INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Consolidated Balance Sheets

June 30, 2010 and December 31, 2009

(Unaudited)

(in thousands, except per share amounts)

See accompanying notes to consolidated financial statements

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Consolidated Statements of Operations and Other Comprehensive (Loss) Income

For the Three and Six Months Ended June 30, 2010 and 2009

(Unaudited)

 (in thousands, except per share amounts)

See accompanying notes to consolidated financial statements

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Consolidated Statements of Cash Flows

For the Six Months Ended June 30, 2010 and 2009

(Unaudited)

(in thousands, except per share amounts)

See accompanying notes to consolidated financial statements

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Consolidated Statements of Cash Flows

(Continued)

For the Six Months Ended June 30, 2010 and 2009

(Unaudited)

(in thousands, except per share amounts)

See accompanying notes to consolidated financial statements

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  Readers of this Quarterly Report should refer to the audited financial statements of Inland Western Retail Real Estate Trust, Inc. for the fiscal year ended December 31, 2009, which are included in the Company’s 2009 Annual Report on Form 10-K, as amended, as certain footnote disclosures which would substantially duplicate those contained in the Annual Report have been omitted from this Quarterly Report.  In the opinion of management, all adjustments necessary, all of which were of normal nature, for a fair presentation have been included in this Quarterly Report.

(1)  Organization and Basis of Presentation

Inland Western Retail Real Estate Trust, Inc. (the “Company”) was formed on March 5, 2003 to acquire and manage a diversified portfolio of real estate, primarily multi-tenant shopping centers and single-user net lease properties.

All amounts in this Form 10-Q are stated in thousands with the exception of per share amounts, square foot amounts, number of properties, number of states, number of leases and number of employees.

The Company issued a total of 459,484 shares of its common stock at $10.00 per share, resulting in gross proceeds of $4,595,193.  In addition, as of June 30, 2010, the Company had issued 68,037 shares through its DRP at prices ranging from $6.85 to $10.00 per share for gross proceeds of $657,379 and had repurchased a total of 43,823 shares through its share repurchase program (SRP) (suspended as of November 19, 2008) at prices ranging from $9.25 to $10.00 per share for an aggregate cost of $432,487.  As a result, the Company had total shares outstanding of 483,698 and had realized total net offering proceeds of $4,820,085 as of June 30, 2010.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions.  These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.  For example, significant estimates and assumptions have been made with respect to useful lives of assets; capitalization of development and leasing costs; fair value measurements; provision for impairment, including estimates of holding periods, capitalization rates and discount rates (where applicable); provision for income taxes; recoverable amounts of receivables; deferred taxes and initial valuations and related amortization periods of deferred costs and intangibles, particularly with respect to property acquisitions.  Actual results could differ from those estimates.

Certain reclassifications, as a result of discontinued operations and the error noted below, have been made to the 2009 consolidated financial statements to conform to the 2010 presentation.  

Subsequent to the issuance of the consolidated financial statements for the three and six months ended June 30, 2009, the Company identified an error in the presentation of its comprehensive (loss) income in the consolidated statements of operations and other comprehensive (loss) income.  Consistent with the accounting guidance for noncontrolling interests, consolidated comprehensive loss and the related amounts attributable to the Company and to noncontrolling interests should be disclosed.  As such, the Company’s consolidated statement of operations and other comprehensive (loss) income for the three and six months ended June 30, 2009 has been corrected to reflect such presentation.  This correction resulted in a $53 increase to total comprehensive income from $7,219 to $7,272 for the three months ended June 30, 2009 and a $3,121 increase to total comprehensive loss from $35,334 to $38,455 for the six months ended June 30, 2009.  In addition, comprehensive income (loss) attributable to noncontrolling interests of $53 and $(3,121) and comprehensive income (loss) attributable to Company shareholders of $7,219 and $(35,334) have been properly presented for the three and six months ended June 30, 2009, respectively.  Although the Company believes the effects are not material to the previously issued consolidated statements of operations and other comprehensive (loss) income, the Company has corrected the presentation of these amounts for comparability purposes. This correction has no effect on the previously reported financial position, results of operations or cash flows.

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

It is the Company’s current strategy to have access to the capital resources necessary to manage its balance sheet, to repay upcoming maturities and, to a lesser extent, to consider making prudent real estate investments should such opportunities arise.  Accordingly, the Company is executing a plan to seek to obtain funds through additional debt or equity financings and/or joint venture capital in a manner consistent with the Company’s intention to operate with what it believes to be a conservative debt capitalization policy.  The Company’s other sources of capital include proceeds from sales of developed and non-core assets, proceeds from the sales of securities in the Company’s marketable securities portfolio, and existing unrestricted cash balances.  In addition, the Company is focused on controlling operating expenses and deferring certain discretionary capital expenditures and has reduced distributions to shareholders to preserve cash for upcoming debt maturities and principal paydowns.  The Company will also seek loan extensions, generally six months to three years, on certain maturing mortgage debt. 

