ISTAR FINANCIAL INC - 10-Q Quarterly Report

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

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FORM 10-Q

(MARK ONE)

/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

OR

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

FOR THE TRANSITION PERIOD FROM ______________ TO ______________

COMMISSION FILE NO. 1-15371

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ISTAR FINANCIAL INC.
(Exact name of registrant as specified in its charter)

MARYLAND 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

1114 AVENUE OF THE AMERICAS, 27TH FLOOR 10036
NEW YORK, NY (Zip Code)
(Address of principal executive offices)

Registrant's telephone number, including area code: (212)930-9400

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Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: NONE

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

As of November 4, 2002, there were 89,993,704 shares of common stock of
iStar Financial Inc., $0.001 par value per share outstanding ("Common Stock").

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ISTAR FINANCIAL INC.
INDEX TO FORM 10-Q

2

PART I. CONSOLIDATED FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ISTAR FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

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* RECLASSIFIED TO CONFORM TO 2002 PRESENTATION.

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

3

ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

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* RECLASSIFIED TO CONFORM TO 2002 PRESENTATION.

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

4

ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)

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

5

ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

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* RECLASSIFIED TO CONFORM TO 2002 PRESENTATION.

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

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ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1--BUSINESS AND ORGANIZATION

BUSINESS--iStar Financial Inc. (the "Company") is the leading
publicly-traded finance company focused on the commercial real estate industry.
The Company provides structured financing to private and corporate owners of
real estate nationwide, including senior and junior mortgage debt, corporate
mezzanine and subordinated capital, and corporate net lease financing. The
Company, which is taxed as a real estate investment trust ("REIT"), seeks to
deliver superior risk-adjusted returns on equity to shareholders by providing
innovative and value-added financing solutions to its customers.

The Company's primary product lines include:

- STRUCTURED FINANCE. The Company provides senior and subordinated loans
that typically range in size from $20 million to $100 million to borrowers
holding high-quality real estate. These loans may be either fixed or
variable rate and are structured to meet the specific financing needs of
the borrowers, including the acquisition or financing of large,
high-quality real estate. The Company offers borrowers a wide range of
structured finance options, including first mortgages, second mortgages,
partnership loans, participating debt and interim facilities. The
Company's structured finance transactions have maturities generally
ranging from three to ten years. As of September 30, 2002, based on gross
carrying values, the Company's structured finance assets represented
25.08% of its assets.

- PORTFOLIO FINANCE. The Company provides funding to regional and national
borrowers who own multiple facilities in geographically diverse
portfolios. Loans are cross-collateralized to give the Company the benefit
of all available collateral and underwritten to recognize inherent
portfolio diversification. Property types include multifamily, suburban
office, hotels and other property types where individual property values
are less than $20 million on average. Loan terms are structured to meet
the specific requirements of the borrower and typically range in size from
$25 million to $150 million. The Company's portfolio finance transactions
have maturities generally ranging from three to ten years. As of
September 30, 2002, based on gross carrying values, the Company's
portfolio finance assets represented 6.33% of its assets.

- CORPORATE FINANCE. The Company provides senior and subordinated capital to
corporations engaged in real estate or real estate-related businesses.
Financings may be either secured or unsecured and typically range in size
from $20 million to $150 million. The Company's corporate finance
transactions have maturities generally ranging from five to ten years. As
of September 30, 2002, based on gross carrying values, the Company's
corporate finance assets represented 12.80% of its assets.

- LOAN ACQUISITION. The Company acquires whole loans and loan participations
which present attractive risk-reward opportunities. Loans are generally
acquired at a small discount to the principal balance outstanding. Loan
acquisitions typically range in size from $5 million to $100 million and
are collateralized by all major property types. The Company's loan
acquisition transactions have maturities generally ranging from three to
ten years. As of September 30, 2002, based on gross carrying values, the
Company's loan acquisition assets represented 9.62% of its assets.

- CORPORATE TENANT LEASING. The Company provides capital to corporations and
borrowers who control facilities leased to single creditworthy tenants.
The Company's net leased assets are generally mission-critical
headquarters or distribution facilities that are subject to long-term
leases with rated corporate credit tenants, and which provide for all
expenses at the property to

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ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1--BUSINESS AND ORGANIZATION (CONTINUED)
be paid by the corporate tenant on a triple net lease basis. Corporate
tenant lease transactions have terms generally ranging from ten to
20 years and typically range in size from $20 million to $150 million. As
of September 30, 2002, based on gross carrying values, the Company's
corporate tenant lease assets represented 41.57% of its assets.

- SERVICING. Through its iStar Asset Services division, the Company provides
rated loan servicing to third-party institutional loan portfolios, as well
as to the Company's own assets. The servicing business did not represent a
meaningful percentage of the gross carrying value of the Company's assets
as of September 30, 2002.

The Company's investment strategy targets specific sectors of the real
estate credit markets in which it believes it can deliver value-added, flexible
financial solutions to its customers, thereby differentiating its financial
products from those offered by other capital providers.

The Company has implemented its investment strategy by:

- Focusing on the origination of large, structured mortgage, corporate and
lease financings where customers require flexible financial solutions.

- Avoiding commodity businesses in which there is significant direct
competition from other providers of capital such as conduit lending and
investment in commercial or residential mortgage-backed securities.

- Developing direct relationships with borrowers and corporate customers as
opposed to sourcing transactions solely through intermediaries.

- Adding value beyond simply providing capital by offering borrowers and
corporate customers specific lending expertise, flexibility, certainty and
continuing relationships beyond the closing of a particular financing
transaction.

- Taking advantage of market anomalies in the real estate financing markets
when the Company believes credit is mispriced by other providers of
capital, such as the spread between lease yields and the yields on
corporate customers' underlying credit obligations.

ORGANIZATION--The Company began its business in 1993 through private
investment funds formed to capitalize on inefficiencies in the real estate
finance market. In March 1998, these funds contributed their approximately
$1.1 billion of assets to the Company's predecessor in exchange for a
controlling interest in that company. Since that time, the Company has grown by
originating new lending and leasing transactions, as well as through corporate
acquisitions.

Specifically, in September 1998, the Company acquired the loan origination
and servicing business of a major insurance company, and in December 1998, the
Company acquired the mortgage and mezzanine loan portfolio of its largest
private competitor. Additionally, in November 1999, the Company acquired TriNet
Corporate Realty Trust, Inc. ("TriNet" or the "Leasing Subsidiary"), then the
largest publicly-traded company specializing in corporate sale/leaseback
transactions for office and industrial facilities (the "TriNet Acquisition").
The TriNet Acquisition was structured as a stock-for-stock merger of TriNet with
a subsidiary of the Company.

Concurrent with the TriNet Acquisition, the Company also acquired its former
external advisor in exchange for shares of the Company's common stock ("Common
Stock") and converted its organizational form to a Maryland corporation. As part
of the conversion to a Maryland corporation,

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ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1--BUSINESS AND ORGANIZATION (CONTINUED)
the Company replaced its former dual class common share structure with a single
class of Common Stock. The Company's Common Stock began trading on the New York
Stock Exchange on November 4, 1999. Prior to this date, the Company's common
shares were traded on the American Stock Exchange.

NOTE 2--BASIS OF PRESENTATION

The accompanying unaudited Consolidated Financial Statements have been
prepared in conformity with the instructions to Form 10-Q and Article 10,
Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles ("GAAP") for complete financial statements. The
Consolidated Financial Statements include the accounts of the Company, its
qualified REIT subsidiaries, and its majority-owned and controlled partnerships.

In the opinion of management, the accompanying Consolidated Financial
Statements contain all adjustments, consisting of normal recurring adjustments,
necessary for a fair statement of the Company's consolidated financial position
at September 30, 2002 and December 31, 2001 and the results of its operations,
changes in shareholders' equity and its cash flows for the three- and nine-month
periods ended September 30, 2002 and 2001, respectively. Such operating results
are not necessarily indicative of the results that may be expected for any other
interim periods or the entire year.

NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

LOANS AND OTHER LENDING INVESTMENTS, NET--As described in Note 4, "Loans and
Other Lending Investments" includes the following investments: senior mortgages,
subordinate mortgages, corporate/ partnership loans, other lending
investments-loans and other lending investments-securities. Management considers
nearly all of its loan and other lending investments to be held-to-maturity,
although a small number of investments may be classified as available-for-sale.
Items classified as held-to-maturity are reflected at amortized historical cost,
while items classified as available-for-sale are reported at fair values.
Unrealized gains and losses on available-for-sale investments are included in
"Accumulated other comprehensive income" on the Company's Consolidated Balance
Sheets, and are not included in the Company's net income.

CORPORATE TENANT LEASE ASSETS AND DEPRECIATION--Corporate tenant lease
assets are generally recorded at cost less accumulated depreciation. Certain
improvements and replacements are capitalized when they extend the useful life,
increase capacity or improve the efficiency of the asset. Repairs and
maintenance items are expensed as incurred. Depreciation is computed using the
straight-line method of cost recovery over estimated useful lives of 40.0 years
for facilities, five years for furniture and equipment, the shorter of the
remaining lease term or expected life for tenant improvements and the remaining
life of the facility for facility improvements.

Corporate tenant lease assets to be disposed of are reported at the lower of
their carrying amount or fair value less costs to sell. The Company also
periodically reviews long-lived assets to be held and used for an impairment in
value whenever events or changes in circumstances indicate that the carrying
amount of such assets may not be recoverable. In management's opinion, corporate
tenant lease assets to be held and used are not carried at amounts in excess of
their estimated recoverable amounts.

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ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CAPITALIZED INTEREST--The Company capitalizes interest costs incurred during
the construction period on qualified build-to-suit projects for corporate
tenants, including investments in joint ventures accounted for under the equity
method. Interest capitalized was approximately $0 and $365,000 during the
three-month periods ended September 30, 2002 and 2001, respectively, and was
approximately $70,000 and $852,000 during the nine-month periods ended
September 30, 2002 and 2001, respectively.

CASH AND CASH EQUIVALENTS--Cash and cash equivalents include cash held in
banks or invested in money market funds with original maturity terms of less
than 90 days.

RESTRICTED CASH--Restricted cash represents amounts required to be
maintained in escrow under certain of the Company's debt obligations and leasing
transactions.

REVENUE RECOGNITION--The Company's revenue recognition policies are as
follows:

LOANS AND OTHER LENDING INVESTMENTS: Management considers nearly all of its
loans and other lending investments to be held-to-maturity, although a small
number of investments may be classified as available-for-sale. The Company
reflects held-to-maturity investments at amortized cost less allowance for loan
losses, acquisition premiums or discounts, deferred loan fees and undisbursed
loan funds. Unrealized gains and losses on available-for-sale investments are
included in "Accumulated other comprehensive income" on the Company's
Consolidated Balance Sheets and are not included in the Company's net income. On
occasion, the Company may acquire loans at small premiums or discounts based on
the credit characteristics of such loans. These premiums or discounts are
recognized as yield adjustments over the lives of the related loans. If loans
that were acquired at a premium or discount are prepaid, the Company immediately
recognizes the unamortized premium or discount as a decrease or increase in the
prepayment gain or loss, respectively. Loan origination or exit fees, as well as
direct loan origination costs, are also deferred and recognized over the lives
of the related loans as a yield adjustment. Interest income is recognized using
the effective interest method applied on a loan-by-loan basis.

A small number of the Company's loans provide for accrual of interest at
specified rates which differ from current payment terms. Interest is recognized
on such loans at the accrual rate subject to management's determination that
accrued interest and outstanding principal are ultimately collectible, based on
the underlying collateral and operations of the borrower.

Prepayment penalties or yield maintenance payments from borrowers are
recognized as additional income when received. Certain of the Company's loan
investments provide for additional interest based on the borrower's operating
cash flow or appreciation of the underlying collateral. Such amounts are
considered contingent interest and are reflected as income only upon certainty
of collection.

LEASING INVESTMENTS: Operating lease revenue is recognized on the
straight-line method of accounting from the later of the date of the origination
of the lease or the date of acquisition of the facility subject to existing
leases. Accordingly, contractual lease payment increases are recognized evenly
over the term of the lease. The cumulative difference between lease revenue
recognized under this method and contractual lease payment terms is recorded as
"Deferred operating lease income receivable" on the Company's Consolidated
Balance Sheets.

PROVISION FOR LOAN LOSSES--The Company's accounting policies require that an
allowance for estimated loan losses be maintained at a level that management,
based upon an evaluation of known and inherent risks in the portfolio, considers
adequate to provide for loan losses. In establishing loan

10

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
loss provisions, management periodically evaluates and analyzes the Company's
assets, historical and industry loss experience, economic conditions and trends,
collateral values and quality, and other relevant factors. Specific valuation
allowances are established for impaired loans in the amount by which the
carrying value, before allowance for estimated losses, exceeds the fair value of
collateral less disposition costs on an individual loan basis. Management
considers a loan to be impaired when, based upon current information and events,
it believes that it is probable that the Company will be unable to collect all
amounts due according to the contractual terms of the loan agreement on a timely
basis. Management measures these impaired loans at the fair value of the loans'
underlying collateral less estimated disposition costs. Impaired loans may be
left on accrual status during the period the Company is pursuing repayment of
the loan; however, these loans are placed on non-accrual status at such time as:
(1) management believes that the potential risk exists that scheduled debt
service payments will not be met within the coming 12 months; (2) the loans
become 90 days delinquent; (3) management determines the borrower is incapable
of, or has ceased efforts toward, curing the cause of the impairment; or
(4) the net realizable value of the loan's underlying collateral approximates
the Company's carrying value of such loan. While on non-accrual status, interest
income is recognized only upon actual receipt. Impairment losses are recognized
as direct write-downs of the related loan with a corresponding charge to the
provision for loan losses. Charge-offs occur when loans, or a portion thereof,
are considered uncollectible and of such little value that further pursuit of
collection is not warranted. Management also provides a loan portfolio reserve
based upon its periodic evaluation and analysis of the portfolio, historical and
industry loss experience, economic conditions and trends, collateral values and
quality, and other relevant factors.

The Company's loans are generally secured by real estate assets or are
corporate lending arrangements to entities with significant rental real estate
operations (e.g., an unsecured loan to a company which operates residential
apartments or retail, industrial or office facilities as rental real estate).
While the underlying real estate assets for the corporate lending instruments
may not serve as collateral for the Company's investments in all cases, the
Company evaluates the underlying real estate assets when estimating loan loss
exposure because the Company's loans generally have preclusions as to how much
senior and/or secured debt the customer may borrow ahead of the Company's
position.

