SHELBOURNE PROPERTIES I 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: 0-16345

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

Delaware 04-3502384
- ----------------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

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 839,286 shares of common stock outstanding, 486,791
shares with an aggregate market value of $13,192,037 were issued and outstanding
and held by non-affiliates.

This report consists of 64 sequentially numbered pages. The Exhibit Index is
located at sequentially numbered page 43.

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TABLE OF CONTENTS
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Page
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PART I.......................................................................................................4

Item 1. Business...................................................................................4

Where Can You Find More Information About Us?...............................................................17

Item 2. Properties................................................................................18
Item 3. Legal Proceedings.........................................................................21
Item 4. Submission of Matters to a Vote of Security Holders.......................................22

PART II.....................................................................................................23

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.....................23
Item 6. Selected Financial Data...................................................................25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................35
Item 8. Financial Statements and Supplementary Data...............................................36
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................................36

Part III....................................................................................................37

Item 10. Directors and Executive Officers of the Registrant........................................37
Item 11. Executive Compensation....................................................................37
Item 12. Security Ownership of Certain Beneficial Owners and Management............................37
Item 13. Certain Relationships and Related Transactions............................................37
Item 14. Controls and Procedures...................................................................37

Part IV.....................................................................................................38

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K...........................38

Exhibit 99.1................................................................................................45

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 I, Inc.,
Shelbourne Properties I GP LLC and Shelbourne Properties I L.P. or to Shelbourne
Properties I, Inc. independently, as the context requires.

OVERVIEW

Our company, Shelbourne Properties I, 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 two office buildings and
one shopping center. 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 I 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 II L.P. and/or Shelbourne Properties III L.P.) or through
wholly owned subsidiaries. The general partner of the Operating Partnership is
Shelbourne Properties I GP LLC, a Delaware limited liability company 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 Fort Lauderdale, Florida and New York, New York. 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 or through joint venture,

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represented 10% or more of our gross revenues during the fiscal year ended
December 31, 2002 and, the Predecessor Partnership's and, subsequently, our
gross revenues during each of the fiscal years ended December 31, 2001 and 2000:
during 2002, 568 Broadway, Southport Shopping Center, Seattle Tower, Century
Park, and Loch Raven represented approximately 36%, 27%, 13%, 13%, and 11% of
gross revenues respectively: during 2001 Southport Shopping Center and 568
Broadway represented 33% and 29% of gross revenues, respectively; during 2000
Southport Shopping Center and 568 Broadway represented 29% and 33% of gross
revenues, respectively. See "Item 2. Properties" for a description of the
Predecessor Partnership's properties.

CORPORATE HISTORY

Predecessor Partnership. Prior to the merger described below, the owner
of the Corporation's properties was Integrated Resources High Equity Partners,
Series 85, a California limited partnership (the "Predecessor Partnership"). The
Predecessor Partnership was formed as of August 19, 1983. 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 1986, the Predecessor Partnership offered and sold 400,000 units of
limited partnership interest (the "Units"). Upon final admission of limited
partners, the Predecessor Partnership had accepted subscriptions for 400,010
units for an aggregate of $100,002,500 in gross proceeds, resulting in net
proceeds from the offering of $98,502,500 (gross proceeds of $100,002,500 less
organization and offering costs of $1,500,000). Subsequent to the conversion
discussed below, the Units were converted into shares of the successor
Corporation on a three for one basis. Throughout the rest of this document,
rather than referring to Units, we will refer to shares on a converted basis.
The Predecessor Partnership invested all of its net proceeds 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 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 $418,768 ($426,867 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 18, 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 II, LLC, made a tender offer to limited partners to
acquire up to 26,936 Units (representing approximately 6.7% of the outstanding
Units) at a price of $114.60 per Unit. The offer closed in January 2000 and all
26,936 Units were acquired in the offer. On a post-conversion basis, the tender
was for the equivalent of 80,808 shares at a price of $38.20 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 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

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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 18, 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 63,159 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) $150,000
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 II, Inc. and Shelbourne Properties III, 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 proceeds from the Hypo Loan described below.

Pursuant to the Transaction, the Corporation paid PCIC approximately
$14,300,000 in cash and the Operating Partnership issued preferred partnership
interests (the "Class A Units") with an aggregate liquidation preference of
$812,674 and a note with an aggregate stated amount between approximately
$17,600,000 and $18,900,000, depending upon the timing of the repayment of the
note. This note was subsequently satisfied for approximately $17,600,000 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 I 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; 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 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

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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 $53.00 (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 $59.00 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 $58.30. 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 $53.00
to $63.15. 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 $59.00 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 $.92.