During the six months ended June 30, 2010, the Company obtained mortgage payable proceeds of $553,175, made mortgage payable repayments of $690,137 and received forgiveness of debt of $19,561.  The Company also entered into modifications of existing loan agreements which extended the maturities of $104,052 of mortgages payable up to January 2012.  As the Company addresses its maturing mortgages payable, it has reduced its overall debt and staggered future mortgage maturity dates so that no more than $550,000 will come due in any one year.  As of June 30, 2010, the Company had $103,821 of mortgages payable that had matured.  Of this amount, the Company has since repaid $8,030.  During the second quarter, in order to prompt discussions with the lenders, the Company ceased making monthly debt service payments on two mortgage loans totaling $61,235 as of June 30, 2010.  The non-payment of these monthly debt service payments amounts to $3,000 annualized and does not result in noncompliance under any of the Company’s other mortgages payable and line of credit agreements.  The Company is currently in active negotiations with the lenders to determine an appropriate course of action under the non-recourse loan agreements.  No assurance can be provided that these negotiations will result in favorable outcomes for the Company.

As of June 30, 2010, the Company had $299,299 of mortgages, excluding principal amortization, maturing in the remainder of 2010.  On January 8, 2010, the Company entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities, of which $193,275 has been utilized as of June 30, 2010.  In addition to allocating the remaining proceeds of $106,725, the Company is in the process of marketing, planning to seek extensions or planning to sell properties relating to the remaining 2010 maturities, which are primarily maturing in the fourth quarter of 2010.  The Company’s current business plan indicates that it will be able to operate in compliance with its loan covenants under its secured line of credit agreement (see Note 9) in 2010 and beyond as the Company extended the credit agreement to October 14, 2011.  The balance outstanding on the line of credit at June 30, 2010 was $133,242.  In light of current economic conditions, the Company may not be able to obtain loan extensions or financing on favorable terms, or at all, in order to meet principal maturity obligations of the remaining 2010 debt maturities, which may cause an acceleration of its secured line of credit and trigger remedies available to lenders on assets securing matured mortgage debt, each of which could significantly impact future operations, liquidity and cash flows available for distribution.

The accompanying consolidated financial statements include the accounts of the Company, as well as all wholly-owned subsidiaries and consolidated joint venture investments.  Wholly-owned subsidiaries generally consist of limited liability companies (LLCs) and limited partnerships (LPs).

The Company’s property ownership is summarized below:

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

The Company consolidates certain property holding entities and other subsidiaries in which it owns less than a 100% equity interest if it is deemed to be the primary beneficiary in a variable interest entity (VIE), (an entity in which the contractual, ownership, or pecuniary interests change with changes in the fair value of the entity’s net assets, as defined by the Financial Accounting Standards Board (FASB)), as amended. The Company also consolidates entities that are not VIEs in which it has financial and operating control in accordance with GAAP.  All significant intercompany balances and transactions have been eliminated in consolidation.  Investments in real estate joint ventures in which the Company has the ability to exercise significant influence, but does not have financial or operating control, are accounted for using the equity method of accounting.  Accordingly, the Company’s share of the income (or loss) of these unconsolidated joint ventures is included in consolidated net loss.

The Company is the controlling member in various consolidated entities.  The organizational documents of these entities contain provisions that require the entities to be liquidated through the sale of their assets upon reaching a future date as specified in each respective organizational document or through put/call arrangements.  As controlling member, the Company has an obligation to cause these property-owning entities to distribute proceeds of liquidation to the noncontrolling interest partners in these partially-owned entities only if the net proceeds received by each of the entities from the sale of assets warrant a distribution based on the agreements.  Some of the LLC or LP agreements for these entities contain put/call provisions which grant the right to the outside owners and the Company to require each LLC or LP to redeem the ownership interest of the outside owners during future periods.  In instances where outside ownership interests are subject to put/call arrangements requiring settlement for fixed amounts, the LLC or LP is treated as a 100% owned subsidiary by the Company with the amount due to the outside owner reflected as a financing arrangement and included in “Other financings” in the accompanying consolidated balance sheets.  Interest expense is recorded on such liabilities in amounts equal to the preferential returns due to the outside owners as provided in the LLC or LP agreements.  In instances where outside ownership interests are subject to call arrangements without fixed settlement amounts, the LLC is treated as a 100% owned subsidiary by the Company with the amount due to the outside owner reflected as a financing and included in “Co-venture obligation” in the accompanying consolidated balance sheets.  Expense is recorded on such liabilities in amounts equal to the preferential returns due to the outside owners as provided in the LLC agreement.

On the consolidated statements of operations and other comprehensive (loss) income, revenues, expenses and net income or loss from less-than-wholly-owned subsidiaries are reported at the consolidated amounts, including both the amounts attributable to Company shareholders and noncontrolling interests.  Consolidated statements of equity are included in the annual financial statements, including beginning balances, activity for the period and ending balances for shareholders’ equity, noncontrolling interests and total equity.