INCOME TAXES--The Company is subject to federal income taxation at corporate
rates on its "REIT taxable income"; however, the Company is allowed a deduction
for the amount of dividends paid to its shareholders, thereby subjecting the
distributed net income of the Company to taxation at the shareholder level only.
In addition, the Company is allowed several other deductions in computing its
"REIT taxable income," including non-cash items such as depreciation expense.
These deductions allow the Company to shelter a portion of its operating cash
flow from its dividend payout requirement under federal tax laws. The Company
intends to operate in a manner consistent with and to elect to be treated as a
REIT for tax purposes. iStar Operating Inc. ("iStar Operating") and TriNet
Management Operating Company, Inc. ("TMOC"), the Company's taxable subsidiaries,
are not consolidated for federal income tax purposes and are taxed as
corporations. For financial reporting purposes, current and deferred taxes are
provided for in the portion of earnings recognized by the Company with respect
to its interest in iStar Operating and TMOC. Accordingly, except for the
Company's taxable subsidiaries, no current or deferred taxes are provided for in
the Consolidated Financial Statements. See Note 6 for a detailed discussion on
the ownership structure and operations of iStar Operating and TMOC.

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ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS (LOSS) PER COMMON SHARE--In accordance with the Statement of
Financial Accounting Standards No. 128 ("SFAS No. 128"), the Company presents
both basic and diluted earnings per share ("EPS"). Basic earnings per share
("Basic EPS") excludes dilution and is computed by dividing net income available
to common shareholders by the weighted average number of shares outstanding for
the period. Diluted earnings per share ("Diluted EPS") reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock, where such exercise or conversion
would result in a lower earnings per share amount.

RECLASSIFICATIONS--Certain prior year amounts have been reclassified in the
Consolidated Financial Statements and the related notes to conform to the 2002
presentation.

USE OF ESTIMATES--The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual results
could differ from those estimates.

CHANGE IN ACCOUNTING PRINCIPLE--In June 1998, the FASB issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 establishes
accounting and reporting standards for derivative financial instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as: (1) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment; (2) a hedge of the exposure to variable cash flows of a forecasted
transaction; or (3) in certain circumstances, a hedge of a foreign currency
exposure. On January 1, 2001, the Company adopted this pronouncement, as amended
by Statement of Financial Accounting Standards No. 137 "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133" and Statement of Financial Accounting Standards No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging
Activities--an Amendment of FASB Statement No. 133." Because the Company has
primarily used derivatives as cash flow hedges of interest rate risk only, the
adoption of SFAS No. 133 did not have a material financial impact on the
financial position and results of operations of the Company. However, should the
Company change its current use of such derivatives, the adoption of SFAS
No. 133 could have a more significant effect on the Company prospectively.

Upon adoption, the Company recognized a charge to net income of
approximately $282,000 and an additional charge of $9.4 million to other
comprehensive income, representing the cumulative effect of the change in
accounting principle.

OTHER NEW ACCOUNTING STANDARDS--In September 2000, the FASB issued Statement
of Financial Accounting Standards No. 140 ("SFAS No. 140"), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This statement is applicable for transfers of assets and extinguishments of
liabilities occurring after June 30, 2001. The Company adopted the provisions of
this statement as required for all transactions entered into on or after
April 1, 2001. The adoption of SFAS No. 140 did not have a significant impact on
the Company.

In July 2001, the SEC released Staff Accounting Bulletin No. 102 ("SAB
102"), "Selected Loan Loss Allowance and Documentation Issues." SAB 102
summarizes certain of the SEC's views on the

12

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
development, documentation and application of a systematic methodology for
determining allowances for loan and lease losses. Adoption of SAB 102 by the
Company did not have a significant impact on the Company.

In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 ("SFAS No. 141"), "Business Combinations" and Statement of Financial
Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible
Assets." SFAS No. 141 requires the purchase method of accounting to be used for
all business combinations initiated after June 30, 2001. SFAS No. 141 also
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in business combinations and requires intangible
assets to be recognized apart from goodwill if certain tests are met. SFAS
No. 142 requires that goodwill not be amortized but instead be measured for
impairment at least annually, or when events indicate that there may be an
impairment. The Company adopted the provisions of both statements on January 1,
2002, as required, and the adoption did not have a significant impact on the
Company.

In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144 provides new guidance on the recognition of
impairment losses on long-lived assets to be held and used or to be disposed of,
and also broadens the definition of what constitutes a discontinued operation
and how the results of a discontinued operation are to be measured and
presented. SFAS No. 144 requires that current operations prior to the
disposition of corporate tenant lease assets and prior period results of such
operations be presented in discontinued operations in the Company's Consolidated
Statements of Operations. The provisions of SFAS No. 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and must be applied at the beginning of a fiscal year. The Company adopted the
provisions of this statement on January 1, 2002, as required, and it did not
have a significant financial impact on the Company.

In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145
rescinds both FASB Statements No. 4 ("SFAS No. 4"), "Reporting Gains and Losses
from Extinguishment of Debt," and the amendment to SFAS No. 4, FASB Statement
No. 64 ("SFAS No. 64"), "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." Through this rescission, SFAS No. 145 eliminates the requirement
(in both SFAS No. 4 and SFAS No. 64) that gains and losses from the
extinguishment of debt be aggregated and, if material, classified as an
extraordinary item, net of the related income tax effect. An entity is not
prohibited from classifying such gains and losses as extraordinary items, so
long as they meet the criteria in paragraph 20 of Accounting Principles Board
Opinion No. 30 ("APB 30"), "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions"; however, due to the nature of
the Company's operations, such treatment may not be available to the Company.
Any gains or losses on extinguishments of debt that were previously classified
as extraordinary items in prior periods presented that do not meet the criteria
in APB 30 for classification as an extraordinary item will be reclassified to
income from continuing operations. The provisions of SFAS No. 145 are effective
for financial statements issued for fiscal years beginning after May 15, 2002.
The Company will adopt the provisions of this statement, as required, on
January 1, 2003.

13

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 ("SFAS No. 146"), "Accounting for Exit or Disposal Activities," to
address significant issues regarding the recognition, measurement, and reporting
of costs that are associated with exit and disposal activities, including
restructuring activities that are currently accounted for pursuant to the
guidance that the Emerging Issues Task Force ("EITF") has set forth in EITF
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The scope of SFAS No. 146 also includes: (1) costs related to
terminating a contract that is not a capital lease; and (2) termination benefits
that employees who are involuntarily terminated receive under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an
individual deferred-compensation contract. The provisions of SFAS No. 146 are
effective for exit or disposal activities that are initiated after December 31,
2002. The Company does not expect SFAS No. 146 to have a material effect on the
Company's Consolidated Financial Statements.

In September 2002, the FASB issued Statement of Financial Accounting
Standards No. 147 ("SFAS No. 147"), "Acquisitions of Certain Financial
Institutions," an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9. SFAS No. 147 provides guidance on the accounting for the
acquisitions of financial institutions, except those acquisitions between two or
more mutual enterprises. SFAS No. 147 removes acquisitions of financial
institutions from the scope of both FASB No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," and FASB Interpretation No. 9,
Applying APB Opinions No. 16 and 17, "When a Savings and Loan Association or a
Similar Institution Is Acquired in a Business Combination Accounted for by the
Purchase Method," and requires that those transactions be accounted for in
accordance with SFAS No. 141 and SFAS No. 142. SFAS No. 147 also amends SFAS
No. 144, to include in its scope long-term, customer-relationship intangible
assets of financial institutions such as depositor-relationship and
borrower-relationship intangible assets and credit cardholder intangible assets.
The Company will adopt the provisions of this statement, as required, on
October 1, 2002. The Company does not expect SFAS No. 147 to have a material
effect on the Company's Consolidated Financial Statements.

14

ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4--LOANS AND OTHER LENDING INVESTMENTS

The following is a summary description of the Company's loans and other
lending investments (in thousands)(1):

EXPLANATORY NOTES:
- ----------------------------------
(1) Amounts and details are for loans outstanding as of September 30, 2002.

(2) Substantially all variable-rate loans are based on 30-day LIBOR and reprice
monthly. The 30-day LIBOR on September 30, 2002 was 1.81%.

(3) Includes a senior interest in a private REMIC whose sole asset is a single
first mortgage loan.

(4) The loans require fixed payments of principal and interest resulting in
partial principal amortization over the term of the loan with the remaining
principal due at maturity.

(5) Includes a participation interest in a second mortgage and a subordinate
interest in a private REMIC whose sole asset is a single first mortgage
loan.

(6) Under some of these loans, the lender receives additional payments
representing additional interest from participation in available cash flow
from operations of the property.

(7) Includes one unsecured loan with a carrying value of approximately $313 as
of September 30, 2002 and approximately $403 as of December 31, 2001.

(8) Generally consists of term preferred stock or debt interests that are
specifically originated or structured to meet customer financing
requirements and the Company's investment criteria. These investments do not
typically consist of securities purchased in the open market or as part of
broadly-distributed offerings.

15

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4--LOANS AND OTHER LENDING INVESTMENTS (CONTINUED)

During the nine-month periods ended September 30, 2002 and 2001,
respectively, the Company originated or acquired an aggregate of approximately
$1,097.8 million and $663.1 million in loans and other lending investments,
funded $18.0 million and $45.2 million under existing loan commitments, and
received principal repayments of $499.5 million and $567.2 million.

As of September 30, 2002, the Company had nine loans with unfunded
commitments. The total unfunded commitment amount was approximately
$63.8 million, of which $32.9 million was discretionary and $30.8 million was
non-discretionary.

The Company's loans and other lending investments are predominantly pledged
as collateral under either the iStar Asset Receivables secured notes, the
secured revolving facilities or secured term loans (see Note 7).

The Company has reflected provisions for loan losses of approximately
$2.0 million and $1.8 million in its results of operations during the
three-month periods ended September 30, 2002 and 2001, respectively, and
$5.8 million and $5.3 million during the nine-month periods ended September 30,
2002 and 2001, respectively. These provisions represent loan portfolio reserves
based on management's evaluation of general market conditions, the Company's
internal risk management policies and credit risk ratings system, industry loss
experience, the likelihood of delinquencies or defaults, and the credit quality
of the underlying collateral. No direct impairment reserves on specific loans
were considered necessary.

NOTE 5--CORPORATE TENANT LEASE ASSETS

During the nine-month periods ended September 30, 2002 and 2001,
respectively, the Company acquired an aggregate of approximately $276.8 million
and $38.4 million in corporate tenant lease assets and disposed of approximately
$3.7 million and $20.3 million in in corporate tenant lease assets.

The Company's investments in corporate tenant lease assets, at cost, were as
follows (in thousands):

Under certain leases, the Company receives additional participating lease
payments to the extent gross revenues of the corporate tenant exceed a base
amount. The Company earned no such additional participating lease payments in
the three- or nine-month periods ended September 30, 2002 and 2001. In addition,
the Company also receives reimbursements from customers for certain facility
operating expenses including common area costs, insurance and real estate taxes.
Customer expense reimbursements for the three months ended September 30, 2002
and 2001 were approximately $7.5 million and $5.8 million, respectively, and
$22.2 million and $18.4 million for the nine months ended September 30, 2002 and
2001, respectively, and are included as a reduction of "Operating
costs--corporate tenant lease assets" on the Company's Consolidated Statements
of Operations.

The Company is subject to expansion option agreements with two existing
customers which could require the Company to fund and to construct up to 161,000
square feet of additional adjacent space

16

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 5--CORPORATE TENANT LEASE ASSETS (CONTINUED)
on which the Company would receive additional operating lease income under the
terms of the option agreements. In addition, upon exercise of such expansion
option agreements, the corporate tenants would be required to simultaneously
extend their existing lease terms for additional periods ranging from six to ten
years.

On September 30, 2002, one of the Company's customers exercised an option to
terminate its lease on 50% of the land leased from the Company. In connection
with this termination, the Company realized $17.5 million in cash lease
termination payments, offset by a $17.4 million impairment charge in connection
with the termination, resulting in a net gain of approximately $123,000. As of
September 30, 2002, the terminated parcel is classified as held for sale on the
Company's Consolidated Balance Sheets. On May 30, 2002, the Company sold one
corporate tenant lease asset for net proceeds of $3.7 million, and a realized
gain of approximately $595,000. The results of operations from corporate tenant
lease assets sold or held for sale in the current period are classified as
discontinued operations even though such income was actually received by the
Company prior to the asset sale. Gains on sale from corporate tenant lease
assets are also classified as discontinued operations.

NOTE 6--JOINT VENTURES AND UNCONSOLIDATED SUBSIDIARIES

The Company's ownership percentages, its investments in and advances to
unconsolidated joint ventures and subsidiaries, its respective income and the
Company's pro rata share of its ventures' third-party, non-recourse debt as of
September 30, 2002 are presented below (in thousands):

EXPLANATORY NOTES:
- ------------------------------

(1) The Company reflects its pro rata share of third-party, non-recourse debt,
rather than the total amount of the joint venture debt, because the
third-party, non-recourse debt held by the joint ventures is not guaranteed
by the Company nor does the Company have any additional commitment to fund
the debt.

(2) Maturity date reflects a one-year extension at the venture's option.

17

ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 6--JOINT VENTURES AND UNCONSOLIDATED SUBSIDIARIES (CONTINUED)

INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED JOINT VENTURES: At
September 30, 2002, the Company had investments in three joint ventures:
(1) TriNet Sunnyvale Partners L.P. ("Sunnyvale"), whose external partners are
John D. O'Donnell, Trustee, John W. Hopkins, and Donald S. Grant, Trustee;
(2) Corporate Technology Centre Associates, LLC ("CTC I"), whose external member
is Corporate Technology Centre Partners, LLC; and (3) ACRE Simon, LLC ("ACRE"),
whose external partner is William E. Simon & Sons Realty Investments, LLC. These
ventures were formed for the purpose of operating, acquiring and, in certain
cases, developing corporate tenant lease facilities.

At September 30, 2002, the ventures comprised 12 net leased facilities. The
Company's combined investment in these joint ventures at September 30, 2002 was
$29.2 million. The joint ventures' carrying value for the 12 facilities owned at
September 30, 2002 was $197.6 million. In aggregate, the joint ventures had
total assets of $234.8 million and total liabilities of $185.8 million as of
September 30, 2002, and net income of $1.8 million and $5.3 million for the
three and nine months ended September 30, 2002. The Company accounts for these
investments under the equity method because the Company's joint venture partners
have certain participating rights giving them shared control over the ventures.

Effective September 29, 2000, iStar Sunnyvale Partners, LP entered into an
interest rate cap agreement limiting the venture's exposure to interest rate
movements on its $24.0 million LIBOR-based mortgage loan to an interest rate of
9.00% through November 9, 2003. Currently, the limited partners of Sunnyvale
have the option to convert their partnership interest into cash; however, the
Company may elect to deliver 297,728 shares of Common Stock in lieu of cash.