On August 16, 2002, the HX Investors Offer expired and HX Investors
acquired 251,785 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.

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

7

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 Fort Lauderdale, Florida, and New York, New York, and has paid
dividends of $4.50 per share on November 21, 2002, $3.50 per share on January
31, 2003 and $52.00 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 $23,832,274, of which $17,639,459 was used to repay the
note issued in the Transaction, $172,733 to pay associated accrued interest and
$667,145 to pay costs associated with the Credit Facility. The excess proceeds
of $5,352,937 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 $1,115. 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.

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.

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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 ($1,362,500 of which is allocable to the
Corporation), a $10,000,000 reserve ($3,892,500 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 Seattle, Washington; Towson, Maryland and San Diego,
California (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 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.

9

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 ($5,287,000 at the January
15, 2003) unless the Operating Partnership, together with the operating
partnerships of Shelbourne Properties II, Inc. and Shelbourne Properties III,
Inc. (together with the Operating Partnership, the "Shelbourne OPs") maintained
at least approximately $54,200,000 of aggregate indebtedness ($17,600,000 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 ($24,300,000 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 the Operating Partnership, Shelbourne
Properties II L.P. and Shelbourne Properties III L.P., 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
$812,000 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 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.

10

Property Sales. On January 21, 2003, Southport Shopping Center was sold
for $23,430,000. After all expenses, prorations, adjustments, and settlement
charges the Corporation received net proceeds in the amount of approximately
$22,981,815. Under the terms of the Credit Facility, all of the net proceeds
from the sale were paid to reduce the amounts due on the Credit Facility.

On February 28, 2003, 568 Broadway Joint Venture, a partnership in
which the Operating Partnership indirectly holds a 38.925% 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 $28,415,250 was allocated to the
Operating Partnership.

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 areas 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 and retail 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 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.

11

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

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

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

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

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

o competition from other o civil unrest, acts of
properties; 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.

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.

12

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 office and
retail properties in three markets: Seattle, Washington; San Diego, California;
and Towson, Maryland. As a result, our business is substantially dependent on
the economies of these markets. A material downturn in demand for office or
retail space in any one of these markets could have a material impact on our
ability to lease the office 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 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.

13

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 affect 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.

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.

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, two of which are located in the States of California and
Washington, historically earthquake-prone areas, 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

14

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.

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.

15

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.

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

16

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.

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.

17

ITEM 2. PROPERTIES

PROPERTY PORTFOLIO

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

(1) SOUTHPORT SHOPPING CENTER

On April 15, 1986, the Predecessor Partnership purchased the fee simple
interest in Southport Shopping Center ("Southport"), a regional shopping center
located on the 17th Street Causeway in Fort Lauderdale, Florida near the
intercoastal waterway and beach area. The center's three buildings, comprising a
total of 143,089 square feet, are situated on a 9.45 acre site. Southport was
built in phases from 1968 to 1977 and expanded again and renovated in 1985. The
site provides parking for 563 cars. The roof on the West quadrant of the main
center building was replaced in 1998 and the center was repainted.

Southport is highly visible from S.E. 17th Street, the major east/west
artery in the commercially-oriented area. Developments in the area are
diversified and include hotels, restaurants, retail centers, office buildings
and the 750,000 square foot Broward County Convention Center, which opened in
1991 and is within walking distance. In 1996, the new 75,000 square foot,
three-story, mixed-use NorthPort Marketplace opened on county owned land
adjacent to the Convention Center. The development has attracted national
restaurant/entertainment chains but is not considered competition for
Southport's tenants.

On January 22, 2003, Southport was sold to an unaffiliated third party
for a gross sales price of $23,430,000. As required by the terms of the Hypo
Loan, the net proceeds from the sale of approximately $23,000,000 were used to
satisfy a portion of the amounts then due on the Hypo Loan.

(2) LOCH RAVEN PLAZA

On June 26, 1986, the Predecessor Partnership purchased the fee simple
interest in Loch Raven Plaza ("Loch Raven"), a retail/office complex located in
Towson, Maryland. It contains approximately 25,000 square feet of office and
storage space and approximately 125,000 square feet of retail space, with
parking for approximately 655 vehicles.

Towson Marketplace, which competes directly with the Loch Raven for
tenants, has been redeveloped and includes Michael's Crafts, Marshall's, Target
and TOYS "R" US as tenants.