Below is a table reflecting the activity of the redeemable noncontrolling interests for the six months ended June 30, 2010 and 2009:

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

During the six months ended June 30, 2010 and 2009, the Company paid certain joint venture partners for the redemption of their interests in certain consolidated joint ventures as summarized below:  

The Company is party to an agreement with an LLC formed as an insurance association captive (the “Captive”), which is wholly-owned by the Company and three related parties, Inland Real Estate Corporation (IREC), Inland American Real Estate Trust, Inc. (IARETI) and Inland Diversified Real Estate Trust, Inc. (IDRETI).  The Captive is serviced by a related party, Inland Risk and Management Services, Inc. for a fee of $25 per quarter.  The Company entered into the agreement with the Captive to stabilize its insurance costs, manage its exposures and recoup expenses through the functions of the Captive program.  The Captive was initially capitalized in 2006 with $750 in cash from the original members IREC, IARETI, a non-affiliated entity which withdrew from the Captive in October 2007, and the Company, of which the Company’s initial contribution was $188.  In August 2009, IDRETI was admitted as a member to the Captive with an initial contribution of $188, at the approval of the members.  Additional contributions were made in the form of premium payments to the Captive determined for each member based upon its respective loss experiences.  The Captive insures a portion of the members’ property and general liability losses, a majority of which is attributable to the Company.  These losses will be paid by the Captive up to and including a certain dollar limit, which varies based on the type of loss, after which the losses are covered by a third-party insurer.  It has been determined that the Captive is a VIE and, as the Company receives the most benefit of all members, the Company is the primary beneficiary.  Therefore, the Captive has been consolidated by the Company.  The Company re-affirmed its conclusion on consolidating the Captive as of June 30, 2010.  The other members’ interests are reflected as “Noncontrolling interests” in the accompanying consolidated financial statements.

The assets of the Captive are restricted to the settlement of liabilities of the Captive.  Similarly, creditors of the Captive do not have recourse to the Company.  Below is a summary of the assets and liabilities of the Captive:

On November 29, 2009, the Company formed IW JV 2009, LLC (IW JV), a wholly-owned subsidiary, and transferred a portfolio of 55 investment properties and the entities which owned them into it.  Subsequently, in connection with a $625,000 debt refinancing transaction, which consisted of $500,000 of mortgages payable and $125,000 of notes payable, on December 1, 2009, the Company raised additional capital of $50,000 from a related party, Inland Equity Investors, LLC (Inland Equity) in exchange for a 23% noncontrolling interest in IW JV.  IW JV, which is controlled by the Company, and therefore consolidated, will continue to be managed and operated by the Company.  Inland Equity is a newly-formed LLC owned by certain individuals, including Daniel L. Goodwin, who controls more than 5% of the common stock of the Company, and Robert D. Parks, who is the Chairman of the Board of the Company and affiliates of

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

The Inland Real Estate Group, Inc.  The independent directors committee reviewed and recommended approval of this transaction to the Company’s board of directors.

Noncontrolling interests are adjusted for additional contributions by noncontrolling interest holders and distributions to noncontrolling interest holders, as well as the noncontrolling interest holders’ share of the net income or losses of each respective entity.

(2)

Summary of Significant Accounting Policies

There have been no changes to the Company’s significant accounting policies in the six months ended June 30, 2010.  Refer to the Company’s 2009 Form 10-K, as amended, for a summary of significant accounting policies.

New Accounting Pronouncements

In June 2009, the FASB issued guidance that amends the consolidation guidance applicable to VIEs.  The amendment requires an enterprise to perform a qualitative analysis when determining whether or not it must consolidate a VIE. It also requires an enterprise to continuously reassess whether it must consolidate a VIE. Additionally, the amendment requires enhanced disclosures about an enterprise's involvement with VIEs and any significant change in risk exposure due to that involvement, as well as how its involvement with VIEs impacts the enterprise's financial statements.  Although the amendment significantly affects the overall consolidation analysis under previously issued guidance, the adoption on January 1, 2010 did not have a material impact on the consolidated financial statements.  

In January 2010, the FASB issued guidance which provides additional requirements and clarifies existing disclosures about fair value measurements.  The guidance requires entities to provide fair value measurement disclosures for each “class” of assets and liabilities, opposed to the old guidance which required disclosures by “major category” of assets and liabilities.  The term “major category” was often interpreted to be a line item on the statement of financial position, whereas the term “class” represents a subset of assets or liabilities within a line item in the statement of financial position, thus expanding on the level of disaggregation.  The guidance also requires an entity to disclose the amounts of significant transfers between Levels 1 and 2, and all significant transfers into and out of Level 3, of the fair value hierarchy.  Furthermore, entities are required to disclose the reasons for those transfers, and the entity’s policy for determining when transfers between levels are recognized.  A description of the valuation techniques and inputs used to determine the fair value of each class of assets or liabilities for Levels 2 and 3 must also be disclosed, including any valuation technique changes and the reason for those changes.  This update further amends the reconciliation of the beginning and ending balances of Level 3 recurring fair value measurements, requiring a separate disclosure of total gains and losses recognized in other comprehensive income and disclosing separately purchases, sales, issuances, and settlements, as opposed to net presentation as previously allowed.  The guidance was effective for the Company on January 1, 2010.  The adoption of the guidance did not have a material impact on the consolidated financial statements.