On April 1, 2002, the former Sierra Land Ventures ("Sierra") joint venture
partner assigned its 50.00% ownership interest in Sierra to a wholly owned
subsidiary of the Company. There was no cash or shares exchanged in this
transaction. As of April 1, 2002, the Company owns 100.00% of the corporate
tenant lease asset previously held by Sierra and therefore consolidates this
asset for accounting purposes.

On July 2, 2002, the Company paid approximately $30.5 million in cash to the
former member of TriNet Milpitas Associates ("Milpitas") joint venture in
exchange for its 50.00% ownership interest. Pursuant to the terms of the joint
venture agreement, the former external member had the right to convert its
interest into 984,476 shares of Common Stock of the Company at any time during
the period February 1, 2002 through January 31, 2003. On May 2, 2002, the former
Milpitas external member exercised this right. Upon the external member's
exercise of its conversion right, the Company had the option to acquire the
partner's interest for cash, instead of shares, for a payment equal to the value
of 984,476 shares of Common Stock multiplied by the ten-day average closing
stock price as of the transaction date. The Company made such election and, as
of July 2, 2002, owns 100.00% of Milpitas, and therefore consolidates these
assets for accounting purposes. The Company accounted for the acquisition of the
external interest using the purchase method.

Income generated from the Company's joint venture investments and
unconsolidated subsidiaries is included in "Equity in earnings from joint
ventures and unconsolidated subsidiaries" on the Company's Consolidated
Statements of Operations.

18

ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 6--JOINT VENTURES AND UNCONSOLIDATED SUBSIDIARIES (CONTINUED)

INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED SUBSIDIARIES: The Company has
an investment in iStar Operating, a taxable subsidiary that, through a
wholly-owned subsidiary, services the Company's loans and certain loan
portfolios owned by third parties. The Company owns all of the non-voting
preferred stock and a 95.00% economic interest in iStar Operating. An affiliate
of the Company's largest shareholder is the owner of all the voting common stock
and a 5.00% economic interest in iStar Operating. As of September 30, 2002,
there have never been any distributions to the common shareholder, nor does the
Company expect to make any in the future. At any time, the Company has the right
to acquire all of the common stock of iStar Operating at fair market value,
which the Company believes to be nominal. In addition to the direct general and
administrative costs of iStar Operating, the Company allocates a portion of its
general overhead expenses to iStar Operating based on the number of employees at
iStar Operating as a percentage of the Company's total employees.

In addition, the Company has an investment in TMOC, a taxable noncontrolled
subsidiary that has a $2.0 million investment in a real estate company based in
Mexico. The Company owns 95.00% of the outstanding voting and non-voting common
stock (representing 1.00% voting power and 95.00% of the economic interest) in
TMOC. The other two owners of TMOC stock are executives of the Company, who own
a combined 5.00% of the outstanding voting and non-voting common stock
(representing 99.00% voting power and 5.00% economic interest) in TMOC. As of
September 30, 2002, there have never been any distributions to the common
shareholders, nor does the Company expect to make any in the future. At any
time, the Company has the right to acquire all of the common stock of TMOC at
fair market value, which the Company believes to be nominal.

Both iStar Operating and TMOC were formed as taxable corporations for
purposes of maintaining compliance with the REIT provisions of the Code and are
accounted for under the equity method for financial statement reporting purposes
and are presented in "Investments in joint ventures and unconsolidated
subsidiaries" on the Company's Consolidated Balance Sheets. If they were
consolidated with the Company for financial statement purposes, they would not
have a material impact on the Company's operations. As of September 30, 2002,
iStar Operating and TMOC have no debt obligations.

19

ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--DEBT OBLIGATIONS

As of September 30, 2002 and December 31, 2001, the Company has debt
obligations under various arrangements with financial institutions as follows
(in thousands):

20

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--DEBT OBLIGATIONS (CONTINUED)

EXPLANATORY NOTES:
- ------------------------------

(1) Substantially all variable-rate debt obligations are based on 30-day LIBOR
and reprice monthly. The 30-day LIBOR on September 30, 2002 was 1.81%.

(2) Maturity date reflects a one-year "term-out" extension at the Company's
option.

(3) On September 30, 2002, the Company closed a $500.0 million secured revolving
credit facility with a leading financial institution. The facility has a
final maturity date of September 2005 and bears interest at LIBOR + 1.50% to
2.25%.

(4) Maturity date reflects a one-year extension at the Company's option.

(5) Maturity date reflects two one-year extensions at the Company's option.

(6) Principal payments on these bonds are a function of the principal repayments
on loan or corporate tenant lease assets which collateralize these
obligations. The dates indicated above represent the expected date on which
the final payment would occur for such class based on the assumptions that
the loans which collateralize the obligations are not voluntarily prepaid,
the loans are paid on their effective maturity dates and no extensions of
the effective maturity dates of any of the loans are granted. The final
maturity date for the underlying indenture on class A1 is May 28, 2017 and
the final maturity date for classes A2, B, C, D, E, F, G, H, J and K is
May 28, 2020.

(7) The notes are callable by the Company at any time for an amount equal to the
total of principal outstanding, accrued interest and the applicable
make-whole prepayment premium.

(8) Subject to mandatory tender on March 1, 2003, to either the dealer or the
Company. The initial coupon of 6.75% applies to the first five-year term
through the mandatory tender date. If tendered to the dealer, the notes must
be remarketed. The rates reset to then-prevailing market rates upon
remarketing.

(9) These obligations were assumed as part of the acquisition of TriNet. As part
of the accounting for the purchase, these fixed-rate obligations were
considered to have stated interest rates which were below the
then-prevailing market rates at which the Leasing Subsidiary could issue new
debt obligations and, accordingly, the Company ascribed a market discount to
each obligation. Such discounts are amortized as an adjustment to interest
expense using the effective interest method over the related term of the
obligations. As adjusted, the effective annual interest rates on these
obligations were 8.81%, 9.51% and 9.04% for the 6.75% Dealer Remarketable
Securities, 7.70% Notes and 7.95% Notes, respectively.

Availability of amounts under the secured revolving credit facilities are
based on percentage borrowing base calculations. In addition, certain of the
Company's debt obligations contain covenants. These covenants are both financial
and non-financial in nature. Significant financial covenants include limitations
on the Company's ability to incur indebtedness beyond specified levels,
restrictions on the Company's ability to incur liens on assets and limitations
on the amount and type of restricted payments, such as repurchases of its own
equity securities, that the Company makes. Significant non-financial covenants
include a requirement in its publicly-held debt securities that the Company
offer to repurchase those securities at a premium if the Company undergoes a
change of control. As of September 30, 2002, the Company believes it is in
compliance with both financial and non-financial covenants on its debt
obligations.

On May 17, 2000, the Company closed the inaugural offering under its
proprietary matched funding program, STARs, Series 2000-1. In the initial
transaction, a wholly-owned subsidiary of the Company issued $896.5 million of
investment-grade bonds secured by the subsidiary's assets, which had an
aggregate outstanding principal balance of approximately $1.2 billion at
inception. Principal payments received on the assets were utilized to repay the
most senior class of the bonds then outstanding. The maturity of the bonds match
funded the maturity of the underlying assets financed under the program. Of the
assets of the subsidiary secured by this financing, 73.96% (by gross carrying
value) consisted of first mortgages and subsequent lien positions and the
remaining 26.04% consisted of junior loans. For accounting purposes, this
transaction was treated as a secured financing: the underlying assets and STARs
liabilities remained on the Company's Consolidated Balance Sheets and no gain on
sale was recognized. On May 28, 2002, the Company fully repaid these bonds.

21

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--DEBT OBLIGATIONS (CONTINUED)
On January 11, 2001, the Company closed a new $700.0 million secured
revolving credit facility which is led by a major commercial bank. The new
facility has a three-year primary term and one-year "term-out" extension option,
and bears interest at LIBOR + 1.40% to 2.15%, depending upon the collateral
contributed to the borrowing base. The new facility accepts a broad range of
structured finance assets and has a final maturity of January 2005.

On February 22, 2001, the Company extended the maturity of its
$350.0 million unsecured revolving credit facility to May 2002. On July 27,
2001, the Company repaid this facility and replaced it with a new
$300.0 million unsecured revolving credit facility.

On May 15, 2001, the Company repaid its $100.0 million 7.30% unsecured
notes. These notes were senior unsecured obligations of the Leasing Subsidiary
and ranked equally with the Leasing Subsidiary's other senior unsecured and
unsubordinated indebtedness.

On June 14, 2001, the Company closed $193.0 million of term loan financing
secured by 15 corporate tenant lease assets. The variable-rate loan bears
interest at LIBOR + 1.85% (not to exceed 10.00% in aggregate) and has two
one-year extensions at the Company's option. The Company used these proceeds to
repay a $77.8 million secured term loan maturing in June 2001 and to pay down a
portion of its revolving credit facilities. In addition, the Company extended
the maturity of its $500.0 million secured revolving credit facility to August
2003. On March 29, 2002, the Company again extended the final maturity of this
facility to August 2005, which includes a one-year "term-out" extension at the
Company's option.

On July 6, 2001, the Company financed a $75.0 million structured finance
asset with a $50.0 million term loan bearing interest at LIBOR + 2.50%. The loan
has a maturity of July 2006, including a one-year extension at the Company's
option. This investment is a $75.0 million term preferred investment in a
publicly-traded real estate customer. The Company's investment carries an
initial current yield of 10.50%, with annual increases of 0.50% in each of the
next two years. In addition, the Company's investment is convertible into the
customer's common stock at a strike price of $25.00 per share. The investment is
callable by the customer between months 13 and 30 of the term at a yield
maintenance premium, and after month 30, at a premium sufficient to generate a
14.62% internal rate of return on the Company's investment. The investment is
putable by the Company to the customer for cash after five years.

On July 27, 2001, the Company completed a $300.0 million unsecured revolving
credit facility with a group of leading financial institutions. The new facility
has an initial maturity of July 2003, with a one-year extension at the Company's
option and another one-year extension at the lenders' option. The new facility
replaces two prior credit facilities maturing in 2002 and 2003, and bears
interest at LIBOR + 2.125%.

On August 9, 2001, the Company issued $350.0 million of 8.75% senior notes
due in 2008. The notes are unsecured senior obligations of the Company. The
Company used the net proceeds to repay outstanding borrowings under its secured
credit facilities.

On March 29, 2002, the Company extended the maturity of its $500.0 million
secured facility to August 2005, which includes a one-year "term-out" extension
at the Company's option.

On May 28, 2002, the Company fully repaid the then remaining $446.2 million
of bonds outstanding under its STARs, Series 2000-1 financing. Simultaneously, a
wholly-owned subsidiary of the Company issued STARs, Series 2002-1, consisting
of $885.1 million of investment-grade bonds secured

22

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 7--DEBT OBLIGATIONS (CONTINUED)
by the subsidiary's structured finance and corporate tenant lease assets, which
had an aggregate outstanding principal balance of approximately $1.1 billion at
inception. Principal payments received on the assets will be utilized to repay
the most senior class of the bonds then outstanding. The maturity of the bonds
match funds the maturity of the underlying assets financed under the program.
The weighted average interest rate on the bonds, on an all-floating rate basis,
was approximately LIBOR + 0.56% at inception. For accounting purposes, this
transaction was treated as a secured financing: the underlying assets and STARs
liabilities remained on the Company's Consolidated Balance Sheets, and no gain
on sale was recognized.

On July 2, 2002, the Company purchased the remaining interest in the
Milpitas joint venture from the former Milpitas external member. Upon purchase
of the interest, the Milpitas joint venture became fully consolidated for
accounting purposes and approximately $79.2 million of secured term debt was
transferred to the Company's Consolidated Balance Sheets.

On September 30, 2002, the Company closed a new $500.0 million secured
revolving credit facility with a leading financial institution. The new facility
has a three-year term and bears interest at LIBOR + 1.50% to 2.25%, depending
upon the collateral contributed to the borrowing base. The new facility accepts
a broad range of structured finance and corporate tenant assets and has a final
maturity date of September 2005.

As of September 30, 2002, future expected/scheduled maturities of
outstanding long-term debt obligations are as follows (in thousands)(1):

2002 (remaining three months)............................... $ 16,282
2003........................................................ --
2004........................................................ 302,589
2005........................................................ 1,341,158
2006........................................................ 293,000
Thereafter.................................................. 1,451,949
----------
Total principal maturities.................................. 3,404,978
Net unamortized debt discounts.............................. (17,418)
----------
Total debt obligations...................................... $3,387,560
==========

EXPLANATORY NOTE:
- ------------------------

(1) Assumes exercise of extensions to the extent such extensions are at the
Company's option.

NOTE 8--SHAREHOLDERS' EQUITY

The Company's charter provides for the issuance of up to 200.0 million
shares of Common Stock, par value $0.001 per share, and 30.0 million shares of
preferred stock. The Company has 4.4 million shares of 9.50% Series A Cumulative
Redeemable Preferred Stock, 2.3 million shares of 9.375% Series B Cumulative
Redeemable Preferred Stock, 1.5 million shares of 9.20% Series C Cumulative
Redeemable Preferred Stock, and 4.6 million shares of 8.00% Series D Cumulative
Redeemable Preferred Stock. The Series A, B, C and D Cumulative Redeemable
Preferred Stock are redeemable without premium at the option of the Company at
their respective liquidation preferences beginning on December 15, 2003,
June 15, 2001, August 15, 2001 and October 8, 2002, respectively.

On December 15, 1998, the Company issued warrants to acquire 6.1 million
shares of Common Stock, as adjusted for dilution, at $34.35 per share. The
warrants are exercisable on or after December 15, 1999 at a price of $34.35 per
share and expire on December 15, 2005.

23

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 8--SHAREHOLDERS' EQUITY (CONTINUED)

CONCENTRATION OF SHAREHOLDER OWNERSHIP--On October 30, 2001, SOF IV SMT
Holdings, L.P. ("SOF IV") and certain of its affiliates sold 18.975 million
shares of Common Stock (including the subsequently exercised 2.475 million share
over-allotment option granted to the underwriters) owned by them. In addition,
on May 15, 2002, SOF IV sold 10.808 million shares of Common Stock (including
the subsequently exercised 808,200 share over-allotment option granted to the
underwriters) owned by them. The Company did not sell any shares in these
offerings. As a result of the secondary offerings, SOF IV currently owns
approximately 25.47% of the Company's Common Stock (based on the diluted
sharecount as of September 30, 2002).