Further to the transaction described under "Item 1. Business-Recent
Developments-Fleet Loan", we granted a mortgage on Loch Raven 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.

(3) CENTURY PARK I

On November 7, 1986, a joint venture (the "Century Park Joint Venture")
comprised of the Predecessor Partnership and High Equity Partners L.P. - Series
86 ("HEP-86"), the predecessor to Shelbourne Properties II, L.P., purchased the
fee simple interest in Century Park I ("Century Park I"), an office complex.

Century Park I, situated on approximately 8.6 acres, is located in the
center of San Diego County in Kearny Mesa, California, directly adjacent to
Highway 163 at the northeast corner of Balboa Avenue and Kearny Villa Road.
Century Park I is part of an office park consisting of six office buildings and
two parking garages, in which Century Park Joint Venture owns three buildings,
comprising 200,002 net rentable square feet and one garage with approximately
810 parking spaces. One of the three buildings was completed in the latter half
of 1985, and the other two buildings were completed in February 1986.

18

Century Park I competes with other office parks and office buildings in
the Kearny Mesa sub-market. New competition in the sub-market includes the
redevelopment of the adjacent property into the Cabrillo Technology Center with
141,800 square feet available plus an additional 284,000 square feet planned and
redevelopment of the 234 acre former General Dynamics site, now known as New
Century Center. Plans for New Century Center call for development of the site
with mixed use commercial, industrial, retail and entertainment areas.

On February 25, 2003, Century Park Joint Venture entered into an
agreement to sell its property to an unaffiliated third party for a purchase
price of $29,750,000. The sale is subject to the buyer completing its due
diligence review. If the property is sold, pursuant to the terms of the Loan,
$20,000,000 of the proceeds from the sale will be required to be paid to Fleet
on account of the Loan. The sale is expected to be consummated, if at all,
during the second quarter of 2003.

Further to the transaction described under "Item 1. Business-Recent
Developments-Fleet Loan", we granted a mortgage on Century Park I 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.

(4) 568 BROADWAY

On December 2, 1986, a joint venture (the "Broadway Joint Venture")
comprised of the Predecessor Partnership and HEP-86 acquired a fee simple
interest in 568-578 Broadway ("568 Broadway"), a commercial building in New
York, New York. Until February 1, 1990, the Predecessor Partnership and HEP-86
each had a 50% interest in the Broadway Joint Venture. On February 1, 1990, the
Broadway Joint Venture admitted a third joint venture partner, High Equity
Partners L.P. - Series 88 ("HEP-88"), the predecessor in interest to Shelbourne
Properties III, L.P., which contributed $10,000,000 for a 22.15% interest in the
joint venture. The Operating Partnership and Shelbourne Properties II, L.P. each
retain a 38.925% 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 its 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, $28,415,250 of which is attributable to the
Operating Partnership's interest in the property.

(5) SEATTLE TOWER

On December 16, 1986, a joint venture (the "Seattle Landmark Joint
Venture") comprised of the Predecessor Partnership and HEP-86 acquired a fee
simple interest in Seattle Tower, a commercial office building located in
downtown Seattle ("Seattle Tower"). The Operating Partnership and Shelbourne
Properties II, L.P. each have a 50% interest in the Seattle Landmark Joint
Venture.

Seattle Tower is located at Third Avenue and University Street on the
eastern shore of Puget Sound in the financial and retail core of the Seattle
central business district. Seattle Tower, built in 1928, is a 27-story
commercial building containing approximately 167,000 rentable square feet,
including almost 10,000 square feet of retail space and approximately 2,211
square feet of storage space. The building also contains a 55-car garage.
Seattle Tower, formerly Northern Life Tower, represented the first appearance in
Seattle of a major building in the Art Deco style. It was accepted into the
National Register of Historic Places in 1975. There are approximately seventy
tenants occupying the building. Leasing efforts are focused on consolidating
space to create single floor tenants.

19

In February 2001, the Seattle area was hit with an earthquake. Seattle
Tower suffered some damage in the earthquake. Repairs have been undertaken and
completed on all tenant spaces, with approximately 75% of the repairs completed
overall. The costs of the repairs are fully covered by insurance, subject to a
$25,000 deductible which has been satisfied.

We believe that Seattle Tower's primary direct competition comes from
three office buildings of similar size or age in the immediate vicinity of
Seattle Tower, which buildings have current occupancy rates which are comparable
to Seattle Tower's.