In January 2010, the FASB issued guidance clarifying the accounting for distributions to shareholders with components of stock and cash.  Prior to this amendment, it was unclear as to whether the stock portion of a distribution should be accounted for as a new share issuance that is reflected in earnings per share prospectively or as a stock dividend by retroactively restating shares outstanding and earnings per share for all periods presented.  The amendment clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or shares with potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance and is reflected in EPS prospectively and is not a stock dividend.  The guidance was effective for the Company on January 1, 2010.  The adoption of the guidance did not have any impact on the consolidated financial statements.

In January 2010, the FASB issued guidance related to decreases in the ownership of a subsidiary.  The guidance clarified that any transaction that involves in-substance real estate should be considered under guidance for sales of real estate and is retroactively effective for periods beginning on or after December 15, 2008.  The Company followed this guidance when accounting for the transfer of the 23% interest in IW JV to Inland Equity for $50,000.  This transaction was accounted for as a financing arrangement and is reflected in “Co-venture obligation” on the consolidated balance sheets.  

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

(3)  Discontinued Operations and Investment Properties Held for Sale

The Company employs a business model, which utilizes asset management as a key component of monitoring its investment properties, to ensure that each property continues to meet expected investment returns and standards.  This strategy incorporates the sale of non-core assets that no longer meet the Company’s criteria.

During 2009, the Company sold eight properties, of which four were sold during the six months ended June 30, 2009, which resulted in net sales proceeds of $83,686 and gain on sales of $21,570.  Three of the four properties were sold during the three months ended June 30, 2009, which resulted in net sales proceeds of $52,563 and gain on sales of $9,346.

On March 15, 2010, the Company closed on the sale of an approximately 79,200 square foot single-user office building, located in San Antonio, Texas, with a sales price of $10,850, which resulted in net sales proceeds of $3,501 and a gain on sale of $52.  The sale resulted in the repayment of debt in the amount of $7,060.

On April 12, 2010, the Company closed on the sale of a 100,400 square foot medical center located in Cupertino, California, with a sales price of $44,000, which resulted in net sales proceeds of $11,017 and a gain on sale of $381.  The sale resulted in the repayment of debt of $32,670.  This property qualified for held for sale accounting treatment during the fourth quarter 2009 at which time depreciation and amortization ceased since it met all of the Company’s held for sale criteria.  As such, the assets and liabilities are separately classified as held for sale on the consolidated balance sheet as of December 31, 2009 and the operations for all periods presented are classified as discontinued operations on the consolidated statements of operations and other comprehensive (loss) income.

On April 26, 2010, the Company closed on the sale of a 41,300 square foot single-user retail building located in Naperville, Illinois, with a sales price of $4,775, which resulted in net cash outflow of $27 and a gain on sale of $875.  The sale resulted in the repayment of debt in the amount of $4,478 and forgiveness of debt of $486.

On May 28, 2010, the Company closed on the sale of a 48,800 square foot single-user retail building located in Hinsdale, Illinois, with a sales price of $11,610, which resulted in net sales proceeds of $3,923 and no gain or loss on the sale. The sale resulted in the repayment of debt in the amount of $7,469.

On June 30, 2010, the Company closed on the sale of an 88,300 square foot single-user retail building located in Oswego, Illinois, with a sales price of $8,950, which resulted in net sales proceeds of $2 and a gain on sale of $749.  The sale resulted in the repayment of debt in the amount of $8,758.

The Company does not allocate general corporate interest expense to discontinued operations.  The results of operations for the three and six months ended June 30, 2010 and 2009 for the investment properties that are accounted for as discontinued operations are presented in the table below:

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

No properties were classified as held for sale as of June 30, 2010.  The following assets and liabilities relate to the one investment property which was classified as held for sale as of December 31, 2009 and is presented in the table below:

(4)  Transactions with Related Parties

The following table summarizes the Company’s related party transactions for the three and six months ended June 30, 2010 and 2009.

Refer to the Company’s Form 10-K for the year ended December 31, 2009, as amended, for details of the related party agreements.

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

(5)

Marketable Securities

The following tables summarize the Company’s investment in marketable securities:

(6)  Stock Option Plan

The Company’s Independent Director Stock Option Plan (Plan), as amended, provides, subject to certain conditions, for the grant to each independent director of options to acquire shares following their becoming a director and for the grant of additional options to acquire shares on the date of each annual shareholders’ meeting.

As of June 30, 2010 and December 31, 2009, there had been a total of 105 options granted, none of which had been exercised or expired.

The Company calculates the per share weighted average fair value of options granted on the date of the grant using the Black Scholes option pricing model utilizing certain assumptions regarding the expected dividend yield, risk free interest rate, expected life and expected volatility rate.  Compensation expense of $11 and $4 related to these stock options was recorded during the three months ended June 30, 2010 and 2009, respectively.  Compensation expense of $22 and $9 related to these stock options was recorded during the six months ended June 30, 2010 and 2009, respectively.  