STOCK REPURCHASE PROGRAM--The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets or loan
repayments and excess cash flow from operations, but also using borrowings under
its credit facilities if the Company determines that it is advantageous to do
so. The only repurchase the Company has made under this program since
November 2000, has been 250,000 shares during the three months ended
September 30, 2002. As of September 30, 2002 and December 31, 2001, the Company
had repurchased approximately 2.6 million shares and 2.3 million shares,
respectively, at an aggregate cost of approximately $48.0 million and
$40.7 million, respectively.

DRIP PROGRAM--The Company maintains a dividend reinvestment and direct stock
purchase plan. Under the dividend reinvestment component of the plan, the
Company's shareholders may purchase additional shares of Common Stock without
payment of brokerage commissions or service charges by automatically reinvesting
all or a portion of their Common Stock cash dividends. Under the direct stock
purchase component of the plan, the Company's shareholders and new investors may
purchase shares of Common Stock directly from the Company without payment of
brokerage commissions or service charges. All purchases of shares in excess of
$10,000 per month pursuant to the direct purchase component are at the Company's
sole discretion. Shares issued under the plan may reflect a discount of up to
3.00% from the prevailing market price of the Company's Common Stock. The
Company is authorized to issue up to 8.0 million shares of Common Stock pursuant
to the dividend reinvestment and direct stock purchase plan. During the
three-month periods ended September 30, 2002 and 2001, the Company issued a
total of 369,609 and 11,239 shares of its Common Stock, respectively, and during
the nine-month periods ended September 30, 2002 and 2001, the Company issued a
total of 1,597,429 and 24,008 shares of its Common Stock, respectively, through
the direct stock purchase component of the plan. Net proceeds during the
three-month periods ended September 30, 2002 and 2001 were approximately
$10.4 million and $297,088, respectively, and $43.9 million and $624,149 during
the nine-month periods ended September 30, 2002 and 2001, respectively.

NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS

RISK MANAGEMENT--In the normal course of its on-going business operations,
the Company encounters economic risk. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest-earning assets. Credit risk is the risk of default on the Company's
lending investments that results from a property's, borrower's or corporate
tenant's inability or unwillingness to make contractually required payments.
Market risk reflects changes in the value of loans due to changes in interest
rates or other market

24

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
factors, including the rate of prepayments of principal and the value of the
collateral underlying loans and the valuation of corporate tenant lease
facilities held by the Company.

USE OF DERIVATIVE FINANCIAL INSTRUMENTS--The Company's use of derivative
financial instruments is primarily limited to the utilization of interest rate
agreements or other instruments to manage interest rate risk exposure. The
principal objective of such arrangements is to minimize the risks and/or costs
associated with the Company's operating and financial structure as well as to
hedge specific anticipated transactions. The counterparties to these contractual
arrangements are major financial institutions with which the Company and its
affiliates may also have other financial relationships. The Company is
potentially exposed to credit loss in the event of nonperformance by these
counterparties. However, because of their high credit ratings, the Company does
not anticipate that any of the counterparties will fail to meet their
obligations.

The Company has entered into the following cash flow hedges that are
outstanding as of September 30, 2002. The net value (liability) associated with
these hedges is reflected on the Company's Consolidated Balance Sheets (in
thousands).

EXPLANATORY NOTE:
- ------------------------

(1) Acquired in connection with the TriNet Acquisition.

Between January 1, 2001 and September 30, 2002, the Company had outstanding
the following cash flow hedges that have expired or been settled (in thousands):

In connection with STARs, Series 2002-1 in May 2002, the Company entered
into a LIBOR interest rate cap struck at 8.00% in the notional amount of
$345.0 million. The Company utilizes the provisions of SFAS No. 133 with respect
to such instruments. SFAS No. 133 provides that the up-front fees paid on
option-based products such as caps should be expensed into earnings based on the
allocation of the premium to the affected periods as if the agreement were a
series of "caplets." These allocated premiums are then reflected as a charge to
income (as part of interest expense) in the affected period.

25

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
On May 28, 2002, in connection with the STARs, Series 2002-1 transaction,
the Company paid a premium of $13.7 million for an interest rate cap. Using the
"caplet" methodology discussed above, amortization of the cap premium is
dependent upon the actual value of the cap over time.

In connection with STARs, Series 2000-1 in May 2000, the Company entered
into a LIBOR interest rate cap struck at 10.00% in the notional amount of
$312.0 million, and simultaneously sold a LIBOR interest rate cap with the same
terms. Since these instruments did not change the Company's net interest rate
risk exposure, they did not qualify as hedges and changes in their respective
values were charged to earnings. As the terms of these arrangements were
substantially the same, the effects of a revaluation of these two instruments
substantially offset one another. On May 28, 2002, these instruments were
settled and are no longer outstanding.

During the year ended December 31, 1999, the Company refinanced its
$125.0 million term loan maturing March 15, 1999 with a $155.4 million term loan
maturing March 5, 2009. The new term loan bears interest at 7.44% per annum,
payable monthly, and amortizes over an approximately 22-year schedule. The new
term loan represented forecasted transactions for which the Company had
previously entered into U.S. Treasury-based hedging transactions. The net
$3.4 million cost of the settlement of such hedges has been deferred and is
being amortized as an increase to the effective financing cost of the new term
loan over its effective ten-year term.

CREDIT RISK CONCENTRATIONS--Concentrations of credit risks arise when a
number of borrowers or customers related to the Company's investments are
engaged in similar business activities, or activities in the same geographic
region, or have similar economic features that would cause their ability to meet
contractual obligations, including those to the Company, to be similarly
affected by changes in economic conditions. The Company regularly monitors
various segments of its portfolio to assess potential concentrations of credit
risks. Management believes the current credit risk portfolio is reasonably well
diversified and does not contain any unusual concentration of credit risks.

Substantially all of the Company's corporate tenant lease assets (including
those held by joint ventures) and loans and other lending investments are
collateralized by facilities located in the United States, with significant
concentrations (i.e., greater than 10.00%) as of September 30, 2002 in
California (23.19%), New York (11.33%) and Texas (11.06%). As of September 30,
2002, the Company's investments also contain greater than 10.00% concentrations
in the following asset types: office (46.56%), industrial (14.30%) and hotel
lending (11.58%).

The Company underwrites the credit of prospective borrowers and customers
and often requires them to provide some form of credit support such as corporate
guarantees, letters of credit and/or cash security deposits. Although the
Company's loans and other lending investments and corporate customer lease
assets are geographically diverse and the borrowers and customers operate in a
variety of industries, to the extent the Company has a significant concentration
of interest or operating lease revenues from any single borrower or customer,
the inability of that borrower or customer to make its payment could have an
adverse effect on the Company.

NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS

The Company's 1996 Long-Term Incentive Plan (the "Plan") is designed to
provide incentive compensation for officers, other key employees and directors
of the Company. The Plan provides for awards of stock options and shares of
restricted stock and other performance awards. The maximum number of shares of
Common Stock available for awards under the Plan is 9.00% of the outstanding
shares of Common Stock, calculated on a fully diluted basis, from time to time;
provided that the

26

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
number of shares of Common Stock reserved for grants of options designated as
incentive stock options is 5.0 million, subject to certain antidilution
provisions in the Plan. All awards under the Plan, other than automatic awards
to non-employee directors, are at the discretion of the Board or a committee of
the Board. At September 30, 2002, a total of approximately 8.2 million shares of
Common Stock were available for awards under the Plan, of which options to
purchase approximately 4.5 million shares of Common Stock were outstanding and
approximately 63,400 shares of restricted stock were outstanding.

In March 1998, the Company issued approximately 2.5 million (as adjusted)
fully vested and immediately exercisable options to purchase shares of Common
Stock at $14.72 per share (as adjusted) to its former advisor with a term of ten
years. The former advisor granted a portion of these options to its employees
and the remainder was allocated to an affiliate. Upon the acquisition of its
former advisor, these individuals became employees of the Company. In general,
the grants to these employees provided for scheduled vesting over a predefined
service period of three to five years and, under certain conditions, provide for
accelerated vesting. These options expire on March 15, 2008.

Changes in options outstanding during the nine months ended September 30,
2002 are as follows:

27

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable options as of September 30, 2002:

EXPLANATORY NOTE:
- ------------------------

(1) Includes approximately 764,000 options which were granted, on a fully
exercisable basis, in March 1998, and which are now held by an affiliate of
SOF IV. Beneficial interests in these options were subsequently regranted by
that affiliate to employees of it and its affiliates, subject to vesting
requirements. In the event that these employees forfeit such options, they
revert to an affiliate of SOF IV, which may regrant them at its discretion.
As of September 30, 2002, approximately 416,000 of these options have become
exercisable by the beneficial owners. Of this total, approximately 286,000
have been exercised as of September 30, 2002.

In the third quarter 2002, the Company adopted the fair value method for
accounting for options issued to employees or directors, as allowed under
Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock-Based Compensation." Accordingly, the Company recognizes a
charge equal to the fair value of these options at the date of grant multiplied
by the number of options issued. This charge will be amortized over the related
remaining vesting terms to individual employees as additional compensation. The
impact for options issued since January 1, 2002 is approximately $110,000, which
is reflected under "General and administrative--stock-based compensation" on the
Company's Consolidated Statements of Operations.

Prior to the third quarter 2002, the Company had elected to use the
intrinsic method for accounting for options issued to employees or directors, as
allowed under SFAS No. 123 and, accordingly, recognized no expense in connection
with these options to the extent that the options' exercise prices equaled or
exceeded the quoted prices of the Company's shares of Common Stock on the grant
or investment dates. However, in connection with the acquisition of the
Company's former external advisor, the Company recognized a deferred stock-based
compensation charge of approximately $5.1 million. This deferred charge
represents the difference between the Company's

28

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
closing stock price on the date it acquired its former external advisor (which
was $20.25), and the strike price of $14.72 per share (as adjusted) for the
unvested portion of the options granted to the former external advisor's
employees, who are now employees of the Company. This deferred charge is being
amortized over the related remaining vesting terms to the individual employees
as an additional expense under "General and administrative--stock-based
compensation" on the Company's Consolidated Statements of Operations.

In addition, in connection with the original grant of options in March 1998
to its former external advisor, the Company utilized the fair value method as
required by SFAS No. 123. An independent financial advisory firm estimated the
value of these options at the date of grant to be approximately $2.40 per share
using a Black-Scholes valuation model. In the absence of comparable historical
market information for the Company, the advisory firm utilized assumptions
consistent with activity of a comparable peer group of companies, including an
estimated option life of five years, a 27.50% volatility rate and an estimated
annual dividend rate of 8.50%. The resulting $6.0 million charge to earnings was
calculated as the number of options allocated to the former external advisor
multiplied by their then estimated value, and was reflected in the Company's
first quarter 1998 financial results.

Future charges may be taken to the extent of additional option grants, which
are at the discretion of the Board of Directors.

During the nine months ended September 30, 2002, the Company granted 36,660
restricted shares to employees that vest proportionately over three years on the
anniversary date of the initial grant. In addition, during the three months
ended September 30, 2002, the Company agreed to grant an aggregate of 155,000
restricted shares to certain employees. The restricted shares will vest on
March 31, 2004 if: (1) the employee remains employed until that date; and
(2) the sixty-day average closing price of the Company's Common Stock equals or
exceeds $23.00 as of such date. These restricted shares will not be issued until
there are sufficient shares of Common Stock available under the Plan. Dividends
will be paid on the restricted shares once they are issued, as dividends are
paid on shares of the Company's Common Stock.

During the year ended December 31, 2001, the Company granted 95,109
restricted shares to employees in lieu of cash bonuses for the year ended
December 31, 2000 at the employees' election. These restricted shares were
immediately vested on the date of grant and were not transferable for a period
of one year following vesting.

During the year ended December 31, 2000, the Company granted 143,646
restricted shares to employees. Of this total, 74,996 restricted shares were
granted in lieu of cash bonuses at the employees' election, were immediately
vested on the date of grant, and were not transferable for a period of one year
following vesting. An additional 68,650 of such restricted shares vest over
periods ranging from one to three years following the date of grant and are
transferable upon vesting.

For accounting purposes, the Company measures compensation costs for these
275,415 shares, not including the 155,000 contingently issuable shares, as of
the date of the grant and expenses such amounts against earnings, either at the
grant date (if no vesting period exists) or ratably over the respective vesting
period. Such amounts appear on the Company's Consolidated Statements of
Operations under "General and administrative--stock-based compensation expense."

During the year ended December 31, 2001, the Company entered into a new
three-year employment agreement with its Chief Executive Officer. Under the
agreement, the Chief Executive Officer receives an annual base salary of
$1.0 million. He may also receive a bonus, which is targeted to be an amount
equal to his base salary, if the Company achieves certain performance targets
set by

29

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
the Compensation Committee. The bonus award may be increased or reduced from the
target depending upon the degree to which the performance goals are exceeded or
are not met, and may not exceed 200.00% of his base salary. The bonus is reduced
by the amount of any dividends paid to the Chief Executive Officer in respect of
phantom shares (described below) which are awarded to him and have contingently
vested. As part of this agreement, the Company confirmed a prior grant of
750,000 stock options made to the executive on March 2, 2001 with an exercise
price of $19.69, which represented the market price at the date of the original
contingent grant. However, because the grant required further approval by the
Compensation Committee and the Board of Directors, no measurement date occurred
for accounting purposes until such approvals were made, at which point the
market price of the Company's Common Stock was $24.90. Accordingly, an aggregate
charge of approximately $3.9 million is being recognized with respect to these
options over the term of this agreement and is reflected on the Company's
Consolidated Statements of Operations under "General and
administrative--stock-based compensation." These options will vest in three
equal installments of 250,000 shares in each January beginning in January 2002.

The Company also granted the executive 2.0 million unvested phantom shares,
each of which represents one share of the Company's Common Stock. These shares
will vest in installments of 350,000 shares, 650,000 shares, 600,000 shares and
400,000 shares on a contingent basis if the 60-day average closing price of the
Company's Common Stock achieves thresholds of $25.00, $30.00, $34.00 and $37.00,
respectively. As of September 30, 2002, the $25.00 and $30.00 thresholds have
been attained, and a total of 1,000,000 of these shares have contingently
vested. Shares that have contingently vested generally will not become fully
vested until the end of the three-year term of the agreement, except upon
certain termination or change of control events. Further, if the average stock
price drops below certain specified levels for a 60-day period prior to such
date, such phantom shares would not fully vest and would be forfeited. If the
Company is not authorized to issue shares to the executive upon full vesting of
the phantom shares, then the vesting will be settled through a cash payment
based upon the market price of the Common Stock during a recent trading period.
The executive will receive dividends on shares that have contingently or fully
vested and have not been forfeited under the terms of the agreement, if and when
the Company declares and pays dividends on its Common Stock. Because no shares
have been issued, dividends received on these phantom shares, if any, will be
reflected as compensation expense by the Company. For accounting purposes, this
arrangement will be treated as a contingent, variable plan and no additional
compensation expense will be recognized until the shares, in whole or in part,
become irrevocably vested, whereupon the Company will reflect a charge equal to
the then fair value of the phantom shares irrevocably vested.

