,600,000.
After satisfying the debt encumbering the property, closing adjustments and
other closing costs, net proceeds were approximately $2,063,000, $1,636,784 of
which is attributable to the Company's interest.

Further to the transaction described under "Item 1. Business-Recent
Developments-Fleet Loan", we granted a mortgage on the TMR Warehouses located in
Orange and Grove City to Fleet as security for the loan made by Fleet to the
Operating Partnership. For more information concerning this mortgage, please see
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Overview" below.

21

OCCUPANCY

The following table lists the occupancy rates of our properties at the
end of each of the last three years.

OCCUPANCY

PROPERTY 12/31/2002 12/31/2001 12/31/2000
- -------- ---------- ---------- ----------

568 Broadway Office Building(2) 99% 97% 100%
Livonia Plaza(1) 91% 92% 91%
Melrose Crossing Phase II(2) 0% 0% 0%
Sunrise Marketplace 99% 96% 92%
SuperValu Stores (3)(4) 0% 78% 76%
Tri-Columbus-Grove City 100% 100% 100%
Tri-Columbus-Hilliard(1) 100% 100% 100%
Tri-Columbus-Orange 100% 100% 100%

(1) Property was sold in January 2003.

(2) Property was sold in February 2003.

(3) Two of the four Super Valu properties, one in Edina, Minnesota, and
one in Toledo, Ohio, were sold in January 2002. One of the Super
Valu properties, located in Norcross, Georgia was sold in August
2002.

(4) The remaining Super Value property is vacant, but the tenant is
still paying rent.

The following table contains information for each tenant that occupies
ten percent or more of the rentable square footage of any of our properties.

PRINCIPAL SQUARE FEET LEASE
NAME OF BUSINESS OF LEASED BY EXPIRATION RENEWAL
PROPERTY TENANT TENANT TENANT ANNUAL RENT DATE OPTIONS
- ------------------ ---------------- ---------------- --------------- ---------------- ---------------- --------------

SUNRISE Smith's Grocery 71,240 $402,240 10/31/08 1-5 yr.
MARKETPLACE retailer

America's Best Furniture 18,974 $170,766 10/31/05 1-5 yr.
Furniture retailer
- ------------------ ---------------- ---------------- --------------- ---------------- ---------------- --------------
TRI-COLUMBUS Volvo Truck parts 583,000 $1,418,825 12/31/10 None.
distributor

Simmons USA Mattress 190,000 $541,500 3/31/04 1-5 yr.
wholesaler

CAPITAL IMPROVEMENTS

See "Item 7. Management's Discussion and Analysis and Results of
Operations."

22

ITEM 3. LEGAL PROCEEDINGS

Delaware Plaintiffs Litigation, Court of Chancery of the State of
Delaware (C.A. No. 19442- NC, and C.A. No. 19611).

On February 26 and March 6, 2002, respectively, plaintiffs Thomas
Hudson and Ruth Grening filed individual and derivative action lawsuits, which
were subsequently consolidated, on behalf of the Companies against NorthStar
Capital Investment Corp. ("NorthStar"), several of its affiliates, and the
members of the boards of directors of the Companies as of February 13, 2002 in
the Court of Chancery of the State of Delaware. The two actions challenged the
propriety of transactions consummated on February 14, 2002, by which the
Companies and their respective operating partnerships agreed to purchase from
NorthStar approximately 30% of the then outstanding shares of each of the
Companies as well as the right to terminate certain management services
agreements.

On May 7, 2002, plaintiffs Grening and Hudson jointly filed a separate
individual and class action in Delaware Chancery Court alleging that the
Companies and the members of the Boards at that time had violated 8 Del. C. ss.
211 by failing to call and hold annual meetings of the stockholders within 13
months of the incorporation of the Companies, and had breached their fiduciary
duties and the provisions of the Companies' Amended and Restated Certificates of
Incorporation, by, inter alia, reducing and reorganizing the Companies' boards
and issuing allegedly false and/or misleading statements and omissions of
material facts in press releases and the 2001 Annual Reports filed with the SEC
by each of the Companies. On May 29, 2002, the Court consolidated the claims
pursuant to 8 Del. C. ss. 211 for purposes of discovery and trial with similar
claims in a lawsuit brought in the same forum by HX Investors and other
stockholders against the Companies.