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

(7)  Leases

Master Lease Agreements

In conjunction with certain acquisitions, the Company receives payments under master lease agreements pertaining to certain non-revenue producing spaces at the time of purchase for periods, generally ranging from three months to three years after the date of purchase or until the spaces are leased.  As these payments are received, they are recorded as a reduction in the purchase price of the respective property rather than as rental income.  The cumulative amount of such payments was $26,968 and $26,577, as of June 30, 2010 and December 31, 2009, respectively.

Operating Leases

The majority of revenues from the Company’s properties consist of rents received under long-term operating leases.  Some leases provide for the payment of fixed base rent paid monthly in advance, and for the reimbursement by tenants to the Company for the tenant’s pro rata share of certain operating expenses including real estate taxes, special assessments, insurance, utilities, common area maintenance, management fees and certain building repairs paid by the landlord and recoverable under the terms of the lease.  Under these leases, the landlord pays all expenses and is reimbursed by the tenant for the tenant’s pro rata share of recoverable expenses paid.  Certain other tenants are subject to net leases which provide that the tenant is responsible for fixed based rent, as well as all costs and expenses associated with occupancy.  Under net leases where all expenses are paid directly by the tenant rather than the landlord, such expenses are not included on the accompanying consolidated statements of operations and other comprehensive (loss) income.  Under net leases where all expenses are paid by the landlord, subject to reimbursement by the tenant, the expenses are included in “Property operating expenses” and reimbursements are included in “Tenant recovery income” on the accompanying consolidated statements of operations and other comprehensive (loss) income.

In certain municipalities, the Company is required to remit sales taxes to governmental authorities based upon the rental income received from properties in those regions.  These taxes may be reimbursed by the tenant to the Company depending upon the terms of the applicable tenant lease.  As with other recoverable expenses, the presentation of the remittance and reimbursement of these taxes is on a gross basis whereby sales tax expenses are included in “Property operating expenses” and sales tax reimbursements are included in “Other property income” on the accompanying consolidated statements of operations and other comprehensive (loss) income.  Such taxes remitted to governmental authorities and reimbursed by tenants were $465 and $517 for the three months ended June 30, 2010 and 2009, respectively.  Such taxes remitted to governmental authorities and reimbursed by tenants were $1,000 and $1,052 for the six months ended June 30, 2010 and 2009, respectively.  

In certain properties where there are large tenants, other tenants may have co-tenancy provisions within their lease that requires that if certain large tenants or “shadow” tenants discontinue operations, a right of termination or reduced rent may exist.

The Company leases land under non-cancellable operating leases at certain of its properties expiring in various years from 2018 to 2105.  The related ground lease rent expense is included in “Property operating expenses” on the accompanying consolidated statements of operations and other comprehensive (loss) income.  In addition, the Company leases office space for certain management offices from third parties and the Company subleases its corporate office space from an Inland affiliate.  Office rent expense is included in “Property operating expenses” in the accompanying consolidated statements of operations and other comprehensive (loss) income.

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

(8)  Mortgages and Notes Payable

The following table summarizes the Company’s mortgages and notes payable at June 30, 2010 and December 31, 2009:

Mortgages Payable

Mortgages payable outstanding as of June 30, 2010 were $3,710,386 and had a weighted average interest rate of 6.04% at June 30, 2010.  Of this amount, $3,606,435 had fixed rates ranging from 3.81% to 10.11% and a weighted average fixed rate of 6.09% at June 30, 2010.  The weighted average interest rates for the fixed rate mortgages payable exclude the impact of the premium and discount amortization.  The remaining $103,951 of outstanding indebtedness represented variable rate loans with a weighted average interest rate of 4.53% at June 30, 2010.  Properties with a net carrying value of $5,478,210 at June 30, 2010 and related tenant leases are pledged as collateral for the mortgage loans.  Development properties with a net carrying value of $89,704 at June 30, 2010 and related tenant leases are pledged as collateral for the construction loans.  As of June 30, 2010, scheduled maturities for the Company’s outstanding mortgage indebtedness had various due dates through March 1, 2037.

During the six months ended June 30, 2010, the Company obtained mortgage payable proceeds of $553,175, made mortgage payable repayments of $690,137 and received forgiveness of debt of $19,561.  As a result of accounting for a group of eight mortgage refinancings as a modification under GAAP, the portion of the debt forgiveness associated with one property has been recorded as mortgage premium on the remaining seven mortgages payable and is being amortized over the remaining term of those loans using the effective interest method.  The new mortgages payable that the Company entered into during the six months ended June 30, 2010 have interest rates ranging from 2.48% to 8.00% and maturities up to ten years.  The stated interest rates of the loans repaid during the six months ended June 30, 2010 ranged from 1.65% to 6.75%.  The Company also entered into modifications of existing loan agreements which extended the maturities of $104,052 of mortgages payable up to January 2012.