In addition, during the year ended December 31, 2001, the Company entered
into a three-year employment agreement, subject to a one-year extension option,
with its President. Under the agreement, in lieu of salary and bonus, the
Company granted the executive 500,000 restricted shares which vest in whole or
in part if the Company's shareholders realize total rates of shareholder return
of between 0.00% and 60.00%, as measured by cumulative dividends paid on the
Company's Common Stock from and after January 1, 2001 and the market price of
the Company's Common Stock. Vested shares would be subject to forfeiture if the
executive's employment with the Company terminated under certain circumstances.
The agreement further provides that if the maximum total shareholder return of
60.00% is achieved for 60 consecutive calendar days on or prior to
September 30, 2002, the full 500,000 share grant automatically becomes fully
vested and not subject to forfeiture as of September 30, 2002, so long as the
executive does not voluntarily resign from the Company without good reason
before that date. The maximum shareholder return of 60.00% was achieved for 60
consecutive calendar days as of April 29, 2002 and the executive remained an
employee of the Company; therefore, the full 500,000

30

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
share award became fully vested as of September 30, 2002. For accounting
purposes, the employment arrangement described above was treated as a
contingent, variable plan until April 29, 2002. The Company incurred a total
non-cash charge of approximately $15.0 million related to the vesting of the
shares, recognized ratably over the period from April 29, 2002 through
September 30, 2002. Accordingly, the non-cash charge recognized for the three
and nine months ended September 30, 2002 was approximately $8.9 million and
$15.0 million, respectively.

The executive received dividends on the share grant from the commencement of
the agreement as and when the Company declared and paid dividends on its Common
Stock. For financial statement purposes, such dividends were accounted for in a
manner consistent with the Company's normal Common Stock dividends as a
reduction to retained earnings.

Certain affiliates of SOF IV and the Company's Chief Executive Officer have
agreed to reimburse the Company for the value of restricted shares awarded to
the President in excess of 350,000 shares, net of tax benefits realized by the
Company or its shareholders on account of compensation expense deductions. The
reimbursement obligation arose once the full restricted share award became fully
vested on September 30, 2002. In the case of the SOFI IV affiliates, the
reimbursement payment must be made through the delivery of approximately
$2.4 million in cash or 131,250 shares of Common Stock on or before June 30,
2003. In the case of the Chief Executive Officer, the reimbursement payment must
be made through the delivery of 18,750 currently vested shares or the forfeiture
of 18,750 contingently vested phantom shares awarded to him under his employment
agreement with the Company. The reimbursement payments will be reflected as
"Additional Paid-In Capital" on the Company's Consolidated Balance Sheets at the
time the payment is received, and not as an offset to the non-cash charge
referenced above.

HIGH PERFORMANCE UNIT PROGRAM

In May 2002, the Company's shareholders approved the iStar Financial High
Performance Unit Program. The program, as more fully described in the Company's
annual proxy statement dated April 8, 2002, is a performance-based employee
compensation plan that only has material value to the participants if the
Company provides superior returns to its shareholders. The program entitles the
employee participants to receive cash distributions in the nature of common
stock dividends if the total rate of return on the Company's Common Stock (share
price appreciation plus dividends) exceeds certain performance levels.

Initially, there are three plans within the program: the 2002 plan, the 2003
plan, and the 2004 plan. Each plan has 5,000 shares of High Performance Common
Stock associated with it. Each share of High Performance Common Stock carries
0.25 votes per share.

The Company's performance is measured over a one-, two-, or three-year
valuation period, beginning on January 1, 2002 and ending on December 31, 2002,
December 31, 2003 and December 31, 2004, respectively. The end of the valuation
period (i.e., the "valuation date") will be accelerated if there is a change in
control of the Company. The High Performance Common Stock has a nominal value
unless the total rate of shareholder return for the relevant valuation period
exceeds the greater of: (1) 10.00%, 20.00%, or 30.00% for the 2002 plan, the
2003 plan and the 2004 plan, respectively; and (2) a weighted industry index
total rate of return consisting of equal weightings of the Russell 1000
Financial Index and the Morgan Stanley REIT Index for the relevant period.

If the total rate of return on the Company's Common Stock exceeds the
threshold performance levels for a particular plan, then distributions will be
paid on the shares of High Performance Common

31

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
Stock related to that plan in the same amounts and at the same times as
distributions are paid on a number of shares of the Company's Common Stock equal
to the following: 7.50% of the Company's excess total rate of return (over the
higher of the two threshold performance levels) multiplied by the weighted
average market value of the Company's common equity capitalization during the
measurement period, all as divided by the average closing price of a share of
the Company's Common Stock for the 20 trading days immediately preceding the
applicable valuation date.

If the total rate of return on the Company's Common Stock does not exceed
the threshold performance levels for a particular plan, then the shares of High
Performance Common Stock related to that plan will have only nominal value--each
of the 5,000 shares will be entitled to dividends equal to 0.01 times the
dividend paid on a share of Common Stock, if and when dividends are declared on
the common stock.

Regardless of how much the Company's total rate of return exceeds the
threshold performance levels, the dilutive impact to the Company's shareholders
resulting from distributions on High Performance Common Stock in each plan is
limited to 1.00% of the number of shares of the Company's Common Stock
outstanding, on a fully diluted basis, on the valuation date for each plan.

The employee participants have purchased their interests in High Performance
Common Stock through a limited liability company at purchase prices approved by
the Company's Board of Directors. The Company's Board has established the prices
of the High Performance Common Stock based upon, among other things, an
independent valuation from a major securities firm. The aggregate initial
purchase prices were set on June 25, 2002 and were approximately $2.8 million,
$1.8 million and $1.3 million for the 2002, 2003 and 2004 plans, respectively.
No employee is permitted to exchange his or her interest in the LLC for shares
of High Performance Common Stock prior to the applicable valuation date.

The additional equity from the issuance of the High Performance Common Stock
is recorded as a separate class of stock and disclosed within shareholders'
equity. Future distributions, if any, will be deducted from net income available
for common shareholders.

401(K) PLAN

Effective November 4, 1999, the Company implemented a savings and retirement
plan (the "401(k) Plan"), which is a voluntary, defined contribution plan. All
employees are eligible to participate in the 401(k) Plan following completion of
three months of continuous service with the Company. Each participant may
contribute on a pretax basis between 2.00% and 15.00% of such participant's
compensation. At the discretion of the Board of Directors, the Company may make
matching contributions on the participant's behalf of up to 50.00% of the first
10.00% of the participant's annual compensation. The Company made gross
contributions of approximately $65,000 and $61,000 to the 401(k) Plan for the
three months ended September 30, 2002 and 2001, respectively, and approximately
$310,000 and $246,000 for the nine months ended September 30, 2002 and 2001,
respectively.

32

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 11--EARNINGS PER SHARE

The following table presents a reconciliation of the numerators and
denominators of the basic and diluted EPS calculations (in thousands, except per
share data):

33

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 11--EARNINGS PER SHARE (CONTINUED)

In addition, there were approximately 173,000 stock options, 6.1 million
warrants and 371,000 joint venture shares that were antidilutive for the three-
and nine-month periods ended September 30, 2002. For the three- and nine-month
periods ended September 30, 2001, there were approximately 167,000 and 277,000
stock options, 6.1 million warrants and 1.4 million joint venture shares that
were antidilutive, respectively.

NOTE 12--COMPREHENSIVE INCOME

In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income" effective for fiscal
years beginning after December 15, 1997. The statement changes the reporting of
certain items currently reported as changes in the shareholders' equity section
of the balance sheet and establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS No. 130 requires that all components of comprehensive
income shall be reported in the financial statements in the period in which they
are recognized. Furthermore, a total amount for comprehensive income shall be
displayed in the financial statements. The Company has adopted this standard
effective January 1, 1998. Total comprehensive income was $56.7 million and
$49.0 million for the three-month periods ended September 30, 2002 and 2001,
respectively, and $162.8 million and $148.1 million for the nine-month periods
ended September 30, 2002 and 2001, respectively. The primary components of
comprehensive income other than net income consist of amounts attributable to
the adoption and continued application of SFAS No. 133 to the Company's cash
flow hedges and changes in the fair value of the Company's available-for-sale
investments.

For the three and nine months ended September 30, 2002, the change in fair
market value of the Company's cash flow hedges was a decrease of $723,000 and an
increase of $3.3 million, respectively,

34

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12--COMPREHENSIVE INCOME (CONTINUED)
and was recorded as adjustments to other comprehensive income. The
reconciliation to other comprehensive income is as follows (in thousands):

Unrealized gains on available-for-sale investments are recorded as
adjustments to shareholders' equity (through accumulated other comprehensive
income) and are not included in adjusted earnings or net income unless realized.

As of September 30, 2002 and December 31, 2001, accumulated other
comprehensive income reflected in the Company's equity on the balance sheet is
comprised of the following (in thousands):

NOTE 13--DIVIDENDS

In order to maintain its election to qualify as a REIT, the Company must
currently distribute, at a minimum, an amount equal to 90.00% of its taxable
income and must distribute 100.00% of its taxable income to avoid paying
corporate federal income taxes. The Company anticipates it will distribute all
of its taxable income to its shareholders. Because taxable income differs from
cash flow from operations due to non-cash revenues or expenses (such as
depreciation), in certain circumstances, the Company may generate operating cash
flow in excess of its dividends or, alternatively, may be required to borrow to
make sufficient dividend payments.

Total dividends attributable to the nine months ended September 30, 2002
were $112.6 million, or $1.26 per share of Common Stock consisting of quarterly
dividends of $0.63 per share which were declared on April 1, 2002 and July 1,
2002. On October 1, 2002, the Company declared a dividend of $0.63 per share of
Common Stock, applicable to the third quarter and payable to shareholders of
record on October 15, 2002. The Company also declared dividends aggregating
$15.7 million, $3.5 million, $2.2 million and $6.0 million, respectively, on its
Series A, B, C and D preferred stock, respectively, for the nine-month period
ended September 30, 2002 and $5.2 million, $1.2 million,

35

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 13--DIVIDENDS (CONTINUED)
$0.7 million and $2.0 million, respectively, on its Series A, B, C and D
preferred stock, respectively, for the three-month period ended September 30,
2001. There are no divided arrearages on any of the preferred shares currently
outstanding.

The Series A preferred stock has a liquidation preference of $50.00 per
share and carries an initial dividend yield of 9.50% per annum. The dividend
rate on the preferred shares will increase to 9.75% on December 15, 2005, to
10.00% on December 15, 2006 and to 10.25% on December 15, 2007 and thereafter.
Dividends on the Series A preferred shares are payable quarterly in arrears and
are cumulative.

Holders of shares of the Series B preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 9.375% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.34 per share. Dividends are cumulative from the date of
original issue and are payable quarterly in arrears on or before the 15th day of
each March, June, September and December or, if not a business day, the next
succeeding business day. Any dividend payable on the Series B preferred stock
for any partial dividend period will be computed on the basis of a 360-day year
consisting of twelve 30-day months. Dividends will be payable to holders of
record as of the close of business on the first day of the calendar month in
which the applicable dividend payment date falls or on another date designated
by the Board of Directors of the Company for the payment of dividends that is
not more than 30 nor less than ten days prior to the dividend payment date.

Holders of shares of the Series C preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 9.20% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.30 per share. The remaining terms relating to dividends of the
Series C preferred stock are substantially identical to the terms of the
Series B preferred stock described above.

Holders of shares of the Series D preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 8.00% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.00 per share. The remaining terms relating to dividends of the
Series D preferred stock are substantially identical to the terms of the
Series B preferred stock described above.

The High Performance Common Stock has not yet reached its first valuation
date and currently has only a nominal dividend component.

The exact amount of future quarterly dividends to common shareholders will
be determined by the Board of Directors based on the Company's actual and
expected operations for the fiscal year and the Company's overall liquidity
position.

NOTE 14--SEGMENT REPORTING

Statement of Financial Accounting Standard No. 131 ("SFAS No. 131")
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected financial information about operating
segments in interim financial reports issued to shareholders.

36

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 14--SEGMENT REPORTING (CONTINUED)
The Company has two reportable segments: Real Estate Lending and Corporate
Tenant Leasing. The Company does not have substantial foreign operations. The
accounting policies of the segments are the same as those described in Note 3.
The Company has no single customer that accounts for 4.20% or more of revenues
(see Note 9 for other information regarding concentrations of credit risk).

The Company evaluates performance based on the following financial measures
for each segment (in thousands):

EXPLANATORY NOTES:
- --------------------

(1) Corporate and Other represents all corporate level items, including general
and administrative expenses and any intercompany eliminations necessary to
reconcile to the consolidated Company totals. This caption also includes the
Company's servicing business, which is not considered a material separate
segment.

37

ISTAR FINANCIAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 14--SEGMENT REPORTING (CONTINUED)
(2) Total revenues represents all revenues earned during the period from the
assets in each segment. Revenue from the Real Estate Lending business
primarily represents interest income and revenue from the Corporate Tenant
Leasing business primarily represents operating lease income.

(3) Total operating and interest expense represents provision for loan losses
for the Real Estate Lending business and operating costs on corporate tenant
lease assets for the Corporate Tenant Leasing business, as well as interest
expense specifically related to each segment. Interest expense on unsecured
notes, general and administrative expense and general and
administrative--stock-based compensation is included in Corporate and Other
for all periods. Depreciation and amortization of $12.7 million and
$8.6 million for the three-month periods ended September 30, 2002 and 2001,
respectively, and $35.0 million and $26.2 million for the nine-month periods
ended September 30, 2002 and 2001, respectively, are included in the amounts
presented above.

(4) Net operating income represents net operating income before minority
interest, equity in earnings from joint ventures and unconsolidated
subsidiaries, income from discontinued operations, gain (loss) from
discontinued operations, extraordinary loss on early extinguishment of debt
and cumulative effect of change in accounting principle.

(5) Total long-lived assets is comprised of Loans and Other Lending Investments,
net and Corporate Tenant Lease Assets, net, for each respective segment.