The Companies vigorously defended all of the litigation, and, on July
1, 2002, HX Investors, the additional stockholders, the Companies, the
additional defendants, and Ms. Grening entered into several related agreements
pursuant to which the aforementioned actions by plaintiffs Grening, Hudson, and
HX Investors were settled, subject, with respect to the class and derivative
actions, to the approval of the Court. In connection with the settlement, among
other things, NorthStar agreed to contribute up to $1 million for the payment of
the class and derivative plaintiffs' attorneys' fees, expenses, and incentive
fees as approved by the Court.

The settlement with Ms. Grening was memorialized by letter agreement dated July
1, 2002, setting forth the agreement in principal. By letter agreement dated
October 28, 2002, Plaintiff Thomas Hudson joined in the agreement in principle.
Confirmatory discovery and drafting of the full settlement agreement is
proceeding, after which Court approval for the settlement must be obtained and
notice and the opportunity to opt-out of the class provided to relevant current
and former stockholders. A class member who elects to opt-out would not be bound
by the terms of the settlement agreement and would have the right to bring a
similar action on his own behalf. The Company does not anticipate that a
substantial number of class members will opt-out or that any action brought by
any class members who opt-out would have a material adverse affect on the
Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On October 29, 2002, the Corporation held a special meeting of the
Stockholders, at which time the Plan of Liquidation was approved by a majority
of the stockholders. See "Item 1. Business-Corporate History-The HX Transaction;
Plan of Liquidation."

23

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

MARKET FOR OUR COMMON STOCK

In May 2001, our Common Stock began trading on the American Stock
Exchange under the symbol "HXF". Prior to that date, there was no established
trading market for interests in the Predecessor Partnership.

The high and low sales prices per share of Common Stock are set forth
below for the periods indicated.

QUARTER ENDED HIGH LOW
- --------------------------------------------------------------------------------
June 30, 2001 33.50 24.94

September 30, 2001 32.11 25.23

December 31, 2001 28.50 23.13

March 31, 2002 40.30 25.12

June 30, 2002 42.00 37.20

September 30, 2002 56.15 41.50

December 31, 2002 58.00 40.75

On March 24, 2003, the closing sale price of the Common Stock as
reported by the American Stock Exchange was $32.40. The Corporation had
approximately 1,303 stockholders of record of Common Stock as of March 24, 2003.

The Corporation has authorized 2,500,000 shares of Common Stock, issued
1,173,998 shares, with 788,772 shares outstanding at March 24, 2003.

DIVIDENDS

As a result of the adoption of the Plan of Liquidation, our management
expects that dividends of cash from operations and property sales will be made
on a timely basis, subject only to maintaining adequate reserves. It is expected
that such dividends will be sufficient to maintain our status as a REIT under
the Internal Revenue Code. The dividend policy with respect to our Common Stock
is subject to revision by the Board of Directors. All dividends in excess of
those required for us to maintain our REIT status will be made by us at the sole
discretion of the Board of Directors and will depend on our taxable earnings,
financial condition, and such other factors as the Board of Directors deems
relevant. The Board of Directors has not established any minimum distribution
level. In order to maintain our qualifications as a REIT, we intend to
periodically evaluate the dividends made to ensure that dividends made, on an
annual basis, will represent at least 90% of our taxable income (which may not
necessarily equal net income as calculated in accordance with generally accepted
accounting principles), determined without regard to the deduction for dividends
paid and excluding any net capital gains.

Holders of Common Stock will be entitled to receive dividends if, as
and when the Board of Directors authorizes and declares dividends. In connection
with the settlement of the lawsuit brought by HX Investors, the Operating
Partnership issued to HX Investors Class B units which entitle HX Investors to
receive 15% of all gross proceeds after payment of the approximately $52.25
(plus interest) per share priority dividend. After giving effect to

24

dividends paid from August 19, 2002 through March 24, 2003, the remaining unpaid
per share priority return is $7.13.