Further to the transaction described under "Item 1. Business-Recent
Developments-Fleet Loan", we granted a mortgage on Seattle Tower 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.

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
- -------- ---------- ---------- ----------

Southport Shopping Center (1) 88% 97% 95%

Loch Raven Plaza 96% 92% 87%

Century Park I Office Complex 100% 100% 100%

568 Broadway Office Building (2) 99% 97% 100%

Seattle Tower Office Building 80% 90% 95%

(1) Property was sold in January 2003

(2) Property was sold in February 2003

20

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
- ------------------ ---------------- ---------------- --------------- ---------------- ---------------- ---------------

LOCH RAVEN PLAZA Greetings & Retailer 42,166 $194,644 1/31/04 4-5 yr.
Readings

Super Fresh Grocery 26,648 $87,000 9/30/05 5-5 yr.
retailer
- ------------------ ---------------- ---------------- --------------- ---------------- ---------------- ---------------
CENTURY PARK San Diego Gas Utilities 118,104 $1,894,640 11/30/07 1-5 yr.
& Electric

Per-Se Physician's 64,817 $855,584 7/31/05 2-5 yr.
Technologies billing service
- ------------------ ---------------- ---------------- --------------- ---------------- ---------------- ---------------
SEATTLE TOWER Electric Telephone 23,475 $510,545 8/31/09 None
Lightwave switching
company

CAPITAL IMPROVEMENTS

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

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, L.P. and other
stockholders against the Companies.

The Companies vigorously defended all of the litigation, and, on July
1, 2002, HX Investors, L.P., 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

21

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 principle. 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."

22

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 "HXD". 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 39.50 25.03

September 30, 2001 34.00 28.00

December 31, 2001 31.91 27.00

March 31, 2002 42.20 27.30

June 30, 2002 43.51 41.60

September 30, 2002 60.20 43.00

December 31, 2002 68.00 57.00

On March 24, 2003, the closing sale price of the Common Stock as
reported by the American Stock Exchange was $27.10. The Corporation had
approximately 1,771 holders of record of Common Stock as of March 24, 2003.

The Corporation has authorized 2,500,000 shares of Common Stock, issued
1,263,189 shares, with 839,286 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 $59.00
(plus interest) per share priority dividend. After giving effect to

23

dividends paid from August 19, 2002 through March 24, 2003, the remaining unpaid
per share priority return is $.92.

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

STOCKHOLDER RECORD
PERIOD ENDED DATE DIVIDEND/SHARE (1)
- --------------------------- ------------------------- -----------------------
December 31, 2001 December 17, 2001 $1.33
- --------------------------- ------------------------- -----------------------

March 31, 2002 - -

June 30, 2002 - -

September 30, 2002 - -

December 31, 2002 November 15, 2002 $4.50

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 $3.50 per share
was made on January 31, 2003 to stockholders of record on January 23, 2003, and
a dividend of $52.00 per share was made 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.

24

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. Consolidated 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 $717,568(4) $3,738,863(4) $10,920,216 $10,952,443 $11,388,898 $9,798,441

Net Income (Loss)
Available for Common 546,778 (18,611,927) 3,470,868 3,847,300 4,847,538 2,931,223(1)
Shareholders
Net Income (Loss) per .65 (20.62) 2.75 3.05 3.84 2.32
Common Share

Distribution per Common 4.50 -- 1.33 -- 0.63 1.25
Share (2) (3)

Total Assets $89,209,158(5) $43,512,115 $49,268,560 $47,872,681 $44,178,753 $40,814,689

(1) Total revenue and net income for the year ended December 31, 1998
includes a $389,359 gain, or $0.31 per share, from the sale of the
Westbrook property.

(2) 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.

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

(4) 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 $6,241,255. Total net income remains
unchanged.

(5) Reflects the conversion to the liquidation basis of accounting
under which real estate is reported at 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.

25

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 I, Inc. was formerly a Delaware limited
partnership, High Equity Partners L.P. - Series 85 ("HEP-85"), which was merged
on April 18, 2001 with and into Shelbourne Properties I L.P., a Delaware limited
partnership (the "Operating Partnership"). The Corporation holds its investment
in its properties through the Operating Partnership in which it held a 99%
direct interest and 1% indirect interest at December 31, 2002. The 1% is held
indirectly through the general partner of the Operating Partnership, Shelbourne
Properties I 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 18, 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 contribution of the Advisory Agreement, the Corporation paid
$14,303,060 in cash and the Operating Partnership issued a note in the amount of
$17,639,459 and issued 812.674 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 251,785 Common Shares. As a
result, HX Investors holds 42% 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 $59.00 (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 Fort Lauderdale, Florida and New
York, New York and has paid dividends of $60.00 per share (including a dividend
of $3.50 per share paid in January 2003 and of $52.00 per share paid in March
2003). In addition, its property located in San Diego, California is under
contract for sale. Pursuant to the Plan of Liquidation, if all of the assets of
the

26

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. Distributions made by us to
you and our other stockholders 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.