38

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

GENERAL

The Company began its business in 1993 through private investment funds
formed to take advantage of the lack of well-capitalized lenders capable of
servicing the needs of high-end customers in its markets. In March 1998, the
private investment funds contributed their approximately $1.1 billion of assets
to the Company's predecessor in exchange for a controlling interest in that
public company. In November 1999, the Company acquired its leasing subsidiary,
TriNet Corporate Realty Trust, Inc. ("TriNet" or the "Leasing Subsidiary"),
which was then the largest publicly-traded company specializing in corporate
sale/leaseback for office and industrial facilities (the "TriNet Acquisition").
Concurrent with the TriNet Acquisition, the Company also acquired its former
external advisor in exchange for shares of its Common Stock and converted its
organizational form to a Maryland corporation. The Company's Common Stock began
trading on the New York Stock Exchange under the symbol "SFI" in November 1999.

RESULTS OF OPERATIONS

THREE-MONTH PERIOD ENDED SEPTEMBER 30, 2002 COMPARED TO THE THREE-MONTH PERIOD
ENDED SEPTEMBER 30, 2001

INTEREST INCOME--Interest income increased by $4.4 million to $66.8 million
for the three months ended September 30, 2002 from $62.4 million for the same
period in 2001. This increase was primarily due to $16.7 million of interest
income on new originations or additional fundings, net of a $10.9 million
decrease from the repayment of loans and other lending investments. This
increase was partially offset by a decrease in interest income on the Company's
variable-rate lending investments as the result of lower average one-month LIBOR
rates of 1.82% in 2002 compared to 3.55% in 2001.

OPERATING LEASE INCOME--Operating lease income increased by $17.6 million to
$63.6 million for the three months ended September 30, 2002 from $46.0 million
for the same period in 2001. Of this increase, $19.0 million was attributable to
new corporate tenant lease investments. This increase was partially offset by
corporate tenant lease dispositions and lower operating lease income on certain
corporate tenant lease assets.

OTHER INCOME--Other income generally consists of prepayment penalties and
realized gains from the early repayment of loans and other lending investments,
financial advisory and asset management fees, lease termination fees, mortgage
servicing fees, loan participation payments and dividends on certain
investments. During the three months ended September 30, 2002, other income
included prepayment penalties and realized gains on loan repayments of
$3.2 million, asset management, mortgage servicing and other fees of
approximately $966,000, and other miscellaneous fees such as dividend payments
and insurance claims of $581,000.

During the three months ended September 30, 2001, other income primarily
included prepayment penalties on loan repayments of $8.7 million, financial
advisory and mortgage servicing fees of approximately $700,000, and loan
participation payments of $680,000.

INTEREST EXPENSE--For the three months ended September 30, 2002, interest
expense increased by $6.4 million to $47.5 million from $41.1 million for the
same period in 2001. This increase was primarily due to the higher average
borrowings on the Company's debt obligations, term loans and secured notes, and
by approximately $492,000 due to additional amortization of deferred financing
costs on the Company's debt obligations in 2002 compared to the same period in
2001. This increase was partially offset by lower average one-month LIBOR rates
of 1.82% in 2002 compared to 3.55% in 2001 on the Company's variable-rate debt
obligations.

OPERATING COSTS--CORPORATE TENANT LEASE ASSETS--For the three months ended
September 30, 2002, operating costs increased by approximately $450,000 to
$3.7 million from $3.2 million for the same

39

period in 2001. This increase is primarily related to additional corporate
tenant lease investments and an increase in operating costs for certain
corporate tenant lease assets, partially offset by corporate tenant lease
dispositions.

DEPRECIATION AND AMORTIZATION--Depreciation and amortization increased by
$4.1 million to $12.7 million for the three months ended September 30, 2002 from
$8.6 million for the same period in 2001. This increase is due to additional
corporate tenant lease investments acquired subsequent to September 30, 2001,
partially offset by corporate tenant lease dispositions completed in 2001.

GENERAL AND ADMINISTRATIVE--For the three months ended September 30, 2002,
general and administrative expenses increased by approximately $2.0 million to
$8.1 million, compared to $6.1 million for the same period in 2001. This
increase is primarily the result of an increase in personnel and related costs.

GENERAL AND ADMINISTRATIVE--STOCK-BASED COMPENSATION--General and
administrative--stock-based compensation increased by approximately
$9.0 million primarily due to a non-cash charge related to the performance-based
vesting of 500,000 restricted shares granted under the Company's long-term
incentive plan and tied to overall shareholder performance (see Note 10 to the
Company's Consolidated Financial Statements).

PROVISION FOR LOAN LOSSES--The Company's charge for provision for loan
losses increased to $2.0 million for the three months ended September 30, 2002
as compared to $1.8 million for the same period in 2001. As more fully discussed
in Note 4 to the Company's Consolidated Financial Statements, the Company has
not realized any actual losses on any of its loan investments to date. The
Company considers it prudent to reflect provisions for loan losses on a
portfolio basis based upon the Company's assessment of general market
conditions, the Company's internal risk management policies and credit risk
rating system, industry loss experience, the Company's assessment of the
likelihood of delinquencies or defaults, and the value of the collateral
underlying its investments. Accordingly, since its first full quarter operating
its current business as a public company (the quarter ended June 30, 1998),
management has reflected quarterly provisions for loan losses in its operating
results.

EQUITY IN EARNINGS FROM JOINT VENTURES AND UNCONSOLIDATED
SUBSIDIARIES--During the three months ended September 30, 2002, equity in
earnings from joint ventures and unconsolidated subsidiaries decreased by
approximately $1.9 million to $85,000 from $2.0 million for the same period in
2001. This decrease is primarily due to the consolidation of one of the
Company's corporate tenant lease joint venture investments (see Note 6 to the
Company Consolidated Financial Statements).

INCOME FROM DISCONTINUED OPERATIONS--For the three-month periods ended
September 30, 2002 and 2001, operating income earned by the Company on corporate
tenant lease assets sold (prior to their sale) and assets held for sale of
approximately $823,000 and $1.2 million, respectively, is classified as
"discontinued operations," even though such income was earned by the Company
prior to the assets' disposition or its classification as "held for sale."

GAIN (LOSS) FROM DISCONTINUED OPERATIONS--During the three months ended
September 30, 2002, one of the Company's customers exercised an option to
terminate its lease on 50% of the land leased from the Company. In connection
with this termination, the Company realized $17.5 million in cash lease
termination payments, offset by a $17.4 million impairment charge in connection
with the termination, resulting in a net gain of approximately $123,000.

During the third quarter of 2001, the Company disposed of one corporate
tenant lease asset for net proceeds of $12.5 million, and recognized a loss of
approximately $1.2 million.

EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT--During the three months
ended September 30, 2002, the Company did not incur any losses on the early
extinguishment of debt.

40

During the three months ended September 30, 2001, the Company prepaid an
unsecured revolving credit facility, which had an original maturity date of
May 2002. In connection with this prepayment, the Company expensed the remaining
unamortized deferred financing costs, which resulted in an extraordinary loss on
early extinguishment of debt of approximately $583,000.

NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2002 COMPARED TO THE NINE-MONTH PERIOD
ENDED SEPTEMBER 30, 2001

INTEREST INCOME--Interest income decreased $6.1 million to $187.1 million
for the nine months ended September 30, 2002 from $193.2 million for the same
period in 2001. Approximately $15.2 million of this decrease is the result of
lower average one-month LIBOR rates of 1.84% in 2002 compared to 4.45% in 2001
on the Company's variable-rate lending investments. This decrease was partially
offset by $52.9 million of interest income on new originations or additional
fundings, net of a $40.0 million decrease in interest income due to the
repayment of loans and other lending investments.

OPERATING LEASE INCOME--Operating lease income increased by $39.9 million to
$177.5 million for the nine months ended September 30, 2002 from $137.6 million
for the same period in 2001. Of this increase, $42.2 million was attributable to
new corporate tenant lease investments. This increase was partially offset by
corporate tenant lease dispositions and lower operating lease income on certain
corporate tenant lease assets.

OTHER INCOME--Other income consists primarily of prepayment penalties and
realized gains from the early repayment of loans and other lending investments,
financial advisory and asset management fees, lease termination fees, mortgage
servicing fees, loan participation payments and dividends on certain
investments. During the nine months ended September 30, 2002, other income
primarily included prepayment penalties and realized gains on loan repayments of
$9.1 million, financial advisory, asset management, mortgage servicing and other
fees of $8.5 million, and loan participation payments of $3.3 million.

During the nine months ended September 30, 2001, other income primarily
included prepayment penalties and gains on loan repayments of $18.9 million,
loan participations of $3.7 million, and financial advisory and mortgage
servicing fees of approximately $1.8 million.

INTEREST EXPENSE--For the nine months ended September 30, 2002, interest
expense increased by approximately by $7.1 million to $135.9 million from
$128.8 million for the same period in 2001. This increase was primarily due to
the higher average borrowings on the Company's debt obligations, term loans and
secured notes, and by approximately $1.8 million due to additional amortization
of deferred financing costs on the Company's debt obligations in 2002 compared
to the same period in 2001. This increase was partially offset by lower average
one-month LIBOR rates of 1.84% in 2002 compared to 4.45% in 2001 on the
Company's variable-rate debt obligations.

OPERATING COSTS--CORPORATE TENANT LEASE ASSETS--For the nine months ended
September 30, 2002, operating costs decreased by $51,000 to $9.7 million from
the same period in 2001. This decrease is primarily related to corporate tenant
lease dispositions, partially offset by new corporate tenant lease investments.

DEPRECIATION AND AMORTIZATION--Depreciation and amortization increased by
$8.8 million to $35.0 million for the nine months ended September 30, 2002 from
$26.2 million for the same period in 2001. This increase is due to additional
corporate tenant lease investments acquired subsequent to September 30, 2001,
partially offset by corporate tenant lease dispositions completed in 2001.

GENERAL AND ADMINISTRATIVE--For the nine months ended September 30, 2002,
general and administrative expenses increased by $4.1 million to $22.8 million,
compared to $18.7 million for the same period in 2001. This increase is
primarily the result of an increase in personnel and related costs.

41

GENERAL ADMINISTRATIVE--STOCK-BASED COMPENSATION--General and administrative
stock-based compensation increased by approximately $14.8 million primarily due
to a non-cash charge related to the performance-based vesting of 500,000
restricted shares granted under the Company's long-term incentive plan and tied
to overall shareholder performance (see Note 10 to the Company's Consolidated
Financial Statements).

PROVISION FOR LOAN LOSSES--The Company's charge for provision for loan
losses increased to $5.8 million for the nine months ended September 30, 2002 as
compared to $5.3 million for the same period in 2001. As more fully discussed in
Note 4 to the Company's Consolidated Financial Statements, the Company has not
realized any actual losses on any of its loan investments to date. The Company
considers it prudent to reflect provisions for loan losses on a portfolio basis
based upon the Company's assessment of general market conditions, the Company's
internal risk management policies and credit risk rating system, industry loss
experience, the Company's assessment of the likelihood of delinquencies or
defaults, and the value of the collateral underlying its investments.
Accordingly, since its first full quarter operating its current business as a
public company (the quarter ended June 30, 1998), management has reflected
quarterly provisions for loan losses in its operating results.

EQUITY IN EARNINGS FROM JOINT VENTURES AND UNCONSOLIDATED
SUBSIDIARIES--During the nine months ended September 30, 2002, equity in
earnings from joint ventures and unconsolidated subsidiaries decreased by
$4.3 million to $1.3 million from $5.6 million for the same period in 2001. This
decrease is primarily due to the consolidation of one of the Company's corporate
tenant lease joint venture investments (see Note 6 to the Company's Consolidated
Financial Statements).

INCOME FROM DISCONTINUED OPERATIONS--For the nine-month periods ended
September 30, 2002 and 2001, operating income earned by the Company on corporate
tenant lease assets sold (prior to their sale) and assets held for sale of
approximately $3.3 million and $3.7 million, respectively, is classified as
"discontinued operations," even though such income was earned by the Company
prior to the assets' disposition or its classification as "held for sale."

GAIN (LOSS) FROM DISCONTINUED OPERATIONS--During the nine months ended
September 30, 2002, one of the Company's customers exercised an option to
terminate its lease on 50% of the land leased from the Company. In connection
with this termination, the Company realized $17.5 million in cash lease
termination payments, offset by a $17.4 million impairment charge in connection
with the termination, resulting in a net gain of approximately $123,000. In
addition, the Company disposed of one corporate tenant lease asset for net
proceeds of $3.7 million, and realized a gain of approximately $595,000.

During the nine months ended September 30, 2001, the Company disposed of
three corporate tenant lease assets for net proceeds of $20.3 million, and
recognized gains of approximately $403,000.

EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT--During the nine months
ended September 30, 2002, the Company fully repaid the then remaining
$446.2 million of bonds outstanding under its STARs, Series 2000-1 financing.
This prepayment resulted in an extraordinary loss of $12.2 million, which
represented approximately $8.2 million in unamortized deferred financing costs
and approximately $4.0 million in prepayment penalties.

During the nine months ended September 30, 2001, the Company repaid a
secured term loan, which had an original maturity date of December 2004. In
connection with this early repayment, the Company incurred certain prepayment
penalties, which resulted in an extraordinary loss on early extinguishment of
debt of approximately $1.0 million during the first quarter of 2001. In
addition, in the third quarter of 2001, the Company prepaid an unsecured
revolving credit facility, which had an original maturity date of May 2002. In
connection with this prepayment, the Company expensed the remaining unamortized
deferred financing costs, which resulted in an extraordinary loss on early
extinguishment of debt of approximately $583,000.

42

ADJUSTED EARNINGS

Adjusted earnings represents net income computed in accordance with GAAP,
before gain (loss) from discontinued operations, extraordinary items and
cumulative effect of change in accounting principle, plus depreciation and
amortization, less preferred stock dividends, and after adjustments for
unconsolidated partnerships and joint ventures. Adjustments for unconsolidated
partnerships and joint ventures reflect the Company's share of adjusted earnings
calculated on the same basis.

The Company believes that to facilitate a clear understanding of the
historical operating results of the Company, adjusted earnings should be
examined in conjunction with net income as shown in the Company's Consolidated
Statements of Operations. Adjusted earnings should not be considered as an
alternative to net income (determined in accordance with GAAP) as an indicator
of the Company's performance, or to cash flows from operating activities
(determined in accordance with GAAP) as a measure of the Company's liquidity,
nor is it indicative of funds available to fund the Company's cash needs or
available for distribution to the Company's shareholders. The Company's
management believes that adjusted earnings more closely approximates operating
cash flow and is a useful measure for investors to consider, in conjunction with
net income and other GAAP measures, in evaluating the Company's financial
performance. This is primarily because the Company is a commercial finance
company that focuses on real estate lending and corporate tenant leasing;
therefore, the Company's net income (determined in accordance with GAAP)
reflects significant non-cash depreciation expense on corporate tenant lease
assets. It should be noted that the Company's manner of calculating adjusted
earnings may differ from the calculation of similarly-titled measures by other
companies.

EXPLANATORY NOTES:
- --------------------

(1) Represents one-time effect of adoption of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as of January 1, 2001.

(2) Excludes an $8.9 million and $15.0 million non-cash charge related to
performance-based vesting of restricted shares granted under the Company's
long-term incentive plan for the three and nine months ended September 30,
2002, respectively.

43

RISK MANAGEMENT

NON-ACCRUAL LOANS--The Company transfers loans to non-accrual status at such
time as: (1) management believes that the potential risk exists that scheduled
debt service payments will not be met within the coming 12 months; (2) the loans
become 90 days delinquent; (3) management determines the borrower is incapable
of, or ceased efforts toward, curing the cause of an impairment; or (4) the net
realizable value of the loan's underlying collateral approximates the Company's
carrying value of such loan. Interest income is recognized only upon actual cash
receipt for loans on non-accrual status. As of September 30, 2002, the Company
had two assets on non-accrual status with an aggregate gross book value of
$5.5 million, or 0.10% of the gross book value of the Company's investments.

One of the two non-accrual loans is a $3.6 million partnership loan on two
shopping malls located in the suburbs of Washington, D.C. This investment was
part of a larger loan originally made by affiliates of Lazard Freres prior to
the Company's acquisition of Lazard's structured finance portfolio in 1998. The
loan matures in September 2003 and bears interest at 12.00%. The Company
received cash payments equal to the interest due on the loan during the nine
months ended September 30, 2002, and the borrower remains current on its
obligations to the Company. However, the Company anticipates that this loan will
remain on non-accrual status for the foreseeable future.

Additionally, the Company, through its investment in TriNet Management
Operating Company, has a $1.9 million investment in debt securities that are
convertible into shares of a real estate company which trades on the Mexican
Stock Exchange. This investment was made by TriNet prior to its acquisition by
the Company in 1999. The securities bear interest at 12.00% per annum and is
payable in arrears on December 4th of each year. The Company received cash
payments equal to the interest due on the investment through December 31, 2001,
and the Company expects to be paid its interest for the year ended 2002 in
December 2002. However, the Company anticipates that this investment will remain
on non-accrual status for the foreseeable future.

LOANS IN DEFAULT--As of September 30, 2002, one of the Company's loans is in
technical default because, since July 2002, the borrower has been paying debt
service one month in arrears. This loan is a $15.3 million second mortgage on a
Class A office building in Washington, D.C. which matures in October 2005. On
August 5, 2002, the five-day grace period for the borrower's July 2002 debt
service payment expired, and the Company sent a default notice to the borrower.
The July debt service payment was received by the Company on August 22, 2002
and, since that time, the Company continues to be paid one month in arrears.
Inclusive of the senior debt on the property, the Company's last-dollar risk
exposure on this asset is approximately $269 per square foot. As a result, the
Company currently believes that the fair value of the collateral supports the
book value of this asset.

FIRST DOLLAR AND LAST DOLLAR EXPOSURE--One component of the Company's risk
management assessment is an analysis of the Company's first and last dollar
loan-to-value percentage with respect to the properties or companies the Company
finances. First dollar loan-to-value represents the average beginning point for
the Company's lending exposure in the aggregate capitalization of the underlying
properties or companies it finances. Last dollar loan-to-value represents the
average ending point for the Company's lending exposure in the aggregate
capitalization of the underlying properties or companies it finances.

LIQUIDITY AND CAPITAL RESOURCES

The Company requires capital to fund its investment activities and operating
expenses. The Company has significant access to capital resources to fund its
existing business plan, which includes the expansion of its real estate lending
and corporate tenant leasing businesses. The Company's capital sources include
cash flow from operations, borrowings under lines of credit, additional term
borrowings, long-term financing secured by the Company's assets, unsecured
financing and the issuance of common,

44

convertible and /or preferred equity securities. Further, the Company may
acquire other businesses or assets using its capital stock, cash or a
combination thereof.

The distribution requirements under the REIT provisions of the Code limit
the Company's ability to retain earnings and thereby replenish or increase
capital committed to its operations. However, the Company believes that its
significant capital resources and access to financing will provide it with
financial flexibility and market responsiveness at levels sufficient to meet
current and anticipated capital requirements, including expected new lending and
corporate tenant leasing transactions.

The Company believes that its existing sources of funds will be adequate for
purposes of meeting its short- and long-term liquidity needs. The Company's
ability to meet its long-term (i.e., beyond one year) liquidity requirements is
subject to obtaining additional debt and equity financing. Any decision by the
Company's lenders and investors to enter into such transactions with the Company
will depend upon a number of factors, such as compliance with the terms of its
existing credit arrangements, the Company's financial performance, industry or
market trends, the general availability of and rates applicable to financing
transactions, such lenders' and investors' resources and policies concerning the
terms under which they make such capital commitments and the relative
attractiveness of alternative investment or lending opportunities.

The Company's longstanding policy is to limit its book debt-to-equity ratio
to approximately 2.0x. As the Company's leverage approaches this level, the
Company will consider equity and other alternatives to reduce leverage. The
exact timing and nature of any equity issuance would be subject to market
conditions.

The Company has four LIBOR-based secured revolving credit facilities with an
aggregate maximum availability of $2.7 billion, of which $1.3 billion was drawn
as of September 30, 2002 (see Note 7 to the Company's Consolidated Financial
Statements). Availability under these facilities is based on collateral provided
under a borrowing base calculation. At September 30, 2002, the Company also had
an unsecured credit facility totaling $300.0 million which bears interest at
LIBOR + 2.125% and matures in July 2004, including a one-year extension at the
Company's option. At September 30, 2002, the Company had not drawn any amounts
under this facility.

RECENT FINANCING ACTIVITIES--On May 17, 2000, the Company closed the
inaugural offering under its proprietary matched funding program, STARs,
Series 2000-1. In the initial transaction, a wholly-owned subsidiary of the
Company issued $896.5 million of investment-grade bonds secured by the
subsidiary's assets, which had an aggregate outstanding principal balance of
approximately $1.2 billion at inception. Principal payments received on the
assets were utilized to repay the most senior class of the bonds then
outstanding. The maturity of the bonds match funded the maturity of the
underlying assets financed under the program. Of the assets of the subsidiary
secured by this financing, 73.96% (by gross carrying value) consisted of first
mortgages and subsequent lien positions and the remaining 26.04% consisted of
junior loans. For accounting purposes, this transaction was treated as a secured
financing: the underlying assets and STARs liabilities remained on the Company's
Consolidated Balance Sheets and no gain on sale was recognized. On May 28, 2002,
the Company fully repaid these bonds.

On January 11, 2001, the Company closed a new $700.0 million secured
revolving credit facility which is led by a major commercial bank. The new
facility has a three-year primary term and one-year "term-out" extension option,
and bears interest at LIBOR + 1.40% to 2.15%, depending upon the collateral
contributed to the borrowing base. The new facility accepts a broad range of
structured finance assets and has a final maturity of January 2005.

On February 22, 2001, the Company extended the maturity of its
$350.0 million unsecured revolving credit facility to May 2002. On July 27,
2001, the Company repaid this facility and replaced it with a new
$300.0 million unsecured revolving credit facility.

45

On May 15, 2001, the Company repaid its $100.0 million 7.30% unsecured
notes. These notes were senior unsecured obligations of the Leasing Subsidiary
and ranked equally with the Leasing Subsidiary's other senior unsecured and
unsubordinated indebtedness.

On June 14, 2001, the Company closed $193.0 million of term loan financing
secured by 15 corporate tenant lease assets. The variable-rate loan bears
interest at LIBOR + 1.85% (not to exceed 10.00% in aggregate) and has two
one-year extensions at the Company's option. The Company used these proceeds to
repay a $77.8 million secured term loan maturing in June 2001 and to pay down a
portion of its revolving credit facilities. In addition, the Company extended
the maturity of its $500.0 million secured revolving credit facility to
August 2003. On March 29, 2002, the Company again extended the final maturity of
this facility to August 2005, which includes a one-year "term-out" extension at
the Company's option.

On July 6, 2001, the Company financed a $75.0 million structured finance
asset with a $50.0 million term loan bearing interest at LIBOR + 2.50%. The loan
has a maturity of July 2006, including a one-year extension at the Company's
option. This investment is a $75.0 million term preferred investment in a
publicly-traded real estate customer. The Company's investment carries an
initial current yield of 10.50%, with annual increases of 0.50% in each of the
next two years. In addition, the Company's investment is convertible into the
customer's common stock at a strike price of $25.00 per share. The investment is
callable by the customer between months 13 and 30 of the term at a yield
maintenance premium, and after month 30, at a premium sufficient to generate a
14.62% internal rate of return on the Company's investment. The investment is
putable by the Company to the customer for cash after five years.

On July 27, 2001, the Company completed a $300.0 million unsecured revolving
credit facility with a group of leading financial institutions. The new facility
has an initial maturity of July 2003, with a one-year extension at the Company's
option and another one-year extension at the lenders' option. The new facility
replaces two prior credit facilities maturing in 2002 and 2003, and bears
interest at LIBOR + 2.125%.

On August 9, 2001, the Company issued $350.0 million of 8.75% senior notes
due in 2008. The notes are unsecured senior obligations of the Company. The
Company used the net proceeds to partially repay outstanding borrowings under
its secured credit facilities.

On March 29, 2002, the Company extended the maturity of its $500.0 million
secured facility to August 2005, which includes a one-year "term-out" extension
at the Company's option.

On May 28, 2002, the Company repaid the then remaining $446.2 million of
bonds outstanding under its STARs, Series 2000-1 financing. Simultaneously, a
wholly-owned subsidiary of the Company issued STARs, Series 2002-1, consisting
of $885.1 million of investment-grade bonds secured by the subsidiary's
structured finance and corporate tenant lease assets, which had an aggregate
outstanding principal balance of approximately $1.1 billion at inception.
Principal payments received on the assets will be utilized to repay the most
senior class of the bonds then outstanding. The maturity of the bonds match
funds the maturity of the underlying assets financed under the program. The
weighted average interest rate on the bonds, on an all-floating rate basis, is
approximately LIBOR + 0.56% at inception. For accounting purposes, this
transaction was treated as a secured financing: the underlying assets and STARs
liabilities remained on the Company's Consolidated Balance Sheets, and no gain
on sale was recognized.

On July 2, 2002, the Company purchased the remaining interest in the
Milpitas joint venture from the former Milpitas external member. Upon purchase
of the interest, the Milpitas joint venture became fully consolidated for
accounting purposes and approximately $79.2 million of secured term debt was
transferred to the Company's Consolidated Balance Sheets.

46

On September 30, 2002, the Company closed a new $500.0 million secured
revolving credit facility with a leading financial institution. The new facility
has a three-year term and bears interest at LIBOR + 1.50% to 2.25%, depending
upon the collateral contributed to the borrowing base. The new facility accepts
a broad range of structured finance and corporate tenant assets and has a final
maturity date of September 2005.

HEDGING ACTIVITIES--The Company has variable-rate lending assets and
variable-rate debt obligations. These assets and liabilities create a natural
hedge against changes in variable interest rates. This means that as interest
rates increase, the Company earns more on its variable-rate lending assets and
pays more on its variable-rate debt obligations and, conversely, as interest
rates decrease, the Company earns less on its variable-rate lending assets and
pays less on its variable-rate debt obligations. When the amount of the
Company's variable-rate debt obligations exceeds the amount of its variable-rate
lending assets, the Company utilizes derivative instruments to limit the impact
of changing interest rates on its net income. The Company does not use
derivative instruments to hedge assets or for speculative purposes. The
derivatives instruments the Company uses are typically in the form of interest
rate swaps and interest rate caps. Interest rate swaps effectively change
variable-rate debt obligations to fixed-rate debt obligations. Interest rate
caps effectively limit the maximum interest rate on variable-rate debt
obligations.

The primary risks from the Company's use of derivative instruments is the
risk that a counterparty to a hedging arrangement could default on its
obligation and the risk that the Company may have to pay certain costs, such as
transaction fees or breakage costs, if a hedging arrangement is terminated by
the Company. As a matter of policy, the Company enters into hedging arrangements
with counterparties that are large, creditworthy financial institutions
typically rated at least "A" by Standard & Poor's ("S&P") and "A2" by Moody's
Investors Service ("Moody's"). The Company's hedging strategy is approved and
monitored by the Company's Audit Committee on behalf of its Board of Directors
and may be changed by the Board of Directors without stockholder approval.

The Company has entered into the following cash flow hedges that are
outstanding as of September 30, 2002. The net value (liability) associated with
these hedges is reflected on the Company's Consolidated Balance Sheets (in
thousands).

EXPLANATORY NOTE:
- --------------------

(1) Acquired in connection with the TriNet Acquisition. (See Note 1 to the
Company's Consolidated Financial Statements).

47

Between January 1, 2001 and September 30, 2002, the Company had outstanding
the following cash flow hedges that have expired or been settled (in thousands):

In connection with STARs, Series 2002-1 in May 2002, the Company entered
into a LIBOR interest rate cap struck at 8.00% in the notional amount of
$345.0 million. The Company utilizes the provisions of Statement of Financial
Accounting Standards No. 133 ("SFAS No. 133), "Accounting for Derivative
Instruments and Hedging Activities," with respect to such instruments. SFAS
No. 133 provides that the up-front fees paid on option-based products such as
caps should be expensed into earnings based on the allocation of the premium to
the affected periods as if the agreement were a series of "caplets." These
allocated premiums are then reflected as a charge to income (as part of interest
expense) in the affected period.

On May 28, 2002, in connection with the STARs, Series 2002-1 transaction,
the Company paid a premium of $13.7 million for an interest rate cap. Using the
"caplet" methodology discussed above, amortization of the cap premium is
dependent upon the actual value of the cap over time.

In connection with STARs, Series 2000-1 in May 2000, the Company entered
into a LIBOR interest rate cap struck at 10.00% in the notional amount of
$312.0 million, and simultaneously sold a LIBOR interest rate cap with the same
terms. Since these instruments did not change the Company's net interest rate
risk exposure, they did not qualify as hedges and changes in their respective
values were charged to earnings. As the terms of these arrangements were
substantially the same, the effects of a revaluation of these two instruments
substantially offset one another. On May 28, 2002, these instruments were
settled and are no longer outstanding.

Certain of the Company's corporate tenant lease joint ventures have hedging
activities which are more fully described in Note 6 to the Company's
Consolidated Financial Statements.