The following table sets forth the dividends paid or declared by the
Corporation on its Common Stock for the previous three years:

PERIOD ENDED STOCKHOLDER RECORD DATE DIVIDEND / SHARE (1)
- --------------------------------------------------------------------------------

December 31, 2001 December 17, 2001 1.87
- --------------------------------------------------------------------------------

March 31, 2002 - -
June 30, 2002 - -
September 30, 2002 - -
December 31, 2002 November 15, 2002 8.25

Explanatory Note:

(1) Commencing with the third quarter of 1999, dividends were
suspended while the requirements of the class action and
derivative litigation involving the Predecessor Partnership were
completed. Dividends resumed in December of 2001.

In addition to the foregoing dividends, a dividend of $2.50 per share
was on January 31, 2003 to stockholders of record on January 23, 2003 and a
dividend of $36.00 per share was paid on March 18, 2003 to stockholders of
record on March 10, 2003.

RECENT SALES OF UNREGISTERED SECURITIES

There were no securities sold by us in 2002 that were not registered
under the Securities Act.

25

ITEM 6. SELECTED FINANCIAL DATA

The following financial data are derived from our audited consolidated
financial statements. The financial data set forth below should be read in
conjunction with "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Item 8. Financial Statements and
Supplementary Data" and the notes thereto appearing elsewhere in this Form 10-K.

Period 10/30/02 Period 1/1/02 to Year Ended December 31,
to 12/31/02 10/29/02 Going Concern
Liquidation Basis Going Concern 2001 2000 1999 1998
- ----------------------------- -------------------- -------------------- --------------- --------------- -------------- -------------

Total Revenue $750,192(3) $3,029,476(3) $8,530,531 $8,110,124 $7,989,276 $8,210,920

Net Income (Loss) Available
for Common Shareholders 498,810 (16,021,301) 2.526.685 2,537,241 1,895,156 2,995,631

Net Income (Loss) per
Common Share .64 (18.94) 2.15 2.16 1.61 2.55

Distributions per Common 8.25 - 1.87 - 1.70 3.40
Share (1)(2)

Total Assets $69,006,373(4) $48,646,112 $56,541,462 $56,549,762 $54,187,702 $55,087,481

(1) All distributions are in excess of accumulated undistributed net income and
therefore represent a return of capital to investors on a generally
accepted accounting principles basis.

(2) Distributions made from and after December 21, 2001 are based on the total
shares issued and outstanding.

(3) Reflects the January 1, 2002 conversion to the equity method of accounting,
as required under generally acceptable accounting principles due to the
incurrence of debt. Prior to the conversion, the Corporation reported its
investments in joint ventures using the pro rata consolidation method of
accounting, under which revenues and expenses attributable to the joint
ventures are presented on a pro rata basis in accordance with the
Corporation's percentage of ownership together with the revenues and
expenses of the Corporation's wholly-owned properties. Under the equity
method of accounting, the net income attributable to the Corporation's
investment in the joint ventures is presented as a single item on the
statement of operations. If the change to the equity method of accounting
had been made on January 1, 2001, revenues reported for 2001 would be
reduced by $4,611,219. Total net income remains unchanged.

(4) Reflects the conversion to the liquidation basis of accounting under which
real estate is reported to its estimated net realizable value. Prior to the
conversion to the liquidation basis of accounting, real estate was reported
at its historical cost, less accumulated depreciation and adjustments for
impairment. Total revenue includes revenues from discontinued operations.

26

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following should be read in conjunction with "Forward-Looking
Statements" and our combined consolidated financial statements and notes thereto
appearing elsewhere in this Form 10-K

OVERVIEW

Shelbourne Properties III, Inc. was formerly a Delaware limited
partnership, High Equity Partners L.P. - Series 88 ("HEP-88"), which was merged
on April 17, 2001 with and into Shelbourne Properties III L.P., a Delaware
limited partnership, (the "Operating Partnership"). The Corporation holds its
investment in its properties through the Operating Partnership in which it had a
99% direct interest and a 1% indirect interest at December 31, 2002. The 1% is
held indirectly through the general partner of the Operating Partnership,
Shelbourne Properties III GP LLC (the "General Partner"), of which the
Corporation is the sole member.