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 ADJUSTMENT 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 $4,144,092 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 $2,000,832, which is included in the consolidated statement
of changes in net assets (liquidation basis) for the period October 30, 2002 to
December 31, 2002. Significant increases (decreases) in the carrying value of
net assets are summarized as follows:

27

Increase to reflect estimated net realizable values of certain real estate properties $ 10,877,025
Deferral of appreciated gain and incentive fee on real estate properties (10,877,025)
Increase to reflect net realizable value of investments in joint ventures 41,650,858
Deferral of appreciated gain and incentive fee on investments in joint ventures (41,650,858)
Reserve for additional costs associated with liquidation (1) (1,300,000)
Write-off of deferred debt costs (700,832)
---------------
Adjustment to reflect the change to liquidation basis of accounting $ (2,000,832)
===============

(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 value 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.

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, the non-operating 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 II L.P. and/or Shelbourne Properties III 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.

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

28

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. 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.

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

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

Real estate, net $ 31,783,227 $(12,545,200) $ 19,238,027
Cash and cash equivalents 14,191,726 (7,308,977) 6,882,749
Other assets 3,013,830 3,083,415 6,097,245
Receivables, net 279,777 (144,526) 135,251
Investment in joint ventures - 16,488,348 16,488,348
------------- ------------ -------------
TOTAL ASSETS $ 49,268,560 $ (426,940) $ 48,841,620
============= ============ =============

LIABILITIES

Accounts payable and accrued expenses $ 783,308 $ (426,940) $ 356,368
------------- ------------ -------------
Total Liabilities $ 783,308 $ (426,940) $ 356,368

29

FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2001

AS REPORTED PRO-FORMA EQUITY METHOD
2001 ADJUSTMENTS 2001
-------------------- ------------------ -----------------

Rental revenues $ 10,337,996 $ (6,241,255) $ 4,096,741
------------- ------------ ------------
Costs and expenses 7,449,348 (3,083,610) 4,365,738
------------- ------------ ------------
Income (loss) before equity income from joint
ventures, interest and other income 2,888,648 (3,157,645) (268,997)

Equity income from joint ventures - 3,518,785 3,518,785
Interest income 551,031 (361,231) 189,800
Other income 31,189 91 31,280
------------- ------------ ------------
Net income $ 3,470,868 $ - $ 3,470,868
============= ============ ============

LIQUIDITY AND CAPITAL RESOURCES

The Corporation uses its working capital reserves and any cash from
operations as its primary source of liquidity. On October 29, 2002, the
Corporation's stockholders approved the Plan of Liquidation. Accordingly, the
Corporation began to sell its properties. In this regard, on October 31, 2002,
568 Broadway Joint Venture, a joint venture in which the Corporation indirectly
holds a 38.925% interest, entered into a contract to sell its property located
at 568 Broadway, New York, New York for a gross sales price of $87,500,000. The
sale of this property occurred on February 28, 2003. In addition, in December
2002, the Corporation entered into a contract to sell Southport Shopping Center
located in Fort Lauderdale, Florida for a gross sales price of $23,430,000. The
sale was closed on January 21, 2003. Pursuant to the terms of the Credit
Facility, all of the net proceeds from the Southport sale of $22,981,815 were
required to be delivered to the Lender to reduce the outstanding balance on the
Credit Facility. On February 25, 2003, the Operating Partnership entered into an
agreement to sell its property located in San Diego, California for a purchase
price of $29,750,000. The sale is subject to the buyer completing its due
diligence review. If the property is sold pursuant to the terms of the current
Loan encumbering the property, $20,000,000 of the proceeds from the sale will be
required to pay down the Loan. The sale is expected to be consummated, if at
all, during the second quarter of 2003.

The Corporation had $550,061 in cash and cash equivalents at December
31, 2002. Cash and cash equivalents are temporarily invested in short-term
instruments. The Corporation's level of liquidity based upon cash