OFF-BALANCE SHEET TRANSACTIONS--The Company is not dependent on the use of
any off-balance sheet financing arrangements for liquidity. As of September 30,
2002, the Company had investments in three corporate tenant lease joint ventures
that are accounted for under the equity method which had total debt obligations
outstanding of approximately $177.1 million. The Company's pro rata share of the
ventures' third-party debt was approximately $77.5 million (see Note 6 to the
Company's Consolidated Financial Statements). These ventures were formed for the
purpose of operating, acquiring and in certain cases, developing corporate
tenant lease facilities. The debt obligations of these joint ventures are
non-recourse to the ventures and the Company and mature between fiscal years
2004 and 2011. As of September 30, 2002, they consisted of six term loans
bearing fixed rates per annum ranging from 7.61% to 8.43% and one variable-rate
term loan with a rate of LIBOR + 1.25% per annum.

RATINGS TRIGGERS--On July 27, 2001, the Company completed a $300.0 million
unsecured revolving credit facility with a group of leading financial
institutions. The new facility has an initial maturity of July 2003 with a
one-year extension at the Company's option and another one-year extension at the
lenders' option. The new facility replaces two prior credit facilities maturing
in 2002 and 2003, and bears interest at LIBOR + 2.125% based on the Company's
senior unsecured credit ratings of BB+ from S&P, Ba1 from Moody's and BBB- from
Fitch Ratings. If the Company achieves a higher rating from either S&P or
Moody's, the facility's interest rate will improve to LIBOR + 2.00%. If the
Company's credit rating is downgraded by any of the rating agencies (regardless
of how far), the facility's interest rate will increase to LIBOR + 2.25%. In the
event the Company receives two credit ratings that are not equivalent, the
spread over LIBOR shall be determined by the lower of the two

48

such ratings. As of September 30, 2002, no amounts have yet been drawn on this
facility. Accordingly, management does not believe any rating changes would have
a material adverse impact on the Company's results of operations. There are no
other ratings triggers in any of the Company's debt instruments or other
operating or financial agreements.

During the three months ended September 30, 2002, the Company's senior
unsecured credit rating was upgraded to an investment grade rating of BBB- from
BB+ by Fitch Ratings. In addition, Moody's and S&P raised their ratings outlook
for the Company's senior unsecured credit rating to "positive."

DRIP PROGRAM--The Company maintains a dividend reinvestment and direct stock
purchase plan. Under the dividend reinvestment component of the plan, the
Company's shareholders may purchase additional shares of Common Stock without
payment of brokerage commissions or service charges by automatically reinvesting
all or a portion of their Common Stock cash dividends. Under the direct stock
purchase component of the plan, the Company's shareholders and new investors may
purchase shares of Common Stock directly from the Company without payment of
brokerage commissions or service charges. All purchases of shares in excess of
$10,000 per month pursuant to the direct purchase component are at the Company's
sole discretion. Shares issued under the plan may reflect a discount of up to
3.00% from the prevailing market price of the Company's Common Stock. The
Company is authorized to issue up to 8.0 million shares of Common Stock pursuant
to the dividend reinvestment and direct stock purchase plan. During the
three-month periods ended September 30, 2002 and 2001, the Company issued a
total of 369,609 and 11,239 shares of its Common Stock, respectively, and during
the nine-month periods ended September 30, 2002 and 2001, the Company issued a
total of 1,597,429 and 24,008 shares of its Common Stock, respectively, through
the direct stock purchase component of the plan. Net proceeds during the
three-month periods ended September 30, 2002 and 2001 were approximately
$10.4 million and $297,088, respectively, and $43.9 million and $624,149 during
the nine-month periods ended September 30, 2002 and 2001, respectively.

STOCK REPURCHASE PROGRAM--The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets or loan
repayments and excess cash flow from operations, but also using borrowings under
its credit facilities if the Company determines that it is advantageous to do
so. The only repurchase the Company has made under this program since
November 2000, has been 250,000 shares during the three months ended
September 30, 2002. As of September 30, 2002 and December 31, 2001, the Company
had repurchased approximately 2.6 million shares and 2.3 million shares,
respectively, at an aggregate cost of approximately $48.0 million and
$40.7 million, respectively.

CRITICAL ACCOUNTING POLICIES

The Company's Consolidated Financial Statements include the accounts of the
Company and all majority-owned and controlled subsidiaries. The preparation of
financial statements in accordance with GAAP requires management to make
estimates and assumptions in certain circumstances that affect amounts reported
in the accompanying consolidated financial statements. 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. The Company does not believe that there is a great likelihood
that materially different amounts would be reported related to the accounting
policies described below. 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.

Management has the obligation to ensure that its policies and methodologies
are in accordance with GAAP. During the nine months ended September 30, 2002,
management reviewed and evaluated its critical accounting policies, as further
disclosed in the Company's December 31, 2001 Form 10-K, and believes them to be
appropriate. The Company's accounting policies are described in Note 3 to the

49

Company's Consolidated Financial Statements. The following are significant
events relating to critical accounting policies during the nine months ended
September 30, 2002:

EXECUTIVE COMPENSATION--The Company's accounting policies generally provide
cash compensation to be estimated and recognized over the period of service.
With respect to stock-based compensation arrangements, as of July 1, 2002 (with
retroactive application to the beginning of the calendar year), the Company has
adopted the fair value method allowed under SFAS No. 123, which values options
on the date of grant and recognizes an expense equal to the fair value of the
option multiplied by the number of options granted over the related service
period. Prior to the third quarter 2002, the Company elected to use APB 25
accounting, which measured the compensation charges based on the intrinsic value
of such securities when they become fixed and determinable, and recognized such
expense over the related service period. These arrangements are often complex
and generally structured to align the interests of management with those of the
Company's shareholders. See Note 10 to the Company's Consolidated Financial
Statements for a detailed discussion of such arrangements and the related
accounting effects.

During 2001, the Company entered into new three-year employment agreements
with its Chief Executive Officer and its President. See Note 10 to the Company's
Consolidated Financial Statements for a more detailed description of both
employment agreements.

The following is a hypothetical illustration of the effects on the Company's
net income and adjusted earnings of the full vesting of phantom units under the
employment agreement with the Chief Executive Officer. During the nine months
ended September 30, 2002, 1,000,000 of the phantom shares awarded to the Chief
Executive Officer were contingently vested. Absent an earlier change of control
or termination of employment, these 1,000,000 shares will not become fully
vested until March 31, 2004. Assuming that the market price of the Common Stock
on March 31, 2004 is $27.92 (which was the market price of the Common Stock on
September 30, 2002), the Company would incur a one-time charge to both net
income and adjusted earnings at that time equal to $27.9 million (the fair
market value of the 1,000,000 shares at $27.92 per share).

On April 29, 2002, the 500,000 unvested restricted shares awarded to the
President became contingently vested as the total shareholder return exceeded
60.00% and became fully vested on September 30, 2002 as all employment
contingencies were met. The Company incurred a non-cash charge of approximately
$15.0 million related to these vested shares, recognized ratably over the
service period from the date of contingent vesting through September 30, 2002.
Accordingly, the non-cash charge recognized for the three and nine months ended
September 30, 2002 was approximately $8.9 million and $15.0 million,
respectively.

NEW ACCOUNTING STANDARDS

In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards for
derivative financial instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as:
(1) a hedge of the exposure to changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment; (2) a hedge of the exposure to
variable cash flows of a forecasted transaction; or (3) in certain circumstances
a hedge of a foreign currency exposure. On January 1, 2001, the Company adopted
this pronouncement, as amended by Statement of Financial Accounting Standards
No. 137 "Accounting for Derivative Instruments and Hedging Activities--Deferral
of the Effective Date of FASB Statement No. 133" and Statement of Financial
Accounting Standards No. 138 "Accounting for Certain Hedging Activities--an
Amendment of FASB No. 133." Because the Company has primarily used derivatives
as cash flow hedges of interest rate risk only, the adoption of SFAS No. 133 did
not have a material financial impact on the financial position and results of
operations of the Company. However, should the Company change its current use of
such

50

derivatives, the adoption of SFAS No. 133 could have a more significant effect
on the Company prospectively.

In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140 ("SFAS No. 140"), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities." This statement is
applicable for transfers of assets and extinguishments of liabilities occurring
after June 30, 2001. The Company adopted the provisions of this statement as
required for all transactions entered into on or after April 1, 2001. The
adoption of SFAS No. 140 did not have a significant impact on the Company.

In July 2001, the SEC released Staff Accounting Bulletin No. 102 ("SAB
102"), "Selected Loan Loss Allowance and Documentation Issues." SAB 102
summarizes certain of the SEC's views on the development, documentation and
application of a systematic methodology for determining allowances for loan and
lease losses. Adoption of SAB 102 by the Company did not have a significant
impact on the Company.

In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 ("SFAS No. 141"), "Business Combinations" and Statement of Financial
Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible
Assets." SFAS No. 141 requires the purchase method of accounting to be used for
all business combinations initiated after June 30, 2001. SFAS No. 141 also
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in business combinations and requires intangible
assets to be recognized apart from goodwill if certain tests are met. SFAS
No. 142 requires that goodwill not be amortized but instead be measured for
impairment at least annually, or when events indicate that there may be an
impairment. The Company adopted the provisions of both statements, as required,
on January 1, 2002 and the adoption did not have a significant impact on the
Company.

In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144 provides new guidance on the recognition of
impairment losses on long-lived assets to be held and used or to be disposed of,
and also broadens the definition of what constitutes a discontinued operation
and how the results of a discontinued operation are to be measured and
presented. SFAS No. 144 requires that current operations prior to the
disposition of corporate tenant lease assets and prior period results of such
operations be presented in discontinued operations in the Company's Consolidated
Statements of Operations. The provisions of SFAS No. 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and must be applied at the beginning of a fiscal year. The Company adopted the
provisions of this statement on January 1, 2002, as required, and it did not
have a significant financial impact on the Company.

In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145
rescinds both FASB Statements No. 4 ("SFAS No. 4"), "Reporting Gains and Losses
from Extinguishment of Debt," and the amendment to SFAS No. 4, FASB Statement
No. 64 ("SFAS No. 64"), "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." Through this rescission, SFAS No. 145 eliminates the requirement
(in both SFAS No. 4 and SFAS No. 64) that gains and losses from the
extinguishment of debt be aggregated and, if material, classified as an
extraordinary item, net of the related income tax effect. An entity is not
prohibited from classifying such gains and losses as extraordinary items, so
long as they meet the criteria in paragraph 20 of Accounting Principles Board
Opinion No. 30 ("APB 30"), "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions"; however, due to the nature of
the Company's operations, such treatment may not be available to the Company.
Any gains or losses on extinguishments of debt that were previously classified
as extraordinary items in prior periods presented that do not meet the criteria
in APB 30 for classification as an extraordinary item will be reclassified to
income from continuing operations. The provisions of SFAS No. 145 are effective
for financial

51

statements issued for fiscal years beginning after May 15, 2002. The Company
will adopt the provisions of this statement, as required, on January 1, 2003.

In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 ("SFAS No. 146"), "Accounting for Exit or Disposal Activities," to
address significant issues regarding the recognition, measurement, and reporting
of costs that are associated with exit and disposal activities, including
restructuring activities that are currently accounted for pursuant to the
guidance that the Emerging Issues Task Force ("EITF") has set forth in EITF
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The scope of SFAS No. 146 also includes: (1) costs related to
terminating a contract that is not a capital lease; and (2) termination benefits
that employees who are involuntarily terminated receive under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an
individual deferred-compensation contract. The provisions of SFAS No. 146 are
effective for exit or disposal activities that are initiated after December 31,
2002. The Company does not expect SFAS No. 146 to have a material effect on the
Company's Consolidated Financial Statements.

In September 2002, the FASB issued Statement of Financial Accounting
Standards No. 147 ("SFAS No. 147"), "Acquisitions of Certain Financial
Institutions," an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9. SFAS No. 147 provides guidance on the accounting for the
acquisitions of financial institutions, except those acquisitions between two or
more mutual enterprises. SFAS No. 147 removes acquisitions of financial
institutions from the scope of both FASB No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," and FASB Interpretation No. 9,
Applying APB Opinions No. 16 and 17, "When a Savings and Loan Association or a
Similar Institution Is Acquired in a Business Combination Accounted for by the
Purchase Method," and requires that those transactions be accounted for in
accordance with SFAS No. 141 and SFAS No. 142. SFAS No. 147 also amends SFAS
No. 144, to include in its scope long-term, customer-relationship intangible
assets of financial institutions such as depositor-relationship and
borrower-relationship intangible assets and credit cardholder intangible assets.
The Company will adopt the provisions of this statement, as required, on
October 1, 2002. The Company does not expect SFAS No. 147 to have a material
effect on the Company's Consolidated Financial Statements.

52

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Company's Securities
and Exchange Act of 1934 (the "Exchange Act") reports is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to the
Company's management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure. The Company has formed a Disclosure Committee that is responsible
for considering the materiality of information and determining the disclosure
obligations of the Company on a timely basis. The Disclosure Committee reports
directly to the Company's Chief Executive Officer and Chief Financial Officer.
The Chief Financial Officer is currently a member of the Disclosure Committee.

Within the 90-day period prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Disclosure Committee and other members of management, including its Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective to timely alert them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's Exchange Act filings.

There have been no significant changes in the Company's internal controls or
in other factors that could significantly affect internal controls subsequent to
the date that the Company carried out its evaluation.

53

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

A. EXHIBITS

3.3 Articles Supplementary for the High Performance Common
Stock-Series 1.

3.4 Articles Supplementary for the High Performance Common
Stock-Series 2.

3.5 Articles Supplementary for the High Performance Common
Stock-Series 3.

B. REPORTS ON FORM 8-K

On August 14, 2002, a Current Report on Form 8-K was filed which included
the certification of the Company's chief executive officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

54

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

iSTAR FINANCIAL INC.

REGISTRANT

Date: November 14, 2002
--------------------------------------------------
Jay Sugarman
CHAIRMAN OF THE BOARD OF DIRECTORS AND
CHIEF EXECUTIVE OFFICER

Date: November 14, 2002
--------------------------------------------------
Spencer B. Haber
PRESIDENT, CHIEF FINANCIAL OFFICER, DIRECTOR AND
SECRETARY

55

CERTIFICATIONS

I, Jay Sugarman, certify that:

1. I have reviewed this quarterly report on Form 10-Q of iStar
Financial Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared; b.evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date: November 14, 2002 ------------------------------------------------
Name: Jay Sugarman
Title: Chief Executive Officer

56

I, Spencer B. Haber, certify that:

1. I have reviewed this quarterly report on Form 10-Q of iStar
Financial Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date: November 14, 2002 ------------------------------------------------
Name: Spencer B. Haber
Title: Chief Financial Officer