On February 14, 2002, the Corporation repurchased the shares of a major
stockholder, Presidio Capital Investment Company LLC ("PCIC"). As part of that
repurchase, Shelbourne Management LLC, a wholly-owned subsidiary of PCIC,
contributed to the Operating Partnership, the advisory agreement between the
Corporation, the Operating Partnership and Shelbourne Management LLC, dated as
of April 17, 2001 (the "Advisory Agreement"), pursuant to which Shelbourne
Management LLC had provided financial and investment advisory services to the
Corporation, and the Operating Partnership. As consideration for the purchase of
the shares and the contribution of the Advisory Agreement, the Corporation paid
$11,830,333 in cash and the Operating Partnership issued a note of the amount of
$14,589,936 and issued 672.178 5% Class A Preferred Partnership Units (with a
liquidation preference of $1,000 per unit) to Shelbourne Management LLC. As a
result, until those preferred units are redeemed, Shelbourne Management LLC is
entitled to receive quarterly distributions from the Operating Partnership at a
rate of 5% per annum of the aggregate liquidation preference of its preferred
units. The agreement governing the repurchase provides for pre-payment penalties
in the event that the Operating Partnership redeems these preferred units prior
to February 14, 2007. As a result of a transaction that was consummated in
January 2003, the 5% Class A Preferred Partnership Units were reclassified as
Class A Partnership Units and modified to eliminate the liquidation preference
and to significantly limit the events that could create a pre-payment penalty.
The Class A Preferred Partnership Units are still entitled to receive quarterly
distributions at a rate of 5% per annum.

During July and August 2002, the Corporation entered into a settlement
agreement with HX Investors L.P. ("HX Investors"), a stockholder in the
Corporation, with respect to a lawsuit brought by HX Investors and others
against the Companies. In connection with this settlement:

o HX Investors made a tender offer for up to 30% of the outstanding
shares of Common Stock. Upon consummation of the offer, HX
Investors acquired 236,631 Common Shares. As a result of the
tender offer and subsequent market acquisitions, HX Investors
holds 41.64% of the outstanding Common Stock.

o On August 19, 2002, the existing Board of Directors and executive
officer of the Corporation resigned, and the Board was
reconstituted to consist of six members, four of whom are
independent directors. In addition, new executive officers were
appointed.

o HX Investors was issued by the Operating Partnership Class B
Units that entitle the holder thereof to receive 15% of the
Operating Partnership's gross proceeds after the payment of a
priority return of approximately $52.25 (plus interest at 6% per
annum, subject to certain increases) per share to the
stockholders of the Corporation.

o A Plan of Liquidation of the Corporation was adopted by the prior
Board of Directors.

On October 29, 2002, the stockholders of the Corporation approved the
Plan of Liquidation. As a result, the Corporation adopted liquidation accounting
and the Operating Partnership has been seeking, and will seek, to sell its
remaining properties at such time as it is believed that the sale price for such
property can be maximized. Since the adoption of the Plan of Liquidation, the
Corporation has sold its properties located in Livonia, Michigan;

27

New York, New York; Hilliard, Ohio and Melrose Park, Illinois, and has paid
dividends of $46.75 per share (including a dividend of $2.50 per share paid in
January 2003 and of $36.00 per share paid in March 2003). Pursuant to the Plan
of Liquidation, if all of the assets of the Corporation are not sold prior to
October 29, 2004, the remaining assets will be placed in a liquidating trust and
the stockholders of the Corporation will receive a beneficial interest in such
trust in total redemption for their shares in the Corporation.

The Corporation is operating with the intention of qualifying as a real
estate investment trust for U.S. Federal Income Tax purposes ("REIT") under
Sections 856-860 of the Internal Revenue Code of 1986 as amended. Under those
sections, a REIT which pays at least 90% of its ordinary taxable income as a
dividend to its stockholders each year and which meets certain other conditions
will not be taxed on that portion of its taxable income which is distributed to
its stockholders.

We have adopted a plan of liquidation that requires us to liquidate all
of our assets and liabilities by October 29, 2004. Dividends made by us to you
and our other stockholders during our liquidation generally will not be taxable
to you until the dividends exceed your adjusted tax basis in your shares, and
then will be taxable to you as long-term capital gain assuming you hold your
shares as capital assets and have held them for more than 12 months when you
receive the dividends as a result of the adoption of the plan of liquidation. If
our assets are not completely liquidated by October 29, 2004, our assets will be
transferred to a liquidating trust on such date and in lieu of owning shares,
you will own a beneficial interest in the liquidating trust of an equivalent
percentage. The transferability of interests in the trust will be significantly
restricted as compared to the shares in the Corporation, and you will be
required to include in your own income your pro rata share of the trust's
taxable income whether or not that amount is actually distributed by the trust
to you in that year.

As a result of the adoption of the Plan of Liquidation, our primary
business objective is to maximize the value of our common stock. Prior to
October 29, 2002, we sought to achieve this objective by managing our existing
properties, making capital improvements to and/or selling properties and by
making additional real estate-related investments.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions in certain circumstances that affect amounts reported
in the accompanying financial statements and related footnotes. In preparing
these financial statements, management has made its best estimates and judgments
of certain amounts included in the financial statements, giving due
consideration to materiality. However, application of these accounting policies
involves the exercise of judgment and use of assumptions as to future
uncertainties, and as a result, actual results could differ from these
estimates.

REAL ESTATE HELD FOR SALE AND ADJUSTMENTS TO LIQUIDATION BASIS OF ACCOUNTING

On October 30, 2002, in accordance with the liquidation basis of
accounting, assets were adjusted to estimated net realizable value and
liabilities were adjusted to estimated settlement amounts, including estimated
costs associated with carrying out the liquidation. The valuation of investments
in joint ventures and real estate held for sale is based on current contracts,
estimates as determined by independent appraisals or other indications of sales
value, net of estimated selling costs (including brokerage commissions, transfer
taxes, legal costs) and capital expenditures of approximately $2,648,000
anticipated during the liquidation period. The valuations of other assets and
liabilities are based on management's estimates as of December 31, 2002. The
actual values realized for assets and settlement of liabilities may differ
materially from amounts estimated. The net adjustment at October 30, 2002,
required to convert from the going concern (historical cost) basis to the
liquidation basis of accounting, totaled $3,562,722, which is included in the
consolidated statement of changes in net assets (liquidation basis) for the
period

28

October 30, 2002 to December 31, 2002. Significant increases (decreases) in the
carrying value of net assets are summarized, as follows:

Increase to reflect estimated net realizable values of certain real estate properties $ 13,469,408
Deferral of appreciated gain and incentive fee on real estate properties (13,469,408)
Decrease to reflect estimated net realizable value of investments in joint ventures (1,448,544)
Increase to reflect net realizable value in joint ventures 14,704,279
Deferral of appreciated gain and incentive fee on investments in joint ventures (14,704,279)
Reserve for additional costs associated with liquidation (1) (1,500,000)
Write-off of deferred debt costs (614,178)
--------------
Adjustment to reflect the change to liquidation basis of accounting $ (3,562,722)
==============

(1) Such costs do not include costs incurred in connection with ordinary
operations.

Adjusting assets to estimated net realizable value resulted in the
adjustment in values of certain real estate properties. The anticipated gains
associated with the write-up of these real estate properties have been deferred
until such time as a sale occurs. The write-down of other assets included
amounts for unamortized lease commissions and straight-line rent.

RESERVE FOR ESTIMATED COSTS DURING THE PERIOD OF LIQUIDATION

Under liquidation accounting, the Corporation is required to estimate
and accrue the non-operating costs associated with executing the Plan of
Liquidation. These amounts can vary significantly due to, among other things,
the timing and realized proceeds from property sales, the costs of retaining
agents and trustees to oversee the liquidation, including the costs of
insurance, the timing and amounts associated with discharging known and
contingent liabilities and the costs associated with cessation of the
Corporation's operations. These non-operating costs are estimates and are
expected to be paid out over the liquidation period. Such costs do not include
costs incurred in connection with ordinary operations.

INVESTMENTS IN JOINT VENTURES

Certain properties are owned in joint ventures with Shelbourne
Properties I L.P. and/or Shelbourne Properties II L.P. Prior to April 30, 2002,
the Corporation owned an undivided interest in the assets owned by these joint
ventures and was severally liable for indebtedness it incurred in connection
with its ownership interest in those properties. Therefore, for periods prior to
April 30, 2002, the Corporation's consolidated financial statements had
presented the assets, liabilities, revenues and expenses of the joint ventures
on a pro rata basis in accordance with the Corporation's percentage of
ownership.

After April 30, 2002, as a result of the Operating Partnership
incurring debt in connection with entering into the note payable discussed in
Note 6 to the Consolidated Financial Statements annexed hereto, the Corporation
was no longer allowed to account for its investments in joint ventures on a
pro-rata consolidation basis in accordance with its percentage of ownership but
must instead utilize the equity method of accounting. Accordingly, the
Corporation's consolidated balance sheet at December 31, 2002 and the
Corporation's consolidated statements of operations commencing January 1, 2002
reflect the equity method of accounting.

RECENTLY ISSUED ACCOUNTING STANDARDS

In August 2001, the FASB issued SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This statement did not have a material effect on the financial statements.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections," which updates, clarifies and simplifies existing accounting
pronouncements, which will be effective for fiscal years beginning after May 15,
2002. This statement will not have a material effect on the Corporation's
financial statements.

29

In November 2002, the FASB issued Interpretation No. 45, Guarantors'
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. The Interpretation elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. This Interpretation does not prescribe a specific approach for
subsequently measuring the guarantor's recognized liability over the term of the
related guarantee. The disclosure provisions of this Interpretation are
effective for the Corporation's December 31, 2002 financial statements. The
initial recognition and initial measurement provisions of this Interpretation
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. This Interpretation had no effect on the Corporation's
financial statements.

In January 2003, the FASB issued Interpretation No. 46, Consolidation
of Variable Interest Entities. This Interpretation clarifies the application of
existing accounting pronouncements to certain 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. The provisions of
the Interpretation will be immediately effective for all variable interest in
variable interest entities created after January 31, 2003, and the Corporation
will need to apply its provisions to any existing variable interest in variable
interest entities by no later than December 21, 2004. The Corporation does not
expect that this will have an impact on the Corporation's consolidated financial
statements.

PRO-FORMA INFORMATION

The pro-forma information is provided for the purpose of facilitating
the comparison of the 2002 and 2001 results of operations in the review of
management's discussion and analysis. Investments in joint ventures were
reported in 2001 under the pro-rata consolidated method of accounting, which
presented the assets and liabilities and revenues and expenses of the joint
ventures on a pro-rata basis in accordance with the Corporation's percentage of
ownership together with the assets and liabilities and revenues and expenses of
the Corporation's wholly-owned properties. In 2002 under the equity method of
accounting, the Corporation's share of assets and liabilities and revenues and
expenses in joint ventures is presented as a single item on the balance sheet
and statement of operations. The Corporation's total equity and net income did
not change as a result of the conversion. The following tables show (i) the
pro-forma condensed consolidated balance sheet as of December 31, 2001 and (ii)
the pro-forma condensed consolidated statement of operations for the year ended
December 31, 2001 both reflecting the pro-forma impact had the change to equity
accounting for the investments in joint ventures occurred in 2001.

30

SHELBOURNE PROPERTIES III, INC.
CONDENSED CONSOLIDATED PRO-FORMA BALANCE SHEET

AS REPORTED PRO-FORMA EQUITY METHOD
DECEMBER 31, 2001 ADJUSTMENTS DECEMBER 31, 2001
------------------------ ------------------- ------------------------

ASSETS

Real estate, net $40,493,332 $(23,344,215) $17,149,117
Real estate held for sale 2,961,146 (2,961,146) -
Cash and cash equivalents 11,122,456 (8,282,967) 2,839,489
Other assets 1,921,600 17,357,319 19,278,919
Receivables, net 42,928 (18,403) 24,525
Investment in joint ventures - 16,914,312 16,914,312
----------- ------------- -----------
TOTAL ASSETS $56,541,462 $ (335,100) $56,206,362
=========== ============= ===========

LIABILITIES

Accounts payable and accrued expenses $ 816,904 $ (335,100) $ 481,804
----------- ------------- -----------

TOTAL LIABILITIES $ 816,904 $ (335,100) $ 481,804
=========== ============= ===========

CONDENSED CONSOLIDATED PRO-FORMA STATEMENT OF OPERATIONS