Mortgages payable outstanding, excluding liabilities associated with the investment property held for sale, as of December 31, 2009 were $3,828,625 and had a weighted average interest rate of 5.57% at December 31, 2009.  Of this amount, $3,715,027 had fixed rates ranging from 4.25% to 10.24% and a weighted average fixed rate of 5.63% at December 31, 2009.  The remaining $113,598 of outstanding indebtedness represented variable rate loans with a weighted average interest rate of 3.56% at December 31, 2009.  Properties with a net carrying value of $5,649,570 at December 31, 2009 and related tenant leases are pledged as collateral for the mortgage loans.  Development properties with a net carrying value of $88,524 at December 31, 2009 and related tenant leases are pledged as collateral for the construction loans.  As

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

of December 31, 2009, scheduled maturities for the Company’s outstanding mortgage indebtedness had various due dates through March 1, 2037.

The majority of the Company’s mortgages payable require monthly payments of interest only, although it has become more common for lenders to require principal and interest payments, as well as reserves for real estate taxes, insurance and certain other costs.  Although the loans obtained by the Company are generally non-recourse, occasionally, when it is deemed to be necessary, the Company may guarantee all or a portion of the debt on a full-recourse basis.  As of June 30, 2010, the Company has guaranteed $65,519 of the outstanding mortgages payable with maturity dates up to August 1, 2014 (see Note 14).  At times, the Company has borrowed funds financed as part of a cross-collateralized package, with cross-default provisions, in order to enhance the financial benefits.  In those circumstances, one or more of the properties may secure the debt of another of the Company’s properties.  Individual decisions regarding interest rates, loan-to-value, debt yield, fixed versus variable-rate financing, term and related matters are often based on the condition of the financial markets at the time the debt is issued, which may vary from time to time.  

As of June 30, 2010, the Company had $103,821 of mortgages payable that had matured.  Of this amount, the Company has since repaid $8,030.  During the second quarter, in order to prompt discussions with the lenders, the Company ceased making monthly debt service payments on two mortgage loans totaling $61,235 as of June 30, 2010.  The non-payment of these monthly debt service payments amounts to $3,000 annualized and does not result in noncompliance under any of the Company’s other mortgages payable and line of credit agreements. The Company is currently in active negotiations with the lenders to determine an appropriate course of action under the non-recourse loan agreements. No assurance can be provided that these negotiations will result in favorable outcomes for the Company.  

As of June 30, 2010, the Company had $299,299 of mortgages payable, excluding principal amortization, maturing in the remainder of 2010.  On January 8, 2010, the Company entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities, of which $193,275 has been utilized as of June 30, 2010.  In addition to allocating the remaining proceeds of $106,725, the Company is in the process of is in the process of marketing, planning to seek extensions or planning to sell properties relating to the remaining 2010 maturities, which are primarily maturing in the fourth quarter of 2010.  

As of June 30, 2010, management believes the Company was in compliance with all financial covenants related to the outstanding mortgages payable.

Notes Payable

Notes payable outstanding as of June 30, 2010 and December 31, 2009 were $175,330 and $175,360, respectively.  Of these amounts, $50,000 represented a note payable to an unconsolidated joint venture.  The note bears interest at 4.80% and is to be repaid on the earlier to occur of (i) an event of default, as defined, or (ii) upon termination of the unconsolidated joint venture’s operating agreement.  The Company has the right to prepay the note without penalty.  During the year ended December 31, 2009, the Company obtained notes payable proceeds of $125,000 from a third party lender related to the debt refinancing transaction for IW JV as discussed in Note 1.  

The following table summarizes the IW JV notes payable as of June 30, 2010 and December 31, 2009:

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

The remaining $330 and $360, respectively, is related to a $600 note, net of amortization, with a third party that bears interest at a rate of 2.00% with a maturity date of September 29, 2010.  The weighted average fixed interest rate on the notes payable was 10.5% at June 30, 2010.

Derivative Instruments and Hedging Activities       

Risk Management Objective of Using Derivatives

The Company is exposed to certain risks arising from both its business operations and economic conditions.  The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities.  The Company manages economic risk, including interest rate, liquidity and credit risk primarily by managing the amount, sources, and duration of its debt funding and, to a limited extent, the use of derivative instruments.

Specifically, the Company has entered into derivative instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  The Company’s derivative instruments, described below, are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash payments principally related to certain of the Company’s borrowings.

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements.  To accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

During 2008, the Company executed two interest rate swaps to hedge the variable cash flows associated with variable-rate debt. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in “Accumulated other comprehensive income” and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.  The derivatives are used to hedge the variable cash flows associated with existing variable-rate debt.  The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.  Due to the Company’s decision in June 2010 to voluntarily prepay a portion of its hedged debt, the Company’s variable-rate debt fell below the notional value on the interest rate swap hedging the aforementioned debt, causing the Company to be temporarily overhedged but the interest rate swap continues to qualify as an effective hedge.  On June 30, 2010, the Company unwound the portion of the swap notional that corresponded with the prepayment.  During the three and six months ended June 30, 2010 and 2009, the Company recorded hedge ineffectiveness of $42 (loss) and none, respectively.

Amounts reported in “Accumulated other comprehensive income” related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt.  Over the next twelve months, the Company estimates that an additional $2,851 will be reclassified as an increase to interest expense.  During the three and six months ended June 30, 2010 and 2009, the Company accelerated $117 (loss) and none, respectively, from other comprehensive income into earnings as a result of the hedged forecasted transactions becoming probable not to occur.

As of June 30, 2010 and December 31, 2009, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheets as of June 30, 2010 and December 31, 2009.

The table below presents the effect of the Company’s derivative financial instruments on the consolidated statements of operations and other comprehensive (loss) income for the three and six months ended June 30, 2010 and 2009.

Credit-risk-related Contingent Features

Derivative financial investments expose the Company to credit risk in the event of non-performance by the counterparties under the terms of the interest rate hedge agreements.  The Company believes it minimizes the credit risk on these transactions by transacting with major creditworthy financial institutions.  As part of the Company’s on-going control procedures, it monitors the credit ratings of counterparties and the exposure to any single entity, which minimizes credit risk concentration.  The Company believes the likelihood of realized losses from counterparty non-performance is remote.

The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on the related indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its corresponding derivative obligation.

The Company’s agreements with each of its derivative counterparties also contains a provision whereby if the Company consolidates with, merges with or into, or transfers all or substantially all its assets to another entity and the creditworthiness of the resulting, surviving, or transferee entity is materially weaker than the Company’s, the counterparty has the right to terminate the derivative obligations.

As of June 30, 2010, the fair value of derivatives in a liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, which the Company has deemed immaterial, was $3,393.  As of June 30, 2010, the Company has not posted any collateral related to these agreements.  If the Company had breached any of these provisions at June 30, 2010, it could have been required to settle its obligations under the agreements at their termination value of $3,393.

Margin Payable

The Company purchases a portion of its securities through a margin account.  As of June 30, 2010 and December 31, 2009, the Company had recorded a payable of $19,539 and none, respectively, for securities purchased on margin.  This debt bears a variable interest rate of LIBOR plus 35 basis points.  At June 30, 2010, this rate was equal to 0.70%.  Interest expense on this debt in the amount of $30 and $87 is recognized within “Interest expense” in the accompanying

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

consolidated statements of operations and other comprehensive (loss) income for the three months ended June 30, 2010 and 2009, respectively.  Interest expense recognized on this debt totaled $44 and $194 for the six months ended June 30, 2010 and 2009, respectively.  This debt is due upon demand.  The value of the Company’s marketable securities serves as collateral for this debt.  During the three and six months ended June 30, 2010, the Company borrowed an additional $10,000 and $22,860, respectively, on its margin account and paid down $1,347 and $3,321, respectively.

Debt Maturities

The following table shows the mortgages payable, notes payable, margin payable and line of credit maturities during the next five years and thereafter:

The maturity table excludes other financings and co-venture obligation as described in Note 1.  The maturity table also excludes accelerated principal payments that may be required as a result of covenants or conditions included in certain loan agreements.  In these cases, the total outstanding mortgage payable is included in the year corresponding to the loan maturity date.  The maturity table includes $103,821 of mortgages payable that had matured as of June 30, 2010 in the 2010 column.  See the mortgages payable section above for additional information on how the Company is addressing its 2010 mortgages payable maturities.

(9)  Line of Credit  

The Company has a secured credit agreement with KeyBank National Association and other financial institutions for borrowings up to $200,000, subject to the collateral pool requirement described below.  Based on the appraised value of the collateral pool, the Company’s ability to borrow was limited to $153,051 as of June 30, 2010.  The credit agreement had an original maturity date of October 14, 2010 which has been extended to October 14, 2011.  The credit agreement requires compliance with certain covenants, such as, among other things, a leverage ratio, fixed charge coverage, minimum net worth requirements, distribution limitations and investment restrictions, as well as limitations on the Company’s ability to incur recourse indebtedness.  The credit agreement also contains customary default provisions including the failure to timely pay debt service payable thereunder, the failure to comply with the Company’s financial and operating covenants, and the failure to pay when the consolidated indebtedness becomes due.  In the event the lenders under the credit agreement declare a default, as defined in the credit agreement, this could result in an acceleration of any outstanding borrowings on the line of credit.

The terms of the credit agreement stipulate, as of June 30, 2010:

·

monthly interest-only payments on the outstanding balance at the rate equal to LIBOR (3% floor) plus 3.50%;

·

quarterly fees ranging from 0.35% to 0.50%, per annum, on the average daily undrawn funds;

·

pay down of the line from net proceeds of asset sales;

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

·

an assignment of corporate cash flow in the event of default;

·

the requirement for a comprehensive collateral pool (secured by mortgage interests in each asset) subject to certain covenants, including a maximum advance rate on the appraised value of the collateral pool of 60%, minimum requirements related to the value of the collateral pool and the number of properties included in the collateral pool, and debt service coverage, and

·

permissions for non-recourse cross-default up to $250,000 and permissions for maturity defaults under non-recourse indebtedness for up to 90 days subject to extension at discretion of the lenders.

As of June 30, 2010, management believes the Company was in compliance with all of the financial covenants under the credit agreement.  The outstanding balance on the line of credit at June 30, 2010 and December 31, 2009 was $133,242 and $107,000, respectively.

(10)  Investment in Unconsolidated Joint Ventures

The following table summarizes the Company’s investments in unconsolidated joint ventures:

The Company has the ability to exercise significant influence, but does not have the financial or operating control over these investments, and as a result the Company accounts for these investments using the equity method of accounting.  Under the equity method of accounting, the net equity investment of the Company is reflected on the accompanying consolidated balance sheets and the accompanying consolidated statements of operations and other comprehensive (loss) income includes the Company’s share of net income or loss from the unconsolidated joint venture.  Distributions from these investments that are related to income from operations are included as operating activities and distributions that are related to capital transactions are included in investing activities in the Company’s consolidated statements of cash flows.

Effective April 27, 2007, the Company formed a strategic joint venture (MS Inland) with a large state pension fund (the “institutional investor”).  Under the terms of the agreement, the profits and losses of MS Inland are split 80% and 20% between the institutional investor and the Company, respectively, except for the interest earned on the initial invested funds, of which the Company is allocated 95%.  The Company’s share of profits in MS Inland was $384 and $394, for the three months ended June 30, 2010 and 2009, respectively.  The Company’s share of profits in MS Inland were $634 and $862, for the six months ended June 30, 2010 and 2009, respectively.  The Company received net cash distributions from MS Inland totaling $2,380 and $2,208, for the six months ended June 30, 2010 and 2009, respectively.

The difference between the Company’s investment in MS Inland and the amount of the underlying equity in net assets of MS Inland is due to basis differences resulting from the Company’s contribution of property assets at its historical net book value versus the fair value of the contributed properties.  Such differences are amortized over the depreciable lives of MS Inland’s property assets.  The Company recorded $81 and $85 of amortization related to this difference for the three months ended June 30, 2010 and 2009, respectively.  The Company recorded $162 and $165 of amortization related to this difference for the six months ended June 30, 2010 and 2009, respectively.  

MS Inland may acquire additional assets using leverage, consistent with its existing business plan, of approximately 50% of the original purchase price or current fair value, if higher.  The Company is the managing member of MS Inland and earns fees for providing property management, acquisition and leasing services to MS Inland.  The Company earned fees of $255 and $281 during the three months ended June, 2010 and 2009, respectively.  The Company earned fees of $604 and $644 during the six months ended June, 2010 and 2009, respectively.  

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

On August 28, 2007, the Company formed an unconsolidated joint venture, Hampton Retail Colorado (Hampton), which subsequently, through wholly-owned subsidiaries Hampton Owned Colorado (Hampton Owned) and Hampton Leased Colorado (Hampton Leased), acquired nine single-user retail properties and eight leasehold assets, respectively.  The ownership percentages associated with Hampton, at June 30, 2010 and December 31, 2009, are based upon the maximum capital contribution obligations under the terms of the joint venture.  The Company’s share of net income (loss) in Hampton was $270 and ($4,635) for the three months ended June 30, 2010 and 2009, respectively, and is included in “Equity in income (loss) of unconsolidated joint ventures” in the consolidated statements of operations and other comprehensive (loss) income.  The Company’s share of net loss in Hampton was $41 and $5,639 for the six months ended June 30, 2010 and 2009, respectively.  

During the three months ended June 30, 2010, Hampton Owned completed the sale of three single-user retail properties, aggregating 126,700 square feet for a combined sales price of $1,885. The aggregated sales resulted in the repayment of debt of $1,626, forgiveness of debt of $1,644, and total gains on sale of $210.

On May 20, 2010, the Company entered into definitive agreements to form a joint venture with RioCan Real Estate Investment Trust (RioCan), a Real Estate Investment Trust (REIT) based in Canada.  The initial RioCan investment includes eight grocery and necessity-based-anchored shopping centers located in Texas.  Under the terms of the agreements, RioCan will contribute cash for an 80% interest in the venture and the Company will retain a 20% interest.  Each property contribution will occur individually over time based on timing of lender consent or refinance of the related mortgages payable.  The Company will earn property management, asset management and other customary fees on the joint venture.  The Company believes this venture will be accounted for as an unconsolidated joint venture.

The Company’s investments in unconsolidated joint ventures are reviewed for potential impairment, in addition to impairment evaluations of the individual assets underlying these investments, whenever events or changes in circumstances warrant such an evaluation.  To determine whether impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until the carrying value is fully recovered.  As a result, the carrying value of its investment in the unconsolidated joint ventures was determined to be fully recoverable as of June 30, 2010 and December 31, 2009.

(11)  Earnings per Share

Basic earnings (loss) per share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period (the “common shares”).  Diluted EPS is computed by dividing net income (loss) by the common shares plus shares issuable upon exercising options.  As of June 30, 2010 and December 31, 2009, options to purchase 105 shares of common stock at the weighted average exercise price of $9.30 per share were outstanding.  The Company is in a net loss position for the six months ended June 30, 2010 and 2009; therefore, the options to purchase shares are not considered in loss per share-diluted since their effect is anti-dilutive.

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INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.

Notes to Consolidated Financial Statements

The following is reconciliation between weighted average shares used in the basic and diluted EPS calculations, excluding amounts attributable to noncontrolling interests: