AMERICAN REALTY INVESTORS INC - 10-K Annual Report

Back to GetFilings.com

================================================================================

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

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

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the Year Ended December 31, 2002
Commission File Number 1-15663

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

American Realty Investors, Inc.
(Exact Name of Registrant as Specified in Its Charter)

Nevada 75-2847135
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

1800 Valley View Lane, Suite 300,
Dallas, Texas 75234
(Address of Principal Executive Offices) (Zip Code)

(469) 522-4200
(Registrant's Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange on
Common Stock, $.01 par which registered
value New York Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act:

NONE

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]

The aggregate market value of the shares of voting and non-voting common
equity held by non-affiliates of the Registrant, computed by reference to the
closing sales price of the Common Stock on the New York Stock Exchange as of
June 28, 2002 (the last business day of the Registrant's most recently
completed second fiscal quarter) was $25,700,922 based upon a total of
2,302,950 shares held as of June 28, 2002 by persons believed to be
non-affiliates of the Registrant. The basis of the calculation does not
constitute a determination by the Registrant as defined in Rule 405 of the
Securities Act of 1933, as amended, such calculation, if made as of a date
within sixty days of this filing would yield a different value. As of March 19,
2003, there were 11,375,127 shares of common stock outstanding.

Documents Incorporated by Reference:

Consolidated Financial Statements of Income Opportunity Realty Investors, Inc.;
Commission File No. 1-14784
Consolidated Financial Statements of Transcontinental Realty Investors, Inc.;
Commission File No. 1-9240

================================================================================

INDEX TO
ANNUAL REPORT ON FORM 10-K

Page
----

PART I

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

Item 2. Properties........................................................................... 7

Item 3. Legal Proceedings.................................................................... 21

Item 4. Submission of Matters to a Vote of Security Holders.................................. 21

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................ 22

Item 6. Selected Financial Data.............................................................. 25

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 26

Item 7A. Quantitative and Qualitative Disclosures Regarding Market Risk....................... 40

Item 8. Consolidated Financial Statements and Supplementary Data............................. 41

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 93

PART III

Item 10. Directors, Executive Officers and Advisor of the Registrant.......................... 93

Item 11. Executive Compensation............................................................... 97

Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 99

Item 13. Certain Relationships and Related Transactions....................................... 100

PART IV

Item 14. Controls and Procedures.............................................................. 107

Item 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.................... 107

Signature Page................................................................................ 109

2

PART I

ITEM 1. BUSINESS

In August 2000, American Realty Investors, Inc. ("ARI"), a Nevada
corporation, acquired American Realty Trust, Inc. ("ART"), a Georgia
corporation and National Realty, L.P. ("NRLP"), a Delaware partnership.

On November 3, 1999, ART and NRLP jointly announced the agreement of their
respective Boards to combine, in a tax-free exchange, under a new company, ARI.
Prior to December 31, 1998, ART accounted for its investment in NRLP under the
equity method. As of December 31, 1998, upon the election of a wholly-owned
subsidiary of ART as general partner of NRLP, ART began consolidation of NRLP's
accounts at that date and consolidation of its operations subsequent to that
date.

The acquisition transaction was closed on August 2, 2000. NRLP unitholders,
except for ART, received one share of ARI Common Stock for each unit of NRLP
held. ART stockholders received .91 shares of ARI Common Stock for each share
of ART Common Stock held. Each share of ART Preferred Stock was converted into
one share of Preferred Stock of ARI, having substantially the same rights as
ART's preferred stock. The ART shares of Common Stock ceased trading on the New
York Stock Exchange on August 2, 2000. The NRLP units of limited partner
interest ceased trading on the American Stock Exchange on August 2, 2000. ARI
Common Stock commenced trading on the New York Stock Exchange on August 3,
2000. ART and NRLP became wholly-owned subsidiaries of ARI. For financial
reporting purposes, the transaction is treated as the purchase of NRLP by ART;
accordingly, the historical information presented for ARI is that of ART.

On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. ("TCI"),
and Income Opportunity Realty Investors, Inc. ("IORI") jointly announced a
preliminary agreement with the plaintiff's legal counsel of the derivative
action entitled Olive et al. V. National Income Realty Trust, et al. for
complete settlement of all disputes in the lawsuit (the "Olive Litigation"). In
February 2002, the court granted final approval of the proposed settlement (the
"Olive Settlement"). Under the Olive Settlement, ARI agreed to either (i)
acquire all of the outstanding shares of IORI and TCI not currently owned by
ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender
offer for all of the outstanding shares of IORI and TCI not currently owned by
ARI. On November 15, 2002, ARI commenced the tender offer for the IORI and TCI
shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash
per IORI share and $17.50 cash per TCI share for the stock held by non
affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036
IORI shares and 1,213,226 TCI shares. The completion of the tender offer
fulfills the obligations under the Olive Settlement, and the Olive Litigation
has been dismissed with prejudice.

After the tender offers, ARI owned 64.8% of the outstanding shares of TCI
and 46.9% of the outstanding shares of IORI. ARI has the same advisor as TCI
and IORI, and TCI and IORI have the same board of directors. Two of the
directors of TCI and IORI also serve as directors of ARI.

Business Plan and Investment Policy

ARI's primary business is investing in equity interests in real estate
(including equity securities of real estate-related entities), leases, joint
venture development projects and partnerships and, to a lesser extent,
financing real estate and real estate activities through investments in
mortgage loans, including first, wraparound and junior mortgage loans.
Information regarding the real estate and mortgage notes receivable portfolios
of ARI is set forth in ITEM 2. "PROPERTIES" and in Schedules III and IV to the
Consolidated Financial Statements included at ITEM 8. "CONSOLIDATED FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA."

ARI, through its wholly owned subsidiary, Milano Restaurants International,
Inc. ("MRI"), operates and franchises several quick-service restaurant concepts
including pizzerias featuring pizza delivery, carry-out and dine-in under the
trademarks "Me-N-Ed's Pizzerias," "Me-N-Ed's Slices" and "Angelo & Vito's
Pizzerias". The first Me-N-Ed's Pizzeria opened in 1958. At December 31, 2002,
there were 58 restaurants in operation,

3

consisting of 46 owned and 12 franchised. Three of the restaurants were located
in Texas and the remainder were in California. In addition to the Pizzerias,
MRI has developed two new concepts: Pizzeria del Pane, a bakery/ cafe concept
and Zia Mia's Cucina Italiana, a full service Italian restaurant to open in
2003.

ARI's businesses are not seasonal. With regard to real estate investments,
ARI is seeking both current income and capital appreciation. ARI's plan of
operation is to continue, to the extent its liquidity permits, to make equity
investments in income producing real estate such as hotels, apartments or
commercial properties or equity securities of real estate-related entities. ARI
also intends to continue to pursue higher risk, higher reward investments, such
as improved and unimproved land where it can obtain financing of substantially
all of a property's purchase price. ARI intends to seek selected dispositions
of certain of its assets, in particular, selected income producing properties
in stabilized markets and certain of its land holdings where the prices
obtainable for such assets justify their disposition. ARI has determined that
it will no longer actively seek to fund or purchase mortgage loans. However, it
may, in selected instances, originate mortgage loans or it may provide purchase
money financing in conjunction with a property sale. See ITEM 2. "PROPERTIES"
and Schedules III and IV to the Consolidated Financial Statements included in
ITEM 8. "CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA."

On June 30, 2002, ARI obtained 74.31% interest in Realty Advisors Korea,
Ltd. ("RAK"), a Korean real estate advisory company, from Basic Capital
Management, Inc. ("BCM"), which is the contractual advisor to ARI and a related
party, for $6.0 million. The business purpose of the transaction was to reduce
the affiliate payable owed by BCM to ARI. ARI's receivable from BCM was reduced
by $6.0 million, and no cash was paid by ARI. At the date of acquisition, RAK's
assets consisted of $2.3 million in cash, $3.0 million in deposits and
marketable securities, and $225,000 in other assets. RAK's net equity was $5.5
million. ARI recorded $1.9 million in goodwill as a result of this transaction.
RAK was incorporated in July 2001. RAK will serve as an advisor to a "corporate
restructuring vehicle" Real Estate Investment Trust ("CR-REIT") that will
initially invest in office buildings in Korea and throughout the world. The
CR-REIT's objective is to increase its market capitalization to $400 million in
managed properties by the end of 2003. Realty Korea CR-REIT Co., Ltd. No. 1,
that is advised by RAK, obtained preliminary approval from the South Korean
government in March 2003.

ARI's Board of Directors has broad authority under ARI's governing documents
to make all types of investments, and may devote available assets to particular
investments or types of investments, without restriction on the amount or
percentage of assets that may be allocated to a single investment or to any
particular type of investment, and without limit on the percentage of
securities of any one issuer that may be acquired. Investment objectives and
policies may be changed at any time by the Board without stockholder approval.

The specific composition of ARI's real estate portfolio will depend largely
on the judgment of management as to changing investment opportunities and the
level of risk associated with specific investments or types of investments.
Management intends to attempt to maintain a real estate portfolio diversified
by location and type of property.

In addition to its equity investments in real estate, ARI has also invested
in private and open market purchases of the equity securities of IORI and TCI,
both affiliates of ARI. See ITEM 2. "PROPERTIES--Investments in Real Estate
Companies and Real Estate Partnerships."

Management of the Company

Although the Board of Directors is directly responsible for managing the
affairs of ARI and for setting the policies which guide it, its day-to-day
operations are performed by BCM, a contractual advisor under the supervision of
the Board. The duties of BCM include, among other things, locating,
investigating, evaluating and recommending real estate and mortgage note
investment and sales opportunities, as well as financing and refinancing
sources. BCM also serves as a consultant in connection with ARI's business plan
and investment policy decisions made by the Board. BCM is indirectly owned by a
trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or
director of BCM, but serves as a representative of the trust, is involved in
daily

4

consultation with the officers of BCM and has significant influence over the
conduct of BCM's business, including the rendering of advisory services and the
making of investment decisions for itself and ARI. As of March 19, 2003, BCM
owned 6,666,744 shares of ARI's Common Stock, approximately 58.6% of the shares
then outstanding. BCM is more fully described in ITEM 10. "DIRECTORS, EXECUTIVE
OFFICERS AND ADVISOR OF THE REGISTRANT--The Advisor."

BCM has been providing advisory services to ARI since February 6, 1989. BCM
also serves as advisor to IORI and TCI. The officers of ARI are also officers
of IORI, TCI and BCM. Two of the Directors of ARI also serve as directors of
IORI and TCI. Affiliates of BCM have provided property management services to
ARI. Currently, Triad Realty Services, Ltd. ("Triad"), an affiliate, and Carmel
Realty, Inc. ("Carmel") provide such property management services. Triad and
Carmel subcontract with other entities for property-level management services.
The general partner of Triad is BCM. The limited partner of Triad is Highland
Realty Services, Inc. ("Highland"), a related party. Until December 2002, Triad
subcontracted the property-level management and leasing of 12 of ARI's
commercial properties (shopping centers, office buildings and a merchandise
mart) to Regis Realty, Inc. ("Regis"), a related party, which was a company
owned by GS Realty Services, Inc. Regis was entitled to receive property and
construction management fees and leasing commissions in accordance with the
terms of its property-level management agreement with Triad. Since January 1,
2003, Regis Realty I, LLC ("Regis I"), has provided these services. Regis I is
owned by Highland. Regis Hotel Corporation, a related party, managed ARI's
eight hotels, until December 2002. Since January 1, 2003, Regis Hotel I, LLC,
has managed ARI's eight hotels. The sole member of Regis I and Regis Hotel I,
LLC is Highland. Carmel is a company owned by First Equity Properties, Inc.,
which is a company affiliated with BCM.

Regis I is also entitled to receive real estate brokerage commissions in
accordance with the terms of the Advisory Agreement as discussed in ITEM 10.
"DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT--The Advisor."

ARI has no employees itself, but MRI has 861 employees and RAK has eight
employees. Employees of BCM render services to ARI.

Competition

Real Estate. The real estate business is highly competitive, and ARI
competes with numerous entities engaged in real estate activities (including
certain entities described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS--Related Party Transactions"), some of which have greater
financial resources than ARI. Management believes that success against such
competition is dependent upon the geographic location of the property, the
performance of property-level managers in areas such as marketing, collections
and control of operating expenses, the amount of new construction in the area
and the maintenance and appearance of the property. Additional competitive
factors with respect to commercial properties are the ease of access to the
property, the adequacy of related facilities, such as parking, and sensitivity
to market conditions in setting rent levels. With respect to apartments,
competition is also based upon the design and mix of the units and the ability
to provide a community atmosphere for the tenants. With respect to hotels,
competition is also based upon the market served, i.e., transient, commercial
or group users. Management believes that beyond general economic circumstances
and trends, the rate at which properties are renovated or the rate new
properties are developed in the vicinity of each of ARI's properties, in
particular its improved and unimproved land, are also competitive factors.

To the extent that ARI seeks to sell any of its properties, the sales prices
for the properties may be affected by competition from other real estate
entities and financial institutions, also attempting to sell properties in
areas where ARI's properties are located, as well as aggressive buyers
attempting to dominate or penetrate a particular market.

5

As described above and in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS--Related Party Transactions," the officers of ARI also serve as
officers of IORI and TCI, both of which are also advised by BCM, and both of
which have business objectives similar to ARI's. ARI's officers and advisor owe
fiduciary duties to both IORI and TCI as well as to ARI under applicable law.
In determining whether a particular investment opportunity will be allocated to
ARI, IORI or TCI, management and the advisor consider the respective investment
objectives of each and the appropriateness of a particular investment in light
of the existing real estate and mortgage notes receivable portfolios of each.
To the extent that any particular investment opportunity is appropriate to more
than one of the entities, the investment opportunity will be allocated to the
entity which has had funds available for investment for the longest period of
time or, if appropriate, the investment may be shared among all or some of the
entities.

In addition, also as described in ITEM 13. "CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS," ARI also competes with entities which are affiliates of
BCM having similar investment objectives in the purchasing, selling, leasing
and financing of real estate and real estate-related investments. In resolving
any potential conflicts of interest which may arise, BCM has informed ARI that
it intends to continue to exercise its best judgment as to what is fair and
reasonable under the circumstances in accordance with applicable law.

ARI is subject to all the risks incident to ownership and financing of real
estate and interests therein, many of which relate to the general illiquidity
of real estate investments. These risks include, but are not limited to,
changes in general or local economic conditions, changes in interest rates and
availability of permanent mortgage financing which may render the purchase,
sale or refinancing of a property difficult or unattractive and which may make
debt service burdensome, changes in real estate and zoning laws, increases in
real estate taxes, federal or local economic or rent controls, floods,
earthquakes, hurricanes and other acts of God and other factors beyond the
control of management or the advisor. The illiquidity of real estate
investments may also impair the ability of management to respond promptly to
changing circumstances. Management believes that such risks are partially
mitigated by the diversification by geographic region and property type of
ARI's real estate and mortgage notes receivable portfolios. However, to the
extent that property sales, new property investments, in particular improved
and unimproved land, or mortgage lending are concentrated in any particular
region the advantages of geographic diversification are mitigated.

Virtually all of ARI's real estate, equity security holdings in IORI and TCI
and its trading portfolio of equity securities are held subject to secured
indebtedness. Such borrowings increase the risk of loss because they represent
a prior claim on ARI's assets and require fixed payments regardless of
profitability. In the event of default, the lender may foreclose on the assets
securing such indebtedness, and ARI could lose its investment in the pledged
assets.

Pizza Parlors. The pizza parlor business is highly competitive and is
affected by changes in consumer tastes and eating habits, as well as national,
regional and local economic conditions, and demographic trends. The performance
of an individual pizza parlor can be affected by changes in traffic patterns,
demographics, and the type, number and location of competing restaurants.

The quick-service restaurant industry is extremely competitive with respect
to price, service, location and food quality. MRI and its franchisees compete
with a variety of other restaurants in the quick-service restaurant industry,
including those that offer dine-in, carry-out and delivery services. These
competitors include national and regional chains, franchisees of other
restaurant chains and local owner-operated restaurants. Some of these
competitors have been in existence longer and have an established market
presence in certain geographic regions, and some have substantially greater
financial, marketing and other resources than MRI and its franchisees. MRI
competes for qualified franchisees with many other restaurant concepts,
including national and regional restaurant chains.

6

MRI's success is largely dependent upon the efforts of its management and
other key personnel. The loss of the service of one or more members of
management could have an adverse effect on MRI's operations. Significant
transitions in management involve important risks, including potential loss of
key personnel, difficulties in implementing changes to operational strategies
and maintaining relationships with franchisees.

At December 31, 2002, MRI owned and operated 46 and franchised 12 pizza
parlors. The results achieved by MRI's relatively small pizza parlor base may
not be indicative of the results of a larger number of pizza parlors in a more
geographically dispersed area. Because of MRI's relatively small pizza parlor
base, an unsuccessful pizza parlor has a more significant effect on MRI's
results of operations than would be the case in a company owning more pizza
parlors.

MRI's existing pizza parlors, both owned and franchised, are located in
California or Texas. At December 31, 2002, there were 55 pizza parlors in
California and three in Texas. Accordingly, MRI's results of operations may be
affected by economic or other conditions in those regions. Also, given MRI's
present geographic concentration, publicity relating to MRI's pizza parlors
could have a more pronounced effect on MRI's overall sales than might be the
case if MRI's pizza parlors were geographically dispersed.

All of MRI's owned pizza parlors are operated on premises leased from third
parties. Most of the pizza parlor leases provide for a minimum annual rent.
There can be no assurance that MRI will be able to renew leases upon expiration
or that the lease terms upon renewal will be as favorable as the current lease
terms. In 2002, MRI opened two new company-owned stores, bought two stores from
franchisees, sold four company-owned stores to franchisees, sold one
company-owned store to another pizza company and distributed two franchised
stores to a former partner upon dissolution of a partnership. In 2003, MRI
plans to construct and open four new company-owned stores.

ITEM 2. PROPERTIES

ARI's principal offices are located at 1800 Valley View Lane, Suite 300,
Dallas, Texas 75234 and are, in the opinion of management, suitable and
adequate for ARI's present operations.

Details of ARI's real estate and mortgage notes receivable portfolios at
December 31, 2002, are set forth in Schedules III and IV, respectively, to the
Consolidated Financial Statements included at ITEM 8. "CONSOLIDATED FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA." The discussions set forth below under the
headings "Real Estate" and "Mortgage Loans" provide certain summary information
concerning ARI's real estate and mortgage notes receivable portfolios.

At December 31, 2002, no single asset accounted for 10% or more of total
assets. At December 31, 2002, 65% of ARI's assets consisted of real estate, 12%
consisted of notes and interest receivable, 11% consisted of investments in
equity investees, including IORI and TCI, and 3% consisted of pizza parlor
equipment and goodwill. The remaining 9% of ARI's assets were cash, cash
equivalents, marketable equity securities, other intangibles and other assets.
The percentage of assets invested in any one category is subject to change and
no assurance can be given that the composition of ARI's assets in the future
will approximate the percentages listed above.

ARI's real estate is geographically diverse. At December 31, 2002, ARI's
real estate was located in all geographic regions of the continental United
States, other than the Northeast region, as shown more specifically in the
table under "Real Estate" below. ARI also holds mortgage notes receivable
secured by real estate located in the Southeast, Southwest, Pacific and Midwest
regions of the continental United States. See SCHEDULE IV to the Consolidated
Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA" for a detailed description of ARI's notes receivable
portfolio.

7

Geographic Regions

[GEOGRAPHIC REGION MAP]

Northeast region comprised of the states of Connecticut,
Delaware, Maryland, Massachusetts, New Hampshire, New Jersey,
New York,Pennsylvania, Rhode Island and Vermont, and the
District of Columbia. ARI has no properties in this region.

Southeast region comprised of the states of Alabama, Florida,
Georgia, Mississippi, North Carolina, South Carolina,
Tennessee and Virginia. ARI has 21 apartments, 3 commercial
properties and 2 hotels in this region.

Southwest region comprised of the states of Arizona, Arkansas,
Louisiana, New Mexico, Oklahoma and Texas. ARI has 9
apartments and 6 commercial properties in this region.

Midwest region comprised of the states of Illinois, Indiana,
Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri,
Nebraska, North Dakota, Ohio, South Dakota, West Virginia and
Wisconsin. ARI has 5 apartments, 1 commercial properties and
1 hotel in this region.

Mountain region comprised of the states of Colorado, Idaho,
Montana, Nevada, Utah and Wyoming. ARI has 2 commercial
properties and 1 hotel in this region.

Pacific region comprised of the states of Alaska, California,
Hawaii, Oregon and Washington. ARI has 2 commercial properties
and 4 hotels in this region.

- --------

Excluded from above are 41 parcels of improved and unimproved land, a hotel
in Sofia, Bulgaria and a single family residence, as described below.

Real Estate

At December 31, 2002, 77% of ARI's assets were invested in real estate and
the equity securities of IORI and TCI. ARI invests in real estate located
throughout the continental United States, either on a leveraged or nonleveraged
basis. ARI's real estate portfolio consists of properties held for investment,
investments in partnerships, properties held for sale and investments in equity
securities of IORI and TCI.

Types of Real Estate Investments. ARI's real estate consists of apartments,
commercial properties (office buildings, shopping centers and a merchandise
mart), hotels and improved and unimproved land. In selecting real estate for
investment, the location, age and type of property, gross rents, lease terms,
financial and business standing of tenants, operating expenses, fixed charges,
land values and physical condition are among the factors considered. Properties
may be purchased subject to debt, or existing debt may be assumed and
properties may be mortgaged, pledged or otherwise collateralized to obtain
financing. The Board of Directors may alter the types of and criteria for
selecting new real estate investments and for obtaining financing without a
vote of stockholders.

Although ARI has typically invested in developed real estate, it may also
invest in new construction or development either directly or in partnership
with nonaffiliated parties or affiliates (subject to approval by the Board of
Directors). To the extent that it invests in construction and development
projects, such as Four Hickory Centre described below, ARI is subject to
business risks, such as cost overruns and construction delays, associated with
such higher risk projects.

8

In the opinion of management, the properties owned by ARI are adequately
covered by insurance.

The following table sets forth the percentages, by property type and
geographic region, of owned real estate (excluding 41 parcels of improved and
unimproved land, a hotel in Sofia, Bulgaria and a single family residence,
described below) at December 31, 2002.

Commercial
Region Apartments Properties Hotels
------ ---------- ---------- ------

Midwest....... 22% 16% 14%
Mountain...... -- 39 11
Pacific....... -- 11 46
Southeast..... 44 15 29
Southwest..... 34 19 --
--- --- ---
100% 100% 100%
=== === ===

The foregoing table is based solely on the number of apartment units, amount
of commercial square footage and number of hotel rooms owned and does not
reflect the value of ARI's investment in each region. See Schedule III to the
Consolidated Financial Statements included in ITEM 8. "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA" for a detailed description of owned real estate.

Excluded from the table above are a 136 room hotel in Sofia, Bulgaria, a
single family residence in Dallas, Texas and 41 parcels of improved and
unimproved land consisting of: a 44.4 acre land parcel in Las Colinas, Texas;
seven parcels of land in Dallas County, Texas, totaling 392.4 acres; four
parcels of land in Irving, Texas, totaling 278.5 acres; an 82.4 acre land
parcel in Oceanside, California; four parcels of land in Tarrant County, Texas,
totaling 129.8 acres; a 130.6 acre land parcel in Harris County, Texas; a 20.6
acre land parcel in Collin County, Texas; eight parcels of land in Farmers
Branch, Texas, totaling 83.5 acres; an 11.8 acre land parcel in Plano, Texas; a
1,150.3 acre land parcel in Austin, Texas; a 199.9 acre parcel of land in Palm
Desert, California; a 63.3 acre land parcel in Travis County, Texas; an 84.0
acre parcel of land in Houston, Texas; an 85.2 acre land parcel in Lewisville,
Texas; a 7.6 acre land parcel in Carrollton, Texas; a 113.8 acre land parcel in
Nashville, Tennessee; a 105.4 acre parcel of land in Denton County, Texas; and
five additional land parcels totaling approximately 84.0 acres. See Schedule
III to the Consolidated Financial Statements included at ITEM 8. "FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA" for a detailed description of ARI's real
estate portfolio.

A summary of the activity in the owned real estate portfolio during 2001 is
as follows:

Owned properties at January 1, 2002................................ 133
Properties purchased (excluding additions to existing land parcels) 3
Property obtained in exchange for land and other property.......... 1
Properties exchanged for other properties.......................... (2)
Properties sold (excluding partial sales).......................... (35)
---
Owned properties at December 31, 2002.............................. 100
===

9

Operating Properties. Set forth below are ARI's operating properties and
the monthly rental rate for apartments and the average annual rental rate for
commercial properties and the average daily room rate and room revenue divided
by total available rooms for hotels and occupancy at December 31, 2002, 2001
and 2000 for apartments and commercial properties and average occupancy during
2002, 2001 and 2000 for hotels:

Rent Per Square Foot Occupancy%
-------------------- --------------
Property Location Units/Square Footage 2002 2001 2000 2002 2001 2000
-------- ------------------ ------------------------- ------ ------ ------ ---- ---- ----
Apartments

Arlington Place........ Pasadena, TX 230 Units/205,476 Sq. Ft. $ .75 $ .73 $ .68 94 97 93
Bay Anchor............. Panama City, FL 12 Units/10,700 Sq. Ft. .56 .55 .53 100 100 100
Bridgestone............ Friendswood, TX 76 Units/65,519 Sq. Ft. .74 .71 .68 92 93 99
Chateau................ Bellevue, NE 115 Units/99,220 Sq. Ft. .71 .71 .68 96 94 97
Chateau Bayou.......... Ocean Springs, MS 122 Units/105,536 Sq. Ft. .67 .67 .65 94 97 89
Confederate Point...... Jacksonville, FL 206 Units/277,860 Sq. Ft. .63 .61 .59 95 98 96
Falcon House........... Ft. Walton, FL 82 Units/71,220 Sq. Ft. .65 .64 .63 98 100 95
Foxwood................ Memphis, TN 220 Units/212,000 Sq. Ft. .61 .58 .55 85 91 90
Georgetown............. Panama City, FL 44 Units/36,160 Sq. Ft. .66 .65 .62 100 93 100
Governor Square........ Tallahassee, FL 168 Units/146,550 Sq. Ft. .66 .65 .63 95 95 95
Greenbriar............. Tallahassee, FL 50 Units/36,600 Sq. Ft. .79 .77 .74 92 90 98
La Mirada.............. Jacksonville, FL 320 Units/341,400 Sq. Ft. .56 .56 .54 93 87 88
Lake Chateau........... Thomasville, GA 98 Units/65,800 Sq. Ft. .60 .59 .57 81 81 95
Landings/Marina........ Pensacola, FL 52 Units/34,464 Sq. Ft. .74 .72 .69 96 94 92
Marquis of Vista Ridge. Lewisville, TX 288 Units/238,176 Sq. Ft. .91 * * 46 * *
Mediterranean Villas... San Antonio, TX 140 Units/158,960 Sq. Ft. .55 .55 .50 84 89 96
Northside Villas....... Tallahassee, FL 81 Units/134,000 Sq. Ft. .65 .63 .61 99 93 97
Oak Tree............... Grandview, MO 189 Units/160,591 Sq. Ft. .65 .65 .62 89 91 89
Park Avenue............ Tallahassee, FL 121 Units/78,979 Sq. Ft. .89 .87 .83 98 94 98
Pinecrest.............. North Augusta, SC 120 Units/113,790 Sq. Ft. .50 * * 91 * *
Quail Point............ Huntsville, AL 184 Units/202,602 Sq. Ft. .47 .47 .46 90 89 90
Regency................ Lincoln, NE 106 Units/111,700 Sq. Ft. .64 .63 .62 94 96 93
Rolling Hills.......... Tallahassee, FL 134 Units/115,730 Sq. Ft. .67 .66 .63 95 97 96
Seville................ Tallahassee, FL 62 Units/63,360 Sq. Ft. .61 .59 .57 97 95 97
Sun Hollow............. El Paso, TX 216 Units/156,000 Sq. Ft. .72 .71 .65 91 84 97
Sunset................. Odessa, TX 240 Units/160,400 Sq. Ft. .47 .45 .41 89 88 85
Tiberon Trails......... Merrillville, IN 376 Units/317,821 Sq. Ft. .76 * * 94 * *
Villa Del Mar.......... Wichita, KS 162 Units/128,004 Sq. Ft. .62 .62 .56 86 91 91
Villager............... Ft. Walton, FL 33 Units/22,840 Sq. Ft. .77 .76 .73 88 94 91
Waters Edge III........ Gulfport, MS 238 Units/212,216 Sq. Ft. .63 .63 .62 90 90 92
Westwood............... Mary Ester, FL 120 Units/93,000 Sq. Ft. .72 .71 .63 98 88 93
Whispering Pines....... Topeka, KS 320 Units/299,264 Sq. Ft. .81 .83 .79 91 94 97
Windsor Tower.......... Ocala, FL 64 Units/66,000 Sq. Ft. .55 .54 .50 97 94 98
Woodhollow............. San Antonio, TX 546 Units/348,692 Sq. Ft. .68 .67 .65 84 96 89
Woodlake............... Carrollton, TX 256 Units/210,208 Sq. Ft. .85 .84 .78 89 94 99

Office Buildings
56 Expressway.......... Oklahoma City, OK 54,649 Sq. Ft. 11.43 11.47 11.23 71 66 77
Cooley Building........ Farmers Branch, TX 27,000 Sq. Ft. 11.49 11.69 9.25 100 69 100
Encino Executive Plaza. Encino, CA 177,211 Sq. Ft. 26.60 26.98 25.17 77 65 78
Executive Court........ Memphis, TN 41,840 Sq. Ft. 11.24 11.06 11.04 0 73 100
Four Hickory Centre.... Farmers Branch, TX 226,911 Sq. Ft. ** ** ** ** ** **
One Hickory Centre..... Farmers Branch, TX 102,615 Sq. Ft. 20.42 18.95 19.90 74 99 72
Two Hickory Centre..... Farmers Branch, TX 96,127 Sq. Ft. 21.23 20.89 21.07 93 75 33
University Square...... Anchorage, AK 22,260 Sq. Ft. 15.54 14.73 14.07 100 100 97

Shopping Centers
Collection............. Denver, CO 267,812 Sq. Ft. 11.13 10.43 9.83 85 88 96
Cross County Mall...... Mattoon, IL 304,575 Sq. Ft. 5.34 5.24 5.10 87 93 94
Cullman................ Cullman, AL 92,466 Sq. Ft. 3.39 3.38 3.27 91 98 98
Plaza on Bachman Creek. Dallas, TX 80,278 Sq. Ft. 10.73 * * 76 * *
Westwood............... Tallahassee, FL 149,855 Sq. Ft. 7.00 6.87 6.74 91 97 93

Merchandise Mart
Denver Mart............ Denver, CO 509,008 Sq. Ft. 11.48 11.20 10.98 92 92 90

Single Family Residence
Tavel Circle........... Dallas, TX 2,271 Sq. Ft. -- -- -- -- -- --

10

Total Room Revenue
Divided by
Average Room Rate Occupancy % Total Available Rooms
----------------------- -------------- --------------------
Property Location Rooms 2002 2001 2000 2002 2001 2000 2002 2001 2000
-------- ------------------ --------- ------- ------- ------- ---- ---- ---- ------ ------ ------

Hotels
Best Western............ Virginia Beach, VA 110 Rooms $105.78 $108.20 $103.94 69 53 60 $72.79 $57.83 $62.29
Chateau Inn............. Fresno, CA 78 Rooms 61.89 57.29 56.38 53 59 58 32.56 34.07 32.64
Clarion KC Airport...... Kansas City, MO 196 Rooms 66.28 73.58 70.67 66 65 72 41.49 48.01 51.18
Grand Hotel Sofia....... Sofia, Bulgaria 136 Rooms 103.56 106.97 * 68 60 * 70.55 60.85 *
Piccadilly Airport...... Fresno, CA 185 Rooms 75.18 70.87 70.22 61 59 61 45.83 42.04 42.87
Piccadilly Shaw......... Fresno, CA 194 Rooms 78.24 73.12 70.96 69 70 69 53.87 50.84 49.07
Piccadilly University... Fresno, CA 190 Rooms 69.58 65.18 67.11 59 62 55 40.93 40.38 36.83
Quality Inn............. Denver, CO 161 Rooms 53.62 53.75 52.83 60 67 69 32.13 35.75 36.30
Williamsburg Hospitality
House................. Williamsburg, VA 296 Rooms 99.79 99.04 93.28 49 52 60 48.86 51.88 55.71

- --------
* Property was purchased or constructed in 2001 or 2002.
** Property was under construction in 2002.

Occupancy presented above and throughout this ITEM 2. is without reference
to whether leases in effect are at, below or above market rates.

In 2002, ARI purchased the following property:

Units/ Purchase Net Cash Debt Interest Maturity
Property Location Sq.Ft./Acres Price Paid Incurred Rate Date
-------- ----------------- ------------- -------- -------- -------- -------- --------
Apartments

Pinecrest/(1)/............. North Augusta, SC 120 Units $ 2,979 $ -- $1,423/(3)/ 8.75% 03/03
Tiberon Trails/(1)/........ Merrillville, IN 376 Units 12,336 -- 6,417/(3)/ 9.00 07/06

Shopping Center
Alta Mesa/(1)/............. Ft. Worth, TX 59,933 Sq.Ft. 3,797 -- 1,804/(3)/ 10.43 10/04
Plaza on Bachman Creek/(2)/ Dallas, TX 80,278 Sq.Ft. 3,103 -- -- -- --

Land
Pioneer Crossing........... Austin, TX 79.4 Acres 1,165 1,213 -- -- --
Willow Springs............. Beaumont, CA 20.7 Acres 140 146 -- -- --

- --------
(1) Property received from BCM, a related party, for forgiveness of debt. The
purchase price was determined using a market rate multiple of net operating
income.
(2) Exchanged with TCI, a related party, for the Oaktree Village Shopping
Center, Rasor land parcel and Lakeshore Villas land parcel.
(3) Assumed debt of seller.

In 2002, ARI sold the following properties:

Net Cash
Units/ Sales Received/ Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price (Paid) Discharged on Sale
-------- ----------------- ------------ ------- --------- ---------- -----------
Apartments

Conradi House.... Tallahassee, FL 98 Units $ 1,809 $ 388 $ 1,047 $ 435
Daluce........... Tallahassee, FL 112 Units 3,634 779 2,494/(3)/ 735
Grand Lagoon..... Panama City, FL 54 Units 2,750 285 2,083 1,572
Lakeshore Villas. Harris County, TX 312 Units 21,957 (764) 13,593 8,942/(7)/
Lee Hills........ Tallahassee, FL 16 Units 445 355 -- 127
Mallard Lake/(1)/ Greensboro, NC 336 Units 14,400 -- 7,362 --
Morning Star..... Tallahassee, FL 82 Units 2,217 718 1,187 618
Oak Hill......... Tallahassee, FL 92 Units 3,200 156/(4)/ 2,550 285
Pheasant Ridge... Bellevue, NE 264 Units 10,400 2,576 6,237 6,763
Pinecrest West... Tallahassee, FL 48 Units 1,600 (48) 1,386 653
Regency.......... Tampa, FL 78 Units 3,200 851 1,710 541

11

Net Cash
Units/ Sales Received/ Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price (Paid) Discharged on Sale
-------- ------------------ -------------- ------- --------- ---------- -----------
Apartments--Continued

Stonebridge.......... Florissant, MO 100 Units $ 4,340 $ 1,142 $ 2,893 $ 3,081
Stonegate............ Tallahassee, FL 83 Units 1,785 486 1,026 (320)
Valley Hi............ Tallahassee, FL 54 Units 1,452 75 1,159 413
Villas............... Plano, TX 208 Units 8,525 3,701 4,023 5,615
Westwood Parc........ Tallahassee, FL 94 Units 2,523 817 1,370 759
White Pines.......... Tallahassee, FL 85 Units 764 10 593 (127)
Woodsong............. Smyrna, GA 190 Units 9,200 2,573 8,196 7,128

Office Building
Centura.............. Dallas, TX 410,901 Sq.Ft. 50,000 -- 43,739/(3)/ 5,762/(5)/
Melrose Business Park Oklahoma City, OK 124,200 Sq.Ft. 1,890 953 816 1,399
Rosedale Towers...... Minneapolis, MN 84,798 Sq.Ft. 7,235 3,324 7,665 2,028/(8)/

Shopping Center
Alta Mesa............ Fort Worth, TX 59,933 Sq.Ft. 3,617 1,399 1,791 --
Oaktree Village/(2)/. Lubbock, TX 45,623 Sq.Ft. 2,302 131 1,389/(10)/ --

Land
Centura Holdings..... Farmers Branch, TX 5.1 Acres 7,747 -- 7,242/(3)/ 1,236/(5)/
Clark................ Farmers Branch, TX 3.3 Acres 4,961 -- -- 2,675/(5)/
Desert Wells......... Palm Desert, CA 171.1 Acres 11,900 1,421 1,000 5,955
Desert Wells......... Palm Desert, CA 238.0 Acres 23,785 321 1,050 15,024/(9)/
Eldorado Parkway..... Collin County, TX 8.8 Acres 1,180 1,030 50 104
Elm Fork............. Denton County, TX 14.5 Acres 2,745 (105) 2,633 1,615
Elm Fork............. Denton County, TX 14.2 Acres 1,526 (54) 701 527
Elm Fork............. Denton County, TX 16.7 Acres 1,617 (299) 1,554 429
Frisco Bridges....... Collin County, TX 10.8 Acres 1,881 151 1,500 (94)
Hollywood Casino..... Farmers Branch, TX 42.8 Acres 16,987 -- 6,222/(3)/ 7,520/(5)/
Katrina.............. Palm Desert, CA 2.1 Acres 1,323 (40) 1,237 978
Katrina.............. Palm Desert, CA 80.0 Acres 6,778 (1,382) 2,500 (2,032)
Katrina.............. Palm Desert, CA 1.8 Acres 700 648 -- 464
Lakeshore Villas/(2)/ Harris County, TX 16.9 Acres 1,499 215 -- --
Marine Creek......... Ft. Worth, TX 54.2 Acres 3,700 -- 1,500/(10)/ 1,334/(5)/
Mason Goodrich....... Houston, TX 7.0 Acres 760 93 593 396
Mason Goodrich....... Houston, TX 7.9 Acres 672 46 554 268
Mason Goodrich....... Houston, TX 10.3 Acres 1,444 93 1,225 895
Mason Goodrich....... Houston, TX 18.0 Acres 2,790 -- 2,690/(10)/ 1,982/(5)/
Mason Goodrich....... Houston, TX 13.0 Acres 1,150 (445) 400 521
Mason Goodrich....... Houston, TX 31.5 Acres 2,800 132 1,425 324
Messick.............. Palm Desert, CA 71.0 Acres 6,015 (163) 1,300 2,056
Monterrey............ Riverside, CA 61.0 Acres 4,625 -- -- 61/(6)/
Nashville............ Nashville, TN 16.6 Acres 1,890 -- 955/(10)/ 1,016/(5)/
Nashville............ Nashville, TN 1.0 Acres 140 (4) 125 73
Rasor/(2)/........... Plano, TX 24.5 Acres 1,211 174 -- --
Thompson II.......... Dallas County, TX .2 Acres 21 20 -- (11)
Varner Road.......... Riverside, CA 129.7 Acres 3,700 671 -- 1,413
Vista Ridge.......... Lewisville, TX 10.0 Acres 1,525 130 1,220 401
Vista Ridge.......... Lewisville, TX 3.9 Acres 630 1 531 170
Willow Springs....... Beaumont, CA 1,503.0 Acres 9,800 (1,345) 2,600 4,872/(9)/
Woolley.............. Farmers Branch, TX 0.4 Acres 637 -- -- 466/(5)/

- --------
(1) Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar,
Regency and Westwood Apartments.
(2) Exchanged with TCI, a related party, for the Plaza on Bachman Creek
Shopping Center.
(3) Debt assumed by purchaser.
(4) Represents dividends on and redemption of Innovo Preferred Stock. See NOTE
7. "NOTES PAYABLE."
(5) Sold to TCI, a related party, to satisfy debt. Gain deferred until sale to
unrelated party.
(6) Sold to TCI, a related party, to satisfy debt. In September 2002, gain of
$34,000 recognized upon sale of 36 acres to unrelated party. Remaining gain
of $27,000 deferred until sale to unrelated party.

12

(7) Sold to Housing for Seniors of Humble, LLC, a related party. Gain deferred
until sale to unrelated party.
(8) The cash received from the sale was not sufficient to repay the entire
amount of the financing obtained from IORI in January 2002. ARI owes $2.1
million to IORI for remaining principal and 12% return.
(9) Gain deferred until collection of mortgage note receivable in March 2003.
See NOTE 25. "SUBSEQUENT EVENTS."
(10) Failure to notify and receive approval from the lender for this
transaction may constitute an event of default under the terms of the debt.

In 2002, ARI financed/refinanced or obtained second mortgage financing on
the following:

Units/ Debt Debt Net Cash Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged Received/(Paid) Rate Date
-------- ------------------ -------------- -------- ---------- --------------- -------- --------

Apartments
Lee Hills............. Tallahassee, FL 16 Units $ 1,750/(2)/ $ 117 $ 590 6.625%/(1)/ 06/05
Valley Hi............. Tallahassee, FL 54 Units -- /(2)/ 878 -- -- --
White Pines........... Tallahassee, FL 85 Units -- /(2)/ -- -- -- --

Land
Desert Wells.......... Palm Desert, CA 244.3 Acres 9,500 9,500 959 10.250/(1)/ 12/04
Katrina............... Palm Desert, CA 201.7 Acres 3,000 5,735 (3,071) 10.250/(1)/ 12/03
Walker................ Dallas County, TX 90.6 Acres 8,500 8,500 (1,411) 11.250/(1)/ 01/03/(3)/

Shopping Center
Plaza on Bachman Creek Dallas, TX 80,278 Sq.Ft. 5,000 -- 4,444 6.625/(1)/ 04/04

Office Buildings
Four Hickory Centre... Farmers Branch, TX 226,911 Sq.Ft. 12,500 -- 3,399 13.000 05/03
Two Hickory Centre.... Farmers Branch, TX 96,127 Sq.Ft. 7,500 5,942 1,277 7.750 06/03
University Square..... Anchorage, AK 22,260 Sq.Ft. 1,250 -- 1,216 8.500/(1)/ 10/17

Related Party Transactions. In each of the following transactions, except
those footnoted as (6), a related party has purchased an entity, which owns the
listed property asset, from ARI. ARI has guaranteed that the asset will produce
at least a 12% return on the purchase price for a period of three years from
the purchase date. If the asset fails to produce the 12% return, ARI will pay
the purchaser any shortfall. In addition, if the asset fails to produce the 12%
return for a calendar year, the purchaser may require ARI to repurchase the
entity for the purchase price. Management has classified these related party
transactions as notes payable.

Debt Debt Net Cash Interest Maturity
Property Location Units/Sq.Ft. Incurred Discharged Received Rate Date
-------- ------------------ -------------- -------- ---------- -------- -------- --------

Apartments
Bay Anchor........ Panama City, FL 12 Units $ 255 $ -- $ 203 5.000% 05/03/(6)(13)/
Confederate Point. Jacksonville, FL 206 Units 1,929 -- -- 12.000 04/05/(7)/
Foxwood........... Memphis, TN 220 Units 1,093 -- -- 12.000 04/05/(8)/
Governor Square... Tallahassee, FL 168 Units 4,480 3,196 611 7.120 05/07/(6)/
Grand Lagoon...... Panama City, FL 54 Units 2,083 1,209 655 5.000 05/03/(6)(10)/
Oak Hill.......... Tallahassee, FL 92 Units 2,550 1,875 478 5.000 05/03/(6)(12)/
Park Avenue....... Tallahassee, FL 121 Units 4,400 2,756 1,341 7.120 05/07/(6)/
Seville........... Tallahassee, FL 62 Units 1,955 1,263 473 5.000 05/03/(6)(13)/
Westwood.......... Mary Ester, FL 120 Units 3,382 2,327 1,023 7.570 05/12/(6)/
Windsor Tower..... Ocala, FL 64 Units 1,989 1,128 702 5.000 05/03/(6)/
Woodhollow........ San Antonio, TX 546 Units 8,160 5,349 2,775 7.120 05/07/(6)/
Woodsong.......... Smyrna, GA 190 Units 2,544 -- -- 12.000 04/05/(9)/

Office Building
One Hickory Centre Farmers Branch, TX 102,615 Sq.Ft. 4,468 -- -- 12.000 04/05/(11)/
Rosedale Towers... Minneapolis, MN 84,798 Sq.Ft. 5,109 -- 5,109 12.000 01/05/(4)/
Two Hickory Centre Farmers Branch, TX 96,127 Sq.Ft. 4,448 -- 4,448 12.000 01/05/(5)/

- --------
(1) Variable interest rate.
(2) Single note with all properties as collateral.
(3) Maturity date extended to July 2004.
(4) IORI purchased 100% of the outstanding common shares of Rosedale
Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1
million. The purchase price was determined based upon the market value

13

of the property, using a market rate multiple of net operating income.
Rosedale owns the Rosedale Towers Office Building. The business purpose of
this transaction was for IORI to make an equity investment in Rosedale,
anticipating a profitable return, and for ARI to receive cash for its equity
investment. Sold to unrelated buyer in December 2002. ARI owes $2.1 million
to IORI for remaining principal and 12% return.
(5) TCI purchased 100% of the common shares of ART Two Hickory Corporation
("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The
purchase price was determined based upon the market value of the property,
using a market rate multiple of net operating income. Two Hickory owns the
Two Hickory Centre Office Building. The business purpose of this
transaction was for TCI to make an equity investment in Two Hickory,
anticipating a profitable return, and for ARI to receive cash for its
equity investment.
(6) Properties sold to partnerships controlled by Metra Capital, LLC ("Metra").
Innovo Group, Inc. ("Innovo") is a limited partner in the partnerships that
purchased the properties. Joseph Mizrachi, a Director of ARI, controls
approximately 11.67% of the outstanding common stock of Innovo. Management
has determined to treat this sale as a refinancing transaction. ARI will
continue to report the assets and the new debt incurred by Metra on its
financial statements. ARI also received $6.3 million of 8% non-recourse,
non-convertible Series A Preferred Stock ("Preferred Shares") of Innovo.
The dividend on the Preferred Shares will be funded entirely and solely
through member distributions from cash flows generated by the operation and
subsequent sale of the sold properties. In the event the cash flows for the
properties are insufficient to cover the 8% annual dividend, Innovo will
have no obligation to cover any shortfall.
The Preferred Shares have a mandatory redemption feature, and are redeemable
from the cash proceeds received by Innovo from the operation and sale of the
properties. All member distributions that are in excess of current and
accrued 8% dividends must be used by Innovo to redeem the Preferred Shares.
Since redemption of these shares is subject to the above future events,
management has elected to record no basis in the Preferred Shares.
(7) TCI purchased all of the general and limited partnership interests in
Garden Confederate Point, L.P. ("Confederate Point") from ARI for $1.9
million. The purchase price was determined based upon the market value of
the property, using a market rate multiple of net operating income.
Confederate Point owns the Confederate Point Apartments. The business
purpose of this transaction was for TCI to make an equity investment in
Confederate Point, anticipating a profitable return, and to reduce ARI's
payable to BCM. Failure to notify and receive approval from the lender for
this transaction may constitute an event of default under the terms of the
debt.
(8) TCI purchased all of the general and limited partnership interests in
Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The purchase
price was determined based upon the market value of the property, using a
market rate multiple of net operating income. Foxwood owns the Foxwood
Apartments. The business purpose of this transaction was for TCI to make an
equity investment in Foxwood, anticipating a profitable return, and to
reduce ARI's payable to BCM. Failure to notify and receive approval from
the lender for this transaction may constitute an event of default under
the terms of the debt.
(9) TCI purchased all of the general and limited partnership interests in
Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The purchase
price was determined based upon the market value of the property, using a
market rate multiple of net operating income. Woodsong owns the Woodsong
Apartments. The business purpose of this transaction was for TCI to make an
equity investment in Woodsong, anticipating a profitable return, and to
reduce ARI's payable to BCM. TCI sold the Woodsong Apartments in July 2002.
(10) Sold to unrelated buyer in December 2002.
(11) TCI purchased 100% of the common shares of ART One Hickory Corporation
("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5 million. The
purchase price was determined based upon the market value of the property,
using a market rate multiple of net operating income. One Hickory owns the
One Hickory Centre Office Building. The business purpose of this
transaction was for TCI to make an equity investment in One Hickory,
anticipating a profitable return, and to reduce ARI's payable to BCM.
Failure to notify and receive approval from the lender for this
transaction may constitute an event of default under the terms of the debt.
(12) Sold to unrelated party in June 2002.
(13) Sold to unrelated party in January 2003. See NOTE 25. "SUBSEQUENT EVENTS."

14

Land Properties. Set forth below are ARI's land properties, consisting of
both improved and unimproved land:

Property Location Acres
-------- ------------------ -------

Bonneau............. Dallas County, TX 8.4
Chase Oaks.......... Plano, TX 11.8
Croslin............. Dallas County, TX .8
Dalho............... Farmers Branch, TX 3.4
Elm Fork............ Denton County, TX 105.4
FRWM Cummings....... Farmers Branch, TX 6.5
HSM................. Farmers Branch, TX 6.2
Jeffries Ranch...... Oceanside, CA 82.4
JHL Connell......... Carrollton, TX 7.6
Katrina............. Palm Desert, CA 199.9
Katy Road........... Harris County, TX 130.6
Keller.............. Tarrant County, TX 30.9
Kelly............... Dallas County, TX .8
Lacy Longhorn....... Farmers Branch, TX 17.1
Las Colinas I....... Las Colinas, TX 44.4
Leone............... Irving, TX 8.2
Mason/Goodrich...... Houston, TX 84.0
McKinney Corners II. Collin County, TX 20.6
Mendoza............. Dallas County, TX .4
Nashville........... Nashville, TN 113.8
Pioneer Crossing.... Austin, TX 1,150.3
Scout............... Tarrant County, TX 64.5
Sladek.............. Travis County, TX 63.3
Stagliano........... Farmers Branch, TX 3.2
Thompson............ Farmers Branch, TX 3.3
Thompson II......... Dallas County, TX 3.5
Tomlin.............. Farmers Branch, TX 9.2
Valley Ranch........ Irving, TX 245.4
Valley Ranch III.... Irving, TX 12.5
Valley Ranch IV..... Irving, TX 12.4
Valley View 34...... Farmers Branch, TX 33.9
Valwood............. Dallas County, TX 246.1
Vineyards........... Tarrant County, TX 15.8
Vineyards II........ Tarrant County, TX 18.6
Vista Ridge......... Lewisville, TX 72.4
Walker.............. Dallas County, TX 132.6
Other (5 properties) Various 84.0

Mortgage Loans

In addition to real estate, a portion of ARI's assets are invested in
mortgage notes receivable, secured by income-producing real estate, unimproved
land and partnership interests. Management expects that the percentage of ARI's
assets invested in mortgage loans will decline, as ARI will no longer seek to
fund or acquire new mortgage loans. However, ARI may, in selected instances,
originate mortgage loans or it may provide purchase money financing in
conjunction with a property sale. Management intends to service and hold for
investment the mortgage notes currently in the portfolio. Mortgage notes
receivable consist of first mortgage loans.

15

Types of Properties Subject to Mortgages. The types of properties securing
mortgage notes receivable at December 31, 2002, consisted of a commercial
building, unimproved land and partnership interests. The type of properties
subject to mortgages in which ARI invests may be altered without a vote of
stockholders.

As of December 31, 2002, the obligors on $41.3 million or 48% of the
mortgage notes receivable portfolio were affiliates of ARI. Also at that date,
$7.9 million or 9% of the mortgage notes receivable portfolio was nonperforming.

The following table sets forth the percentages (based on the outstanding
mortgage loan balance at December 31, 2002), by geographic region, of the
commercial properties that serve as collateral for ARI's mortgage notes
receivable. Excluded are $81.5 million of mortgage notes secured by unimproved
land and other security. See Schedule IV to the Consolidated Financial
Statements included in ITEM 8. "CONSOLIDATED FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA" for additional details of ARI's mortgage notes receivable
portfolio.

Commercial
Region Properties
------ ----------

Southwest 100.0%
=====

A summary of the activity in the mortgage notes receivable portfolio during
2002 is as follows:

Mortgage notes receivable at January 1, 2002.. 10
Loans funded.................................. 10
Loans collected in full....................... (6)
Loans sold.................................... --
---
Mortgage notes receivable at December 31, 2002 14
===

During 2002, $2.1 million in interest and $15.1 million in principal were
collected on mortgage notes receivable.

First Mortgage Loans. These loans generally provide for level periodic
payments of principal and interest sufficient to substantially repay the loan
at or prior to maturity, but may involve interest-only payments or moderate or
negative amortization of principal or all interest and a "balloon" principal
payment at maturity. With respect to first mortgage loans, it is ARI's general
policy to require that the borrower provide a title policy or an acceptable
legal opinion of title as to the validity and the priority of ARI's mortgage
lien over all other obligations, except liens arising from unpaid property
taxes and other exceptions normally allowed by first mortgage lenders.

The following discussion briefly describes first mortgage loans funded in
2002, as well as events that affected previously funded first mortgage loans
during 2002.

In May 2002, ARI sold its leasehold interests in various oil and gas mineral
development properties for $1.3 million, receiving a note from the buyer for
the purchase price. The note bore interest at 10.0% per annum, matured in May
2004 and required monthly payments of principal and accrued interest. See NOTE
4. "OIL AND GAS OPERATIONS." In November 2002, the note was sold to 10300
Gaywood Trust, a related party, for $1.3 million plus accrued but unpaid
interest, to satisfy debt. No cash was received by ARI for the sale of the note.

In August 2002, ARI sold a 14.2 acre tract of its Elm Fork land parcel for
$1.5 million, paying $54,000 after payment of closing costs and debt paydown
and providing purchase money financing of $763,000. The loan bore interest at
10.0% per annum and matured in October 2002. All principal and interest were
due at maturity. In October 2002, the note was collected in full, including
accrued but unpaid interest.

16

In September 2002, ARI sold its Messick land parcel and an 80.0 acre tract
of its Katrina land parcel for $12.8 million, paying $1.5 million after payment
of closing costs and debt paydown and providing purchase money financing of
$9.6 million. The loan bore interest at 8.0% per annum, matured in September
2004 and required quarterly payments of accrued interest. All principal and
accrued interest were due at maturity. In February 2003, ARI accepted $7.4
million as full payment for $7.7 million in principal and accrued interest. In
March 2003, the remaining $1.9 million loan balance was sold to an unrelated
party for $1.8 million plus accrued but unpaid interest. See NOTE 25.
"SUBSEQUENT EVENTS."

In October 2002, ARI sold its Varner Road land parcel for $3.7 million,
receiving $671,000 after payment of closing costs and providing purchase money
financing of $2.8 million. The loan bears interest at 9.0% per annum, matures
in October 2004 and requires quarterly interest payments. All principal and
accrued but unpaid interest are due at maturity.

In December 2002, ARI sold its Willow Springs land parcel for $9.8 million,
paying $1.3 million after payment of closing costs and debt paydown and
providing purchase money financing of $7.8 million. The loan bore interest at
8.0% per annum, matured in December 2005 and required periodic interest
payments beginning in June 2003. In March 2003, the loan was sold to an
unrelated party for $7.5 million plus accrued and unpaid interest. See NOTE 25.
"SUBSEQUENT EVENTS."

Also in December 2002, ARI sold a 238.0 acre tract of its Desert Wells land
parcel for $23.8 million, receiving $321,000 after payment of closing costs and
debt paydown and providing purchase money financing of $21.4 million. The first
lien financing of $17.8 million bore interest at 8.0% per annum, matured in
December 2004 and required payments beginning in March 2003. In March 2003, the
loan was sold to an unrelated party for $17.1 million plus accrued and unpaid
interest. See NOTE 25. "SUBSEQUENT EVENTS." The second lien financing of $3.6
million bore interest at 8.0% per annum and matured on March 31, 2003. All
principal and interest were due at maturity.

In March 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for
$2.8 million, receiving $700,000 in cash and providing purchase money financing
of the remaining $2.1 million of the sales price. The loan bore interest at
12.0% per annum and matured in July 2001. All principal and interest were due
at maturity. In January 2002, $274,000 in principal and $226,000 in interest
was collected. In March 2002, the note was collected in full, including accrued
but unpaid interest.

In November 2001, ARI sold a 12.71 acre tract of its Santa Clarita land
parcel for $1.9 million, receiving $1.5 million in cash and providing purchase
money financing of the remaining $437,000 of the sales price. The loan bore
interest at 8.0% per annum and matured in November 2002. In November 2002, the
note was collected in full, including accrued but unpaid interest.

Also in November 2001, ARI sold the Blackhawk Apartments for $7.1 million,
receiving $1.5 million in cash after the assumption of $4.0 million of mortgage
debt and providing purchase money financing of the remaining $1.6 million of
the sales price. The loan bore interest at 10.0% per annum and matured in May
2002. Monthly principal and interest payments were required. In April 2002, the
note was collected in full, including accrued but unpaid interest.

Junior participations. In December 2002, ARI sold a 171.1 acre tract of its
Desert Wells land parcel for $11.9 million, receiving $1.4 million after
payment of closing costs and debt paydown and providing purchase money
financing of $8.9 million. The loan bore no interest and matured in March 2003.
The principal was due at maturity. In December 2002, interest in $7.7 million
of the loan was sold to an unrelated party for $7.7 million. ARI retained a
junior interest in $1.2 million of the loan. In March 2003, the note was
collected in full.

Other. In September 1999, in conjunction with the sale of two apartments in
Austin, Texas, $2.1 million in purchase money financing was provided, secured
by limited partnership interests in two limited partnerships owned by the
buyer. The financing bore interest at 16.0% per annum, required monthly
payments of interest only

17

at 6.0%, beginning in February 2000 and required a $200,000 principal paydown
in December 1999, which was not received, and matured in August 2000. ARI had
the option of obtaining the buyer's general and limited partnership interests
in the collateral partnerships in full satisfaction of the financing. In March
2000, ARI agreed to forbear foreclosing on the collateral securing the note and
released one of the partnership interests, in exchange for a payment of
$250,000 and executed deeds of trusts on certain properties owned by the buyer.
In March 2000, the borrower made a $1.1 million payment, upon receipt of which
ARI returned the deeds of trust. The borrower executed a replacement promissory
note for the remaining note balance of $1.0 million, which is unsecured,
non-interest bearing and matures in April 2003.

In December 1999, a note with a principal balance of $1.2 million, secured
by a pledge of a partnership interest in a partnership which owns real estate
in Addison, Texas, matured. The maturity date was extended to April 2000 in
exchange for an increase in the interest rate to 14.0% per annum. All other
terms remained the same. In February 2001, the loan amount was increased to
$1.6 million and the maturity date was extended to June 2001. In February 2002,
$1.5 million in principal and $87,000 in interest were collected. In July 2002,
the note was collected in full, including accrued but unpaid interest.

Related Party. In June 2002, ARI converted $4.5 million of its receivable
from BCM, a related party, to a recourse note receivable. This transaction was
to provide ARI with additional security over that provided by an unsecured
receivable. The note bears interest at 10.0% per annum, matures in March 2004
and requires quarterly payments of principal and accrued interest, beginning in
December 2002.

In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for
Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying
$764,000 after payment of closing costs and debt paydown and providing purchase
money financing of $8.4 million. One loan has a principal amount of $2.0
million. The loan is unsecured, and is guaranteed by Unified Housing
Foundation, Inc. ("Unified"), a related party. The second loan has a principal
amount of $6.4 million, and is secured by a pledge by United of 100% of the
Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature
in December 2009 and require quarterly payments beginning in March 2003.
Richard W. Humphrey, a director of ARI, is the President of Humble and the
President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a
director of ARI, is the General Manager of Unified.

In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of
credit to One Realco Corporation ("One Realco"), which owns approximately 14.7%
of the outstanding shares of ARI's Common Stock. One Realco periodically
borrows money to meet its cash obligations. The line of credit bears interest
at 12.0% per annum. All principal and interest were due at maturity in February
2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in
principal and $416,000 in interest was collected. In December 2001, $21,000 in
principal and $804,000 in interest was collected. In February 2002, the line of
credit was increased to $18.0 million, accrued but unpaid interest of $217,000
was added to the principal and the maturity date was extended to February 2004.
In March 2002, ARI funded an additional $1.8 million, increasing the
outstanding principal balance to $15.5 million. In October 2002, $856,900 in
interest was collected, by the return of 85,690 shares of ARI Series A
Preferred Stock. All principal and interest are due at maturity. Ronald E.
Kimbrough, Acting Principal Executive Officer, Executive Vice President and
Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001
and 2002, Mr. Kimbrough did not participate in day-to-day operations or
management of One Realco.

In December 2000, an unsecured loan with a current principal balance of $1.9
million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to
provide funds to purchase, renovate and expand a shopping center property in
Warwick, Rhode Island. All principal and interest were due at maturity. At
December 2002, the loan, and $188,000 of accrued interest, remained unpaid.
Richard D. Morgan, a Warwick shareholder, served as a director of ARI until
October 2001.

In December 2000, a loan with a current principal balance of $1.6 million to
Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide
funds to purchase and renovate a shopping center property in

18

Oklahoma City, Oklahoma, is secured by (1) a 100% interest in Bordeaux, which
owns a shopping center in Oklahoma City, Oklahoma; (2) 100% of the stock of
Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in
Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux
members. At December 2002, the loan, and $710,000 of accrued interest, remained
unpaid. Richard D. Morgan, a Bordeaux member, served as a director of ARI until
October 2001.

In March 2000, a loan with a current principal balance of $2.6 million to
Lordstown, L.P., matured. The loan, to provide funds to purchase for resale
various parcels of land, is secured by a second lien on land in Ohio and
Florida, by 100% of the general and limited partner interest in Partners
Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest
in subsequent land sales. At December 2002, the loan, and $1.1 million of
accrued interest, remained unpaid. A corporation controlled by Richard D.
Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a
director of ARI until October 2001.

In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an
affiliate. The loan, to provide funds for acquisitions or working capital
needs, was secured by all of the outstanding shares of common stock of American
Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and
matured in November 2001. In January 2000, $100,000 was collected. In November
2001, the maturity date was extended to November 2004. The collateral was
changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by
BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate
was changed to 2% over the prime rate, currently 6.25% per annum, and the
accrued but unpaid interest of $984,000 was added to the principal. The new
principal balance is $5.6 million. All principal and accrued interest are due
at maturity.

Investments in Real Estate Companies and Real Estate Partnerships

Real estate entities. ARI's investment in real estate entities includes the
equity securities of two publicly traded real estate companies, IORI and TCI,
and interests in real estate joint venture partnerships. BCM, ARI's advisor,
also serves as advisor to IORI and TCI.

Since acquiring its initial investments in IORI and TCI in 1989, ARI has
made additional investments in the equity securities of both entities through
private and open market purchases. The cost with respect to shares of IORI and
TCI at December 31, 2002 totaled $64.1 million. The aggregate carrying value
(cost plus or minus equity in income or losses and less distributions received)
of the equity securities of IORI and TCI was $78.4 million at December 31, 2002
and the aggregate market value was $78.6 million. The aggregate investee book
value of IORI and TCI based upon the December 31, 2002 financial statements of
each entity was $121.4 million. See ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS."

The Board of Directors has authorized the expenditure of up to an aggregate
of $50.0 million to acquire, in open market purchases, shares of IORI and TCI,
excluding private purchase transactions which are separately authorized. As of
December 31, 2002, ARI had expended an aggregate of $8.6 million to acquire
shares of IORI and TCI, in open market purchases, in accordance with these
authorizations. ARI expects to make additional investments in the equity
securities of IORI and TCI to the extent its liquidity permits.

On October 3, 2000, ARI and IORI entered into an agreement which provided
IORI and ARI with an option to purchase 1,858,900 shares of common stock of TCI
from a third party. On October 19, 2000, IORI assigned all of its rights to
purchase such shares to ARI. The total cost to purchase the TCI shares was
$30.8 million. In October 2000, ARI paid $5.6 million of the option price. In
April 2001, the remainder of the option price was paid, and ARI acquired the
TCI shares. See ITEM 1. "BUSINESS" for discussion of the tender offer for
shares of TCI and IORI Common Stock by ARI.

19

Pertinent information regarding ARI's investment in the equity securities of
the IORI and TCI at December 31, 2002, is summarized below (dollars in
thousands):

Percentage Equivalent
of ARI's Carrying Value Investee Book Market Value of
Ownership at of Investment at Value at Investment at
Investee December 31, 2002 December 31, 2002 December 31, 2002 December 31, 2002
- -------- ----------------- ----------------- ----------------- -----------------

IORI.. 28.49% $ 7,383 $ 10,628 $ 7,711
TCI... 49.81 71,035 110,769 70,926

IORI and TCI each own a considerable amount of real estate, much of which
they have held for many years. Because of depreciation, these entities may earn
substantial amounts in periods in which they sell real estate and will probably
incur losses in periods in which they do not. ARI's reported income or loss
attributable to these entities will differ materially from its cash flow
attributable to them.

At December 31, 2002, ARI did not have a controlling equity interest in
either IORI or TCI; therefore, it could not, acting by itself, determine either
the individual investments or the overall investment policies of either of
them. However, due to ARI's equity investments in, and the existence of common
officers with, each of IORI and TCI and that IORI and TCI have the same advisor
as ARI, ARI could be considered to have the ability to exercise significant
influence over the operating and investing policies of IORI and TCI. At
December 31, 2002, ARI accounted for its investment in IORI and TCI using the
equity method. Under the equity method, ARI recognized its proportionate share
of the income or loss from the operations of IORI and TCI currently, rather
than when realized through dividends or on sale. The carrying value of ARI's
investment in IORI and TCI, as set forth in the table above, is the original
cost of investment in each adjusted for ARI's proportionate share of IORI's and
TCI's income or loss and distributions received.

The following summary description of IORI and TCI is based upon information
publicly reported by each entity.

IORI. IORI is a Nevada corporation which was originally organized on
December 14, 1984, as a California business trust and commenced operations on
April 10, 1985. IORI's business is investing in real estate through direct
equity investments and partnerships. IORI holds equity investments in
apartments and commercial properties (office buildings) in the Pacific,
Southeast and Southwest regions of the continental United States with a
concentration in the Southwest region. At December 31, 2002, IORI owned 12
income producing properties located in three states. These properties consisted
of seven apartments comprising 777 units and five office buildings with an
aggregate of 291,254 sq. ft. In addition, IORI owned two parcels of unimproved
land, totaling 205 acres.

IORI reported a net income of $2.1 million in 2002 as compared to net loss
of $3.5 million in 2001. IORI's net income in 2002 included gains on sale of
real estate of $6.8 million. IORI's cash flow from property operations was $3.4
million in 2002. At December 31, 2002, IORI had total assets of $90.2 million,
which consisted of $74.8 million in real estate held for investment, $15.4
million in investments in partnerships and other assets and $10,000 in cash and
cash equivalents.

ARI received no dividends from IORI in 2002.

TCI. TCI is a Nevada corporation which was originally organized on
September 6, 1983, as a California business trust, and commenced operations on
January 31, 1984. On November 30, 1999, TCI acquired, through merger,
Continental Mortgage and Equity Trust ("CMET"), both of which, at the time,
were equity investees of ARI. Pursuant to the merger agreement, TCI acquired
all of the outstanding CMET shares of beneficial interest in a tax-free
exchange of shares, issuing 1.181 shares of its common stock for each
outstanding CMET share.

20

TCI has investment policies similar to those of IORI. TCI holds equity
investments in apartments, commercial properties (office buildings, industrial
warehouses and shopping centers) and hotels throughout the continental United
States with a concentration in the Southeast and Southwest regions. At December
31, 2002, TCI owned 103 income producing properties located in 18 states and
one income producing property in Poland. These properties consisted of 54
apartments comprising 10,439 units, 26 office buildings with an aggregate of
3.9 million sq. ft., 11 industrial warehouses with an aggregate of 1.7 million
sq. ft., seven shopping centers with an aggregate of 668,284 sq. ft., a fitness
club with 56,532 sq. ft. and five hotels with a total of 374 rooms. In
addition, TCI owned 34 parcels of unimproved land, totaling 1,043 acres. TCI
also holds mortgage notes receivable secured by real estate located in the
Midwest, Southeast and Southwest regions of the continental United States.

TCI reported net income of $4.9 million in 2002 and $19.8 million in 2001.
TCI's net income in 2002 included gains from the sale of real estate of $38.9
million, whereas its net income in 2001 included gains from the sale of real
estate of $49.0 million. TCI's cash flow from property operations was $43.9
million in 2002. At December 31, 2002, TCI had total assets of $858.5 million,
which consisted of $737.0 million in real estate held for investment, $22.5
million in real estate held for sale, $13.8 million in investments in real
estate entities, $27.9 million in notes and interest receivable, $46.7 million
in other assets and $10.6 million in cash and cash equivalents. At December 31,
2002, TCI owned 345,728 shares of IORI's common stock, approximately 24.0% of
the shares then outstanding.

ARI received no dividends from TCI in 2002.

Realty Advisors Korea, Ltd. On June 30, 2002, ARI obtained 74.31% interest
in Realty Advisors Korea, Ltd. ("RAK"), a Korean real estate advisory company,
from BCM, a related party, for $6.0 million. The business purpose of the
transaction was to reduce the affiliate payable owed by BCM to ARI. ARI's
receivable from BCM was reduced by $6.0 million, and no cash was paid by ARI.
At the date of acquisition, RAK's assets consisted of $2.3 million in cash,
$3.0 million in deposits and marketable securities, and $225,000 in other
assets. RAK's net equity was $5.5 million. ARI recorded $1.9 million in
goodwill as a result of this transaction.

ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida
Public Funds II, in which ART Florida Portfolio II, Ltd. owned an interest,
sold Villas Continental Apartments. ARI received $1.3 million in cash from the
sale. ARI's share of the loss incurred on the sale was $286,000, which is
included in loss on sale of investments in equity investees in the Consolidated
Statements of Operations.

ITEM 3. LEGAL PROCEEDINGS

ARI is involved in various lawsuits arising in the ordinary course of
business. In the opinion of ARI's management the outcome of these lawsuits will
not have a material impact on ARI's financial condition, results of operations
or liquidity.

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

Not applicable.

21

PART II

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

ARI's Common Stock is traded on the New York Stock Exchange using the symbol
"ARL". The following table sets forth the high and low sales prices as reported
in the consolidated reporting system of the New York Stock Exchange.

Quarter Ended High Low
------------- ------ ------

March 31, 2003 (through March 19, 2003) $10.65 $ 7.50

March 31, 2002......................... 9.95 6.40
June 30, 2002.......................... 11.27 6.70
September 30, 2002..................... 11.50 8.20
December 31, 2002...................... 10.34 7.50

March 31, 2001......................... 14.52 12.50
June 30, 2001.......................... 12.66 9.75
September 30, 2001..................... 12.00 10.16
December 31, 2001...................... 13.00 9.80

As of March 19, 2003, the closing market price of ARI's Common Stock on the
New York Stock Exchange was $8.21 per share.

As of March 19, 2003, ARI's Common Stock was held by 5,099 stockholders of
record.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2002 regarding
compensation plans under which equity securities of ARI are authorized for
issuance.

Equity Compensation Plan Information
Number of Securities
Remaining Available for
Number of Securities to Weighted-Average Future Issuance Under Equity
be Issued Upon Exercise Exercise Price of Compensation Plans
of Outstanding Options, Outstanding Options, (Excluding Securities
Warrants and Rights Warrants and Rights Reflected in Column (a))
----------------------- -------------------- ----------------------------
Plan Category (a) (b) (c)
- ------------- ----------------------- -------------------- ----------------------------

Equity compensation plans approved by
securityholders.................... 105,750 $16.22 234,250

See Note 12 to the Consolidated Financial Statements for information
regarding the material features of the above plans.

During the second quarter of 1999, the Board of Directors established the
policy that dividend declarations on ARI's Common Stock would be determined on
an annual basis following the end of each year. In accordance with that policy,
the Board determined not to pay any dividends in 2002. Future distributions to
Common stockholders will be dependent upon ARI's realized income, financial
condition, capital requirements and other factors deemed relevant by the Board.

There are 15,000,000 shares of Series A 10% Cumulative Convertible Preferred
Stock authorized, with a par value of $2.00 per share and a liquidation
preference of $10.00 per share plus accrued and unpaid dividends. Dividends are
payable at the annual rate of $1.00 per share or $.25 per share quarterly to
stockholders of record on the last day of each March, June, September and
December when and as declared by the Board of Directors.

22

The Series A Preferred Stock may be converted after August 15, 2003, into
Common Stock at 90% of the average daily closing price of ARI's Common Stock
for the prior 20 trading days. At December 31, 2002, 3,226,858 shares of Series
A Preferred Stock were outstanding and 1,808,879 shares were reserved for
issuance as future consideration in various business transactions. Of the
outstanding shares, 300,000 shares are owned by ART Edina, Inc., and 600,000
shares are owned by ART Hotel Equities, Inc., wholly-owned subsidiaries of ARI.
Dividends are not paid on the shares owned by ARI subsidiaries.

There are 80,000 shares of Series B 10% Cumulative Convertible Preferred
Stock authorized, with a par value of $2.00 per share and a liquidation
preference of $100.00 per share plus accrued but unpaid dividends. The Series B
Preferred Stock bears an annual dividend of $11.00 per share or $2.75 per
quarter to stockholders of record on the last day of each March, June,
September and December when and as declared by the Board of Directors. The
Series B Preferred Stock was reserved for conversion of the Class A limited
partner units of Valley Ranch, L.P. In March 1999, an agreement was reached for
ARI to acquire the eight million Class A units then outstanding, for $1.00 per
unit. At December 31, 2002, all of the Class A units had been repurchased. At
December 31, 2002, no Series B Preferred Stock was outstanding.

There are 231,750 shares of Series C Cumulative Convertible Preferred Stock
authorized, with a par value of $2.00 per share and liquidation preference of
$100.00 per share plus accrued and unpaid dividends. The Series C Preferred
Stock bears a quarterly dividend of $.90 per share through June 30, 2001 and
$2.50 per share thereafter, to stockholders of record on the last day of March,
June, September and December when and as declared by the Board of Directors.
The Series C Preferred Stock is reserved for conversion of the Class A limited
partner units of ART Palm, L.P. At December 31, 2002, 11,813,750 Class A units
were outstanding. The Class A units may be exchanged for Series C Preferred
Stock at the rate of 100 Class A units for each share of Series C Preferred
Stock. At December 31, 2000, shares of Series C Preferred Stock could be
converted into 25,000 shares of ARI Common Stock. At June 30, 2002, additional
shares of Series C Preferred Stock could be converted into 16,250 shares of ARI
Common Stock. On or after June 30, 2003, additional shares of Series C
Preferred Stock may be converted into 16,250 shares of ARI Common Stock. On or
after December 31, 2005, additional shares of Series C Preferred Stock may be
converted into 16,250 shares of ARI Common Stock. On or after December 31,
2006, all remaining outstanding shares of Series C Preferred Stock may be
converted into ARI Common Stock. All conversions of Series C Preferred Stock
into ARI Common Stock will be at 90% of the average daily closing price of
ARI's Common Stock for the prior 20 trading days. In January 2001, 2.5 million
Class A limited partner units of ART Palm, L.P. were redeemed for $2.5 million
in cash. In December 2001, 7.2 million Class A limited partner units of ART
Palm, L.P. were redeemed for $5.8 million, including $2.5 million in cash. ARI
gave a note payable for the remaining $3.3 million. The note bore interest at
10.00% per annum, with a payment of $1.9 million plus accrued but unpaid
interest due in June 2002, and the remaining principal and accrued but unpaid
interest due at maturity in December 2002. The note was paid in full in January
2003, including accrued but unpaid interest. In July 2002, 1.6 million Class A
limited partner units of ART Palm, L.P. were redeemed for $1.6 million in cash.
At December 31, 2002, no Series C Preferred Stock was outstanding.

There are 91,000 shares of Series D 9.50% Cumulative Preferred Stock
authorized, with a par value of $2.00 per share, and a liquidation preference
of $20.00 per share. Dividends are payable at the annual rate of $1.90 per year
or $.475 per quarter to stockholders of record on the last day of each March,
June, September and December when and as declared by the Board of Directors.
The Series D Preferred Stock is reserved for the conversion of the Class A
limited partner units of Ocean Beach Partners, L.P. The Class A units may be
exchanged for Series D Preferred Stock at the rate of 20 Class A units for each
share of Series D Preferred Stock. No more than one-third of the Class A units
could be exchanged prior to May 31, 2001. Between June 1, 2001 and May 31, 2006
all unexchanged Class A units are exchangeable. At December 31, 2002, no shares
of Series D Preferred Stock were outstanding.

23

There are 500,000 shares of Series E 6% Cumulative Preferred Stock
authorized, with a par value $2.00 per share and a liquidation preference of
$10.00 per share. Dividends are payable at the annual rate of $.60 per share or
$.15 per quarter to stockholders of record on the last day of each March, June,
September and December when and as declared by the Board of Directors. At
December 31, 2002, 50,000 shares of Series E Preferred Stock were outstanding.

There are 10,000 shares of Series I 8% Cumulative Preferred Stock
authorized, with a par value of $2.00 per share and a liquidation preference of
$1,000.00 per share. Dividends are payable at the annual rate of $80.00 per
share or $20.00 per quarter to stockholders of record on the last date of each
March, June, September and December when and as declared by the Board of
Directors. At December 31, 2002, no shares of Series I were outstanding. In
February 2003, 10,000 shares were issued to ART Morgan, Inc., a wholly-owned
subsidiary of ARI. Dividends are not paid on these shares.

24

ITEM 6. SELECTED FINANCIAL DATA

For the Years Ended December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(dollars in thousands, except per share)

EARNINGS DATA
Operating income........................ $ 21,842 $ 25,310 $ 39,246 $ 44,772 $ 14,298
Gain on land sales...................... 16,727 5,598 29,001 23,552 17,254
Pizza parlor gross margin............... 6,750 6,277 5,784 4,503 4,044
----------- ----------- ----------- ----------- -----------
Income from operations.................. 45,319 37,185 74,031 72,827 35,596
Equity in loss of investees............. (20,914) (13,352) (4,581) (5,512) (4,893)
Loss on sale of investments in equity
investees............................. (286) (387) (8,774) -- --
Equity in gain on sale of real estate by
equity investees...................... -- 22,542 18,571 17,359 42,859
Other income............................ 8,590 2,448 2,039 5,568 (5,288)
Other expenses.......................... 92,734 103,829 137,043 184,813 91,079
Gain on sale of real estate............. -- 77,816 67,727 105,708 --
----------- ----------- ----------- ----------- -----------
Net income (loss) from continuing
operations............................ (60,025) 22,423 12,000 11,137 (22,805)
Net income (loss) from discontinued
operations............................ 51,561 (7,354) (9,321) (839) --
Net income (loss)....................... (8,464) 15,069 2,679 10,298 (22,805)
Preferred dividend requirement.......... (2,401) (2,485) (2,327) (2,281) (1,177)
----------- ----------- ----------- ----------- -----------
Income (loss) applicable to Common
shares................................ $ (10,865) $ 12,584 $ 352 $ 8,017 $ (23,982)
=========== =========== =========== =========== ===========
PER SHARE DATA
Net income (loss) from continuing
operations............................ $ (5.49) $ 1.70 $ .93 $ .82 $ (2.24)
Net income (loss) from discontinued
operations............................ 4.53 (.63) (.90) (.07) --
----------- ----------- ----------- ----------- -----------
Net income (loss) applicable to
Common shares......................... $ (.96) $ 1.07 $ .03 $ .75 $ (2.24)
=========== =========== =========== =========== ===========
Dividends per Common share.............. $ -- $ -- $ -- $ .05 $ .20
Weighted average shares
outstanding........................... 11,375,127 11,714,374 10,399,890 10,759,416 10,695,388
BALANCE SHEET DATA
Real estate, net........................ $ 463,757 $ 588,203 $ 653,744 $ 771,630 $ 734,907
Notes and interest receivable, net...... 82,133 30,382 13,831 38,604 52,053
Total assets............................ 709,045 758,763 787,015 919,546 918,605
Notes and interest payable.............. 475,433 564,298 616,331 706,196 768,272
Margin borrowings....................... 8,558 28,040 13,485 33,264 35,773
Stockholders' equity.................... 77,242 85,884 73,402 46,266 38,272
Book value per share.................... $ 6.79 $ 7.33 $ 7.06 $ 4.30 $ 3.58

25

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

Introduction

ARI was organized in 1999. In August 2000, ARI acquired ART and NRLP. ART
was organized in 1961 to provide investors with a professionally managed,
diversified portfolio of real estate and mortgage loan investments selected to
provide opportunities for capital appreciation as well as current income. ART
owns a portfolio of real estate and mortgage loan investments. NRLP was
organized in 1987, and subsequently acquired all of the assets and assumed all
of the liabilities of 35 public and private limited partnerships. NRLP owns a
portfolio of real estate and mortgage loan investments.

Critical Accounting Policies

Critical accounting policies are those that are both important to the
presentation of ARI's financial condition and results of operations and require
management's most difficult, complex or subjective judgements. ARI's critical
accounting policies relate to the evaluation of impairment of long-lived assets
and the evaluation of the collectibility of accounts and notes receivable.

If events or changes in circumstances indicate that the carrying value of a
rental property to be held and used or land held for development may be
impaired, management performs a recoverability analysis based on estimated
undiscounted cash flows to be generated from the property in the future. If the
analysis indicates that the carrying value is not recoverable from future cash
flows, the property is written down to estimated fair value and an impairment
loss is recognized. If management decides to sell rental properties or land
held for development, management evaluates the recoverability of the carrying
amounts of the assets. If the evaluation indicates that the carrying value is
not recoverable from estimated net sales proceeds, the property is written down
to estimated fair value less costs to sell and an impairment loss is recognized
within income from continuing operations. ARI's estimates of cash flow and fair
values of the properties are based on current market conditions and consider
matters such as rental rates and occupancies for comparable properties, recent
sales data for comparable properties and, where applicable, contracts or the
results of negotiations with purchasers or prospective purchasers. ARI's
estimates are subject to revision as market conditions and ARI's assessments of
them change. In the third quarter of 2002, ARI recognized asset impairments of
$480,000. In the fourth quarter of 2002, ARI recognized asset impairments of
$3.7 million.

ARI's allowance for doubtful accounts receivable and notes receivable is
established based on analysis of the risk of loss on specific accounts. The
analysis places particular emphasis on past due accounts. Management considers
such information as the nature and age of the receivable, the payment history
of the tenant or other debtor, the financial condition of the tenant or other
debtor and ARI's assessment of its ability to meet its lease or interest
obligations. ARI's estimate of the required allowance, which is reviewed on a
quarterly basis, is subject to revision as these factors change and is
sensitive to the effects of economic and market conditions.

26

Obligations and Commitments

ARI has contractual obligations and commitments primarily with regards to
the payment of mortgages.

The following table aggregates ARI's expected contractual obligations and
commitments subsequent to December 31, 2002. (Dollars in thousands.)

PAYMENTS DUE BY PERIOD
------------------------------------------------------------
2003 2004 2005 2006 2007 Thereafter Total
-------- ------- ------- ------- ------- ---------- --------
(in thousands)

Variable interest rate notes
Instrument's maturities... $ 31,762 $21,580 $ 1,112 $ -- $ -- $ 1,029 $ 55,483
Instrument's amortization. 1,404 1,286 1,294 102 110 1,972 6,168
Interest.............. 5,285 3,375 489 390 380 2,968 12,887
Fixed interest rate notes
Instrument's maturities... $122,584 $25,259 $45,754 $10,498 $40,548 $114,935 $359,578
Instrument's amortization. 4,951 5,010 4,753 4,523 4,129 26,699 50,065
Interest.............. 33,906 22,068 18,047 15,118 13,043 30,760 132,942
Principal payments........... 160,701 53,135 52,912 15,123 44,788 144,635 471,294
Operating leases............. 2,239 2,140 1,901 1,623 1,350 3,952 13,205

Effective December 18, 1998, a wholly-owned subsidiary of ART was elected
general partner of NRLP. Prior to December 31, 1998, ART accounted for its
investment in NRLP under the equity method. As of December 31, 1998, upon the
election of its wholly-owned subsidiary as general partner of NRLP, ART began
consolidation of NRLP's accounts and has consolidated its operations subsequent
to that date.

Liquidity and Capital Resources

General. Cash and cash equivalents at December 31, 2002 totaled $8.4
million, compared with $709,000 at December 31, 2001. Although ARI anticipates
that during 2003 it will generate excess cash from operations, as discussed
below, such excess cash is not sufficient to discharge all of ARI's debt
obligations as they mature. ARI will therefore again rely on externally
generated funds, including aggressive land sales, selected sales of income
producing properties, borrowings against its investments in various real estate
entities, refinancing of properties and, to the extent necessary, borrowings to
meet its debt service obligations, pay taxes, interest and other non-property
related expenses.

Notes payable totaling $160.7 million are scheduled to mature during 2003.
During the first quarter of 2003, ARI either extended, refinanced, paid down,
paid off or received commitments from lenders to extend or refinance $39.0
million of the debt scheduled to mature in 2003. See NOTE 2. "REAL ESTATE,"
NOTE 8. "NOTES AND INTEREST PAYABLE" and NOTE 25. "SUBSEQUENT EVENTS."

ARI expects a further decline in cash from property operations in 2003. This
expected decrease results from the reduced number of apartment properties in
ARI's real estate portfolio.

Net cash used in operating activities was $52.7 million in 2002 compared to
$48.6 million in 2001. Fluctuations in the components of cash from operating
activities are discussed in the paragraphs that follow.

Net cash from property operations (rents collected less payments for
expenses applicable to rental income) decreased to $21.5 million in 2002 from
$26.8 million in 2001. This decrease was primarily attributable to apartment
properties sold in 2002 and 2001.

Net cash from pizza operations (sales less cost of sales) decreased to $5.5
million in 2002 from $6.4 million in 2001. The decrease was primarily
attributable to increased accounts receivable in 2002.

27

Interest collected decreased to $1.6 million in 2002 from $1.8 million in
2001. The decrease was attributable to the reduced number of outstanding loans
for which interest is due prior to maturity.

No distributions were received from equity investees in 2002, compared to
$53,000 in 2001. The decrease was due to the elimination of dividends paid by
investees. Distributions from equity investees are expected to be minimal in
2003.

Interest paid decreased to $54.4 million in 2002 from $62.6 million in 2001.
The decrease was primarily attributable to the reduction in outstanding loan
balances as properties were sold in 2002 and 2001.

Advisory fees paid decreased to $5.4 million in 2002 from $6.7 million in
2001. The decrease was due to the decrease in ARI's gross assets, the basis for
such fee.

No incentive fees were paid to affiliates in 2002, compared to $1.6 million
in 2001.

Distributions to minority interest holders decreased to $2.6 million in 2002
from $4.1 million in 2001. These distributions represent returns paid to
limited partner unitholders of controlled consolidated partnerships. See NOTE
2. "REAL ESTATE."

General and administrative expenses paid decreased to $12.0 million in 2002
from $12.7 million in 2001. The decrease was primarily attributable to a
decrease in reimbursements paid to ARI's advisor.

Other cash used in operating activities was $6.9 million in 2002 compared to
$4.1 million from other operating activities in 2001. The change was primarily
attributable to a $6.0 million bond posted in 2002, pursuant to an appeal of a
judgment from a lawsuit. See NOTE 23. "COMMITMENTS AND CONTINGENCIES AND
LIQUIDITY."

In 2002, ARI purchased a total of 100.1 acres of land in Austin, Texas and
Beaumont, California, in separate transactions for a total of $1.3 million. ARI
paid $1.4 million in cash, including closing costs. ARI obtained two
apartments, a shopping center and ownership interest in a foreign entity from
an affiliate for forgiveness of $20.7 million of debt, in a non-cash
transaction. ARI also received a shopping center from an affiliate in exchange
for a shopping center and two land parcels.

In 2002, ARI sold a total of 2,589.3 acres of land in Farmers Branch, Fort
Worth, Houston, Lewisville, Plano, Collin County, Dallas County, Denton County
and Harris County, Texas; Beaumont, Palm Desert and Riverside, California; and
Nashville, Tennessee in 32 separate transactions for a total of $128.1 million.
ARI received net cash of $2.3 million, after paying off or paying down or
assumption by the purchaser of $40.7 million in mortgage debt secured by such
land parcels and after providing purchase money financing of $51.2 million. ARI
also sold 18 apartments, three office buildings and two shopping centers for a
total of $159.2 million. ARI received net cash of $18.4 million, after the
payoff or assumption by the purchaser of mortgage debt totaling $114.3 million
and after providing purchase money financing of $8.4 million.

In 2001, ARI exchanged 8.9 acres of land in Farmers Branch, Texas and 10.5
acres of land in Lewisville, Texas for a 168 unit apartment in Addison, Texas.
See NOTE 2. "REAL ESTATE."

ARI expects that funds from existing cash resources, aggressive sales of
land and selected income producing property sales, refinancing of real estate,
and borrowings against its real estate will be sufficient to meet the cash
requirements associated with ARI's current and anticipated level of operations,
maturing debt obligations and existing commitments. To the extent that ARI's
liquidity permits or financing sources are available, ARI will make investments
in real estate, primarily in improved and unimproved land, will continue making
investments in real estate entities and marketable equity securities, and will
develop and construct income-producing properties.

28

ARI expects that it will be necessary for it to sell $62.9 million, $38.3
million and $7.0 million of its land holdings during each of the next three
years to satisfy the debt on the land as it matures. If ARI is unable to sell
at least the minimum amount of land to satisfy the land debt obligations as
they mature, ARI, intends to extend such debt or sell other of its assets,
specifically income producing properties, to pay the debt.

Loans Payable. ARI has margin arrangements with various brokerage firms
which provide for borrowings of up to 50% of the market value of marketable
equity securities. The borrowings under the margin arrangements are secured by
the equity securities and bear interest rates ranging from 5.25% to 24.0%.
Margin borrowings totaled $8.6 million (approximately 14.7% of market value) at
December 31, 2002, compared to $28.0 million at December 31, 2001. See NOTE 9.
"MARGIN BORROWINGS."

Equity Investments. During the fourth quarter of 1988, ARI began purchasing
shares of IORI and TCI which have the same advisor as ARI. It is anticipated
that additional equity securities of IORI and TCI may be acquired in the future
through open-market and negotiated transactions to the extent ARI's liquidity
permits. See ITEM 1. "BUSINESS" for discussion of the tender offer for shares
of TCI and IORI common stock by ARI.

Equity securities of IORI and TCI held by ARI may be deemed to be
"restricted securities" under Rule 144 of the Securities Act of 1933
("Securities Act"). Accordingly, ARI may be unable to sell such equity
securities other than in a registered public offering or pursuant to an
exemption under the Securities Act for a one year period after they are
acquired. Such restrictions may reduce ARI's ability to realize the full fair
market value of such investments if ARI attempted to dispose of such securities
in a short period of time.

ARI's cash flow from these investments is dependent on the ability of each
of IORI and TCI to make distributions. In December 2000, the Boards of IORI and
TCI suspended the payment of quarterly dividends. ARI received no distributions
from TCI and IORI in 2002, and ARI anticipates receiving no distributions from
IORI and TCI in 2003.

In 2002, ARI paid dividends to its Preferred stockholders totaling $2.4
million. ARI paid $25,000 in accumulated back dividends in 2002 on previously
unexchanged units of NRLP.

Management reviews the carrying values of ARI's properties and mortgage
notes receivable at least annually and whenever events or a change in
circumstances indicate that impairment may exist. Impairment is considered to
exist if, in the case of a property, the future cash flow from the property
(undiscounted and without interest) is less than the carrying amount of the
property. For notes receivable impairment is considered to exist if it is
probable that all amounts due under the terms of the note will not be
collected. If impairment is found to exist, a provision for loss is recorded by
a charge against earnings to the extent that the investment in the note exceeds
management's estimate of the fair value of the collateral securing such note.
The mortgage note receivable review includes an evaluation of the collateral
property securing each note. The property review generally includes: (1)
selective property inspections; (2) a review of the property's current rents
compared to market rents; (3) a review of the property's expenses; (4) a review
of maintenance requirements; (5) a review of the property's cash flow; (6)
discussions with the manager of the property; and (7) a review of properties in
the surrounding area.

Commitments

ARI will rely on externally generated funds, including aggressive land
sales, selected sales of income producing properties, refinancing of properties
and, to the extent necessary, borrowings to meet these commitments.

Results of Operations

2002 Compared to 2001. ARI reported a net loss of $8.5 million in 2002
compared to net income of $15.1 million in 2001. ARI's net income in 2002
included gains on the sale of real estate of $50.5 million compared to gains on
the sale of real estate of $83.4 million in 2001. The primary factors
contributing to ARI's net income are discussed in the following paragraphs.

29

Rents decreased to $89.5 million in 2002 from $101.9 million in 2001. Rent
from commercial properties of $28.0 million in 2002 approximated the $27.8
million in 2001, rent from hotels of $31.7 million in 2002 approximated the
$32.0 million in 2001 and rent from apartments decreased to $29.1 million in
2002 from $41.2 million in 2001. Apartment rents decreased in 2002 as a result
of the sale of 17 apartments in 2001. Rents are expected to decrease in 2003 as
a result of continued property sales.

Property operations expense decreased to $67.7 million in 2002 from $76.6
million in 2001. Property operations expense for commercial properties
increased to $17.8 million in 2002 from $15.9 million in 2001, hotel expense
decreased to $23.9 million in 2002 from $25.2 million in 2001, land expense
decreased to $6.0 million in 2002 from $8.6 million expense in 2001 and
apartment expense decreased to $19.1 million in 2002 from $26.2 million in
2001. The increase in commercial property operation expense was primarily
attributable to increased subleasing costs at three properties. The decrease in
hotel operations expense was primarily due to a reduction in property
improvement costs. The decrease in land operations expense was primarily due to
the sale of 34 land parcels in 2001. The decrease in apartment property
operations expense was primarily due to the sale of 17 apartments in 2001.
Property operations expense is expected to decrease in 2003 as a result of
continued property sales.

Pizza parlor sales and cost of sales increased to $36.7 million and $30.0
million in 2002 from $34.2 million and $27.9 million in 2001. The increases
were primarily attributable to same-store sales increases of 7.9% in 2002 from
2001 levels. Pizza parlor gross margin in 2003 is expected to approximate 2002,
unless costs change significantly.

Interest income of $3.1 million in 2002 approximated the $2.8 million income
in 2001. Interest income is expected to increase in 2003 as a result of the new
notes from property sales in late 2002.

Equity in loss of investees decreased to $(20.9) million in 2002, from
$(13.4) million in 2001. The decrease was primarily attributable to increased
net losses, before gains on sale of real estate, for TCI and IORI in 2002. See
NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."

Loss on sale of investments in equity investees improved to $(286,000) in
2002 from $(387,000) in 2001. In 2002, loss on the sale of Villas Continental
Apartments was recognized. In 2001, loss on the sale of TCI common stock was
recognized.

Equity in gain on sale of real estate by equity investees increased to $24.1
million in 2002, from $22.5 million in 2001. The 2002 results are reported as a
component of net income (loss) from discontinued operations, and the 2001
results are reported as a component of net income (loss) from continuing
operations. See NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."

Other income increased to $5.4 million in 2002 from a loss of $369,000 in
2001. The increase was primarily due to $2.2 million received in settlement of
a lawsuit against a brokerage firm for improper sales in 2000 of TCI common
stock owned by ARI and held by the brokerage firm, and $1.4 million received as
partial settlement of a lawsuit against a lender for improperly attempting to
seize, in 1996, a mortgage note receivable due to ARI. ARI sold the note to BCM
in 1999, with the provision that any settlement received in excess of the
amount paid by BCM, plus accrued interest, would be returned to ARI.

Interest expense decreased to $57.7 million in 2002 from $65.0 million
expense in 2001. The decrease is primarily attributable to property sales in
2002 and 2001. Also in 2002, ARI recognized a $912,000 loss on an interest rate
swap contract. See NOTE 21. "DERIVATIVE FINANCIAL INSTRUMENTS."

Depreciation and amortization decreased to $10.2 million in 2002 from $11.7
million in 2001. The decrease was primarily attributable to the sale of
properties in 2002 and 2001. Depreciation and amortization expense should
decrease in 2003 as a result of continued property sales.

30

General and administrative expenses of $12.5 million in 2002 approximated
the $12.7 million in 2001. General and administrative expenses in 2003 are
expected to approximate 2002.

Advisory fees decreased to $5.9 million in 2002 from $6.7 million in 2001.
The decrease was attributable to the decrease in ARI's gross assets, the basis
for such fee. Advisory fees are expected to decrease in 2003, as ARI's gross
asset base is expected to decrease through property sales.

There was no net income fee to affiliate in 2002, compared to $166,000 in
2001. The net income fee payable to ARI's advisor is 10% of the net income for
the year, in excess of a 10% return on shareholders' equity. For 2002, ARI's
net income was below the 10% return threshold.

There was no incentive fee to affiliate in 2002, compared to $3.8 million in
2001. The incentive fee is only due if ARI is also subject to the net income
fee. For 2002, the net income fee requirements were not met; therefore, no
incentive fee was due. This fee represents 10% of the excess of net capital
gains over net capital losses from sales of operating properties. The amount of
the fee, if any, in 2003 will be dependent on the operating properties sold and
net capital gains realized.

Writedown of assets held for sale increased to $4.2 million in 2002, from
$2.5 million in 2001. In 2002, the carrying values of a shopping center in Fort
Worth, Texas, sold in the fourth quarter of 2002 and an 89.3 acre tract of land
in Palm Desert, California, sold in the first quarter of 2003, were reduced to
their net realizable value. In 2001, the impairment of an asset was recognized.

Minority interest increased to $1.3 million in 2002 from $972,000 in 2001.
Minority interest is the earnings attributable to owners other than ARI, of
certain controlled entities. Minority interest in 2002 and 2001 was
attributable, in part, to the preferred return limited partner units of Ocean
Beach Partners, L.P., Valley Ranch, L.P., Grapevine American, L.P., Edina Park
Plaza Associates, L.P. and Hawthorne Lakes Associations, L.P., ART Florida
Portfolio III and ART Palm, L.L.C. In 2001, minority interest includes, in
addition to the preferred returns discussed above, $(429,000) reflecting 20%
minority interest in the net loss from the Grand Hotel Sofia.

Gains on sale of real estate decreased to $48.4 million in 2002 from $83.4
million in 2001. In 2002, gains of $28.7 million were recognized on the sale of
14 apartments: Conradi House, Daluce, Grand Lagoon, Lee Hills, Morning Star,
Oak Hill, Pheasant Ridge, Pinecrest West, Regency, Stonebridge, Valley Hi,
Villas, Westwood Parc and Woodsong; $3.4 million on the sale of two commercial
properties: Melrose Business Park and Rosedale Towers; and $18.9 million on the
sale of land: 171.1 acres of Desert Wells land, 8.8 acres of Eldorado Parkway
land, three tracts totaling 45.4 acres of Elm Fork land, two tracts totaling
3.9 acres of Katrina land, five tracts totaling 69.7 acres of Mason Goodrich
land, 61.0 acres of Monterrey land, 1.0 acre of Nashville land, 129.7 acres of
Varner Road land and two tracts totaling 13.9 acres of Vista Ridge land. In
2002, losses of $2.6 million were recognized on the sale of Stonegate
Apartments, Woodsong Apartments, 10.8 acres of Frisco Bridges land, 80.0 acres
of Katrina land, and 0.2 acres of Thompson II land.

In 2001, gains of $73.5 million were recognized on the sale of 15
apartments: Rockborough, Carriage Park, Kimberly Woods, Place One, Shadowood,
Bent Tree, Club Mar, Covered Bridge, Crossing at Church, Chalet I, Chalet II,
Nora Pines, Timbercreek, Blackhawk, and Woodstock; $2.2 million on the sale of
Regency Pointe Shopping Center; and $16.0 million on the sale of land: two
tracts totaling 27.2 acres of Chase Oaks land, 10.0 acres of Elm Fork land,
27.8 acres of Frisco Bridges land, 1.7 acres of Las Colinas land, 22.1 acres of
Mason Goodrich land, 4.2 acres of Nashville land, 5 tracts totaling 49.7 acres
of Katrina land, 6.6 acres of Rasor land, 12.7 acres of Santa Clarita land,
232.8 acres of Scoggins land, 408.0 acres of Scout land, 10.4 acres of Tree
Farm land, and 0.4 acres of Waters Edge Apartment land. In 2001, losses of $8.3
million were recognized on the sale of Glenwood Apartments, 12.0 acres of Plano
Parkway land, 120.4 acres of Yorktown land, two tracts totaling 3.2 acres of
Nashville land, Ashford Apartments, 6.7 acres of Santa Clarita land, 107.0
acres of Elm Fork land, and 27.4 acres of Vista Ridge land.

31

Net income from discontinued operations was $51.6 million in 2002 compared
to net loss from discontinued operations of $(7.4) million in 2001. The net
income (loss) relates to 23 properties and leasehold interests in oil and gas
properties that ARI sold during 2002 and eight properties that ARI sold in
2003. The following table summarized revenue and expense information for the
properties sold.

2002 2001
------- -------

Revenue
Rental.................................................... $21,346 $27,432
Property operations....................................... 13,405 16,837
------- -------
7,941 10,595
Expenses
Interest.................................................. 8,144 12,003
Depreciation.............................................. 4,011 5,946
------- -------
12,155 17,949
Net loss from discontinued operations........................ (4,214) (7,354)
Gain on sale of real estate............................... 31,706 --
Equity in gain on sale of real estate by equity investees. 24,069 --
------- -------
Net income (loss) from discontinued operations............... $51,561 $(7,354)
======= =======

2001 Compared to 2000. ARI reported net income of $15.1 million in 2001
compared to $2.7 million in 2000. ARI's net income in 2001 included gains on
the sale of real estate of $83.4 million compared to gains on the sale of real
estate of $96.7 million in 2000. The primary factors contributing to ARI's net
income are discussed in the following paragraphs.

Rents decreased to $101.9 million in 2001 from $120.6 million in 2000. Rent
from commercial properties of $27.8 million in 2001 approximated the $28.7
million in 2000, rent from hotels decreased to $32.0 million in 2001 from $33.1
million in 2000 and rent from apartments decreased to $43.4 million in 2001
from $57.1 million in 2000. The decrease in rent from hotels was primarily
attributable to reduced occupancy. Apartment rents decreased in 2001 as a
result of the sale of nine apartments in 2000 and 17 apartments in 2001.

Property operations expense decreased to $76.6 million in 2001 from $81.4
million in 2000. Property operations expense for commercial properties of $15.9
million in 2001 approximated the $16.1 million expense in 2000, hotel expense
increased to $25.2 million in 2001 from $24.1 million in 2000, land expense
decreased to $8.6 million in 2001 from $9.7 million expense in 2000 and
apartment expense decreased to $26.2 million in 2001 from $31.3 million in
2000. The increase in hotel operations expense was primarily due to property
improvement costs. The decrease in land operations expense was primarily due to
the sale of 26 land parcels in 2000 and 34 land parcels in 2001. The decrease
in apartment property operations expense was primarily due to the sale of nine
apartments in 2000 and 17 apartments in 2001.

Pizza parlor sales and cost of sales were $34.2 million and $27.9 million in
2001 and $32.6 million and $26.8 million, in 2000. Pizza parlor operations
gross margin in 2001 increased over the gross margin in 2000 primarily due to
reduced interest costs after refinancing debt in 2001 and reduced occupancy
costs.

Interest income of $2.8 million in 2001 approximated the $3.0 million income
in 2000.

Equity in loss of investees decreased to $(13.4) million in 2001, from
$(4.6) million in 2000. The decrease was primarily attributable to increased
net losses, before gains on sale of real estate, for TCI and IORI in 2001. See
NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."

32

Loss on sale of investments in equity investees improved to $(387,000) in
2001, from $(8.7) million in 2000. In 2001, loss on sale of TCI common stock
was recognized. In 2000, losses include $(7.6) million on sale of TCI stock,
$(246,000) on sale of IORI common stock and $(872,000) on the sale of Vestavia
Lakes Apartments.

Equity in gain on sale of real estate by equity investees increased to $22.5
million in 2001, from $18.6 million in 2000. See NOTE 6. "INVESTMENTS IN EQUITY
INVESTEES."

Other income improved to a loss of $369,000 in 2001 from a loss of $926,000
in 2000. The increase was primarily due to a reduction in losses on the sale of
marketable securities.

Interest expense decreased to $65.0 million in 2001 from $66.5 million
expense in 2000. The decrease was primarily attributable to the sale of land
parcels and apartments in 2001 and 2000.

Depreciation and amortization decreased to $11.8 million in 2001 from $12.9
million in 2000. The decrease was primarily attributable to the sale of nine
apartments in 2000 and 17 apartments in 2001.

General and administrative expenses decreased to $12.7 million in 2001 from
$17.1 million in 2000. The decrease was primarily attributable to a decrease in
cost reimbursements to ARI's advisor.

Advisory fees increased to $6.7 million in 2001 from $5.9 million in 2000.
The increase was attributable to the inclusion of NRLP assets in ARI's gross
assets, the basis for such fee.

Net income fee to affiliate in 2001 was $166,000. The income fee payable to
ARI's advisor is 10% of the net income for the year, in excess of a 10% return
on shareholders' equity. No net income fee was paid in 2000.

Incentive fees increased to $3.8 million in 2001 from $1.6 million in 2000.
The increase was attributable to 18 eligible sales in 2001 compared to four
eligible sales in 2000. This fee represents 10% of the excess of net capital
gains over net capital losses from sales of operating properties.

There was no provision for loss in 2001, compared to $2.0 million in 2000.
In 2000, a litigation reserve was established, related to a breach of contract
dispute.

Writedown of assets held for sale increased to $2.5 million in 2001, from
$248,000 in 2000. In 2001, the impairment of an asset was recognized. In 2000,
the carrying value of an 11.3 acre tract of land in Plano, Texas, sold in the
first quarter of 2001, was reduced to its net realizable value.

Minority interest decreased to $972,000 in 2001 from $30.7 million in 2000.
Minority interest is the earnings attributable to owners, other than ARI, of
certain controlled entities. Minority interest in 2001 and 2000 was
attributable, in part, to the preferred return limited partner units of Ocean
Beach Partners, L.P., Valley Ranch, L.P., Grapevine American, L.P., Edina Park
Plaza Associates, L.P. and Hawthorne Lakes Associations, L.P., ART Florida
Portfolio III and ART Palm, L.L.C. In 2000, minority interest includes, in
addition to the preferred returns discussed above, $29.8 million of earnings
attributable to the limited partners in NRLP prior to the merger. Minority
interest in 2001 declined due to the 2000 acquisition of NRLP by ARI.

Gains on sale of real estate decreased to $83.4 million in 2001 from $96.7
million in 2000. In 2001, gains of $73.5 million were recognized on the sale of
15 apartments: Rockborough, Carriage Park, Kimberly Woods, Place One,
Shadowood, Bent Tree, Club Mar, Covered Bridge, Crossing at Church, Chalet I,
Chalet II, Nora Pines, Timbercreek, Blackhawk, and Woodstock; $2.2 million on
the sale of Regency Pointe Shopping Center; and $16.0 million on the sale of
land: two tracts totaling 27.2 acres of Chase Oaks land, 10.0 acres of Elm Fork
land, 27.8 acres of Frisco Bridges land, 1.7 acres of Las Colinas land, 22.1
acres of Mason Goodrich land, 4.2 acres of Nashville land, 5 tracts totaling
49.7 acres of Katrina land, 6.6 acres of Rasor land, 12.7 acres of Santa
Clarita land, 232.8 acres of Scoggins land, 408.0 acres of Scout land, 10.4
acres of Tree Farm land, and 0.4 acres

33

of Waters Edge Apartment land. In 2001, losses of $8.3 million were recognized
on the sale of Glenwood Apartments, 12.0 acres of Plano Parkway land, 120.4
acres of Yorktown land, two tracts totaling 3.2 acres of Nashville land,
Ashford Apartments, 6.7 acres of Santa Clarita land, 107.0 acres of Elm Fork
land, and 27.4 acres of Vista Ridge land.

In 2000, gains of $45.9 million were recognized on the sale of nine
apartments: Summerwind, Windtree, The Pines, Whispering Pines, Four Seasons,
Sherwood Glen, Fair Oaks, Hidden Valley and Candlelight Square; $21.9 million
on the sale of commercial properties: Katella Plaza, Marina Playa, Harbor Plaza
and Preston Center; and $30.6 million on the sale of land: 420 acres of
Duchesne land, three tracts totaling 166.7 acres of Frisco Bridges land, 749.1
acres of Keller land, 0.02 acres of Katy land, four tracts totaling 41.2 acres
of Mason/Goodrich land, 157.9 acres of Mastenbrook land, 82.0 acres of McKinney
Corners I, II, III, IV and V land, 20.67 acres of Monterey land, four tracts
totaling 8.69 acres of Nashville land, 182.5 acres of Pantex land, two tracts
totaling 329.4 acres of Parkfield land, three tracts totaling 89.51 acres of
Rasor land, 80.4 acres of Rowlett Creek land, 3.0 acres of Salmon River land,
126.6 acres of Vann Cattle land, 5.4 acres of Vista Business Park land, and
70.3 acres of Wakefield land. In 2000, losses of $1.6 million were recognized
on the sale of 14.6 acres of McKinney Corners II land, 377.15 acres of Pioneer
Crossing land, 4.79 acres of Plano Parkway land, 22.4 acres of Valley Ranch
land, and 36.43 acres of Vista Business Park land.

Loss from discontinued operations improved to $(7.4) million in 2001 from
$(9.3) million in 2000. The loss relates to 23 properties and leasehold
interests in oil and gas properties that ARI sold during 2002 and eight
properties that ARI sold in 2003. The following table summarized revenue and
expense information for the properties sold.

2001 2000
------- -------

Revenue
Rental............................ $27,432 $17,551
Property operations............... 16,837 12,718
------- -------
10,595 4,833
Expenses
Interest.......................... 12,003 10,221
Depreciation...................... 5,946 3,933
------- -------
17,949 14,154
Net loss from discontinued operations $(7,354) $(9,321)
======= =======

Related Party Transactions

Historically, ARI, TCI, IORI and BCM have each engaged in and may continue
to engage in business transactions, including real estate partnerships, with
related parties. Management believes that all of the related party transactions
represented the best investments available at the time and were at least as
advantageous to ARI as could have been obtained from unrelated parties.

Operating Relationships

In October 1997, ARI entered into leases with BCM and an affiliate of BCM
for space at the One Hickory Centre Office Building, construction of which was
completed in December 1998. The BCM leases, effective upon ARI obtaining
permanent financing of the building, were for 75,852 sq.ft. (approximately 75%
of the building), had terms of ten and fifteen years and provided for annual
base rent of $19.25 per sq.ft. for the first year. In January 2001, both leases
were terminated, and ARI entered into a new lease with BCM, effective October
1, 2000. The new lease is for 59,463 sq.ft. (approximately 62% of the
building), has a term of three years, and provides for annual base rent of $1.3
million or $21.50 per sq.ft. Effective March 1, 2002, the lease was amended to
57,879 sq.ft. (approximately 59% of the building), with an annual base rent of
$1.2 million, or $21.50 per sq.ft. In April 2002, ARI sold the subsidiary which
owns the building to TCI.

34

In 2002, ARI paid BCM, its affiliates and a related party $5.9 million in
advisory fees, $689,000 in mortgage brokerage and equity refinancing fees,
$13,000 in property acquisition fees, $5.4 million in real estate brokerage
commissions, $1.9 million in construction supervision fees and $4.2 million in
property and construction management fees and leasing commissions, net of
property management fees paid to subcontractors, other than affiliates of BCM.
In addition, as provided in the Advisory Agreement, BCM received cost
reimbursements of $2.5 million.

Partnership Transactions

BCM has entered into put agreements with certain holders of the Class A
limited partner units of Ocean Beach Partners, L.P. The Class A units are
convertible into Series D Cumulative Preferred Stock of ARI. The put price of
the Series D Preferred Stock is $20.00 per share plus accrued but unpaid
dividends.

BCM entered into put agreements with the holders of the Class A limited
partner units of Valley Ranch, L.P. Such Class A units were convertible into
Series B Cumulative Convertible Preferred Stock of ARI which was further
convertible into Common Stock of ARI. The put price for the Class A units was
$1.00 per unit and the put price for either the Series B Preferred Stock or
ARI's Common Stock was 80% of the average daily closing price of ARI's Common
Stock for the prior 20 trading days. In March 1999, ARI reached agreement with
the Class A unitholders of Valley Ranch, L.P. to acquire their eight million
Class A units for $1.00 per unit. In 1999, three million units were purchased.
Additionally, one million units were purchased in January 2000 and two million
units were purchased in May 2001. ARI purchased the remaining two million units
in 2002.

BCM has entered into put agreements with the holders of the Class A units of
ART Palm, L.P. Such Class A units are convertible into Series C Cumulative
Convertible Preferred Stock of ARI. The put price for the Class A units is
$1.00 per unit and the put price for either the Series C Preferred Stock or
ARI's Common Stock is 90% of the average daily closing price of ARI's Common
Stock for the prior 20 trading days. The put agreement calls for ARI to
repurchase the outstanding Class A units as follows: June 30, 2003, 1,625,000
units; December 31, 2005, 1,625,000 units; and December 31, 2006, 8,563,750
units.

Advances and Loans

From time-to-time, ARI and its affiliates have made advances to each other,
which have not had specific repayment terms, do not bear interest, are
unsecured and have been reflected in ARI's financial statements as other assets
or other liabilities. At December 31, 2002, after accounting for affiliate
purchases and sales, amounts still owed by ARI were $26.6 million, $6.6
million, $3.5 million and $2.7 million to BCM, TCI, IORI and Regis,
respectively.

In March 2000, a loan with a current principal balance of $2.6 million to
Lordstown, L.P., matured. The loan, to provide funds to purchase for resale
various parcels of land, is secured by a second lien on land in Ohio and
Florida, by 100% of the general and limited partner interest in Partners
Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest
in subsequent land sales. At December 2002, the loan, and $1.1 million of
accrued interest, remained unpaid. A corporation controlled by Richard D.
Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a
director of ARI until October 2001.

In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an
affiliate. The loan, to provide funds for acquisitions or working capital
needs, was secured by all of the outstanding shares of common stock of American
Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and
matured in November 2001. In January 2000, $100,000 was collected. In November
2001, the maturity date was extended to November 2004. The collateral was
changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by
BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate
was changed to 2% over the prime rate, currently 6.25% per annum, and the
accrued but unpaid interest of $984,000 was added to the principal. The new
principal balance is $5.6 million. All principal and accrued interest are due
at maturity.

35

In December 2000, an unsecured loan with a current principal balance of $1.8
million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to
provide funds to purchase, renovate and expand a shopping center property in
Warwick, Rhode Island. All principal and interest were due at maturity. At
December 2002, the loan, and $188,000 of accrued interest, remained unpaid.
Richard D. Morgan, a Warwick shareholder, served as a director of ARI until
October 2001.

In December 2000, a loan with a current principal balance of $1.6 million to
Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide
funds to purchase and renovate a shopping center in Oklahoma City, Oklahoma, is
secured by (1) a 100% interest in Bordeaux, which owns a shopping center in
Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments One,
Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma; and
(3) the personal guarantees of the Bordeaux members. At December 2002, the
loan, and $710,000 of accrued interest, remained unpaid. Richard D. Morgan, a
Bordeaux member, served as a director of ARI until October 2001.

In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of
credit to One Realco Corporation ("One Realco"), which owns approximately 14.7%
of the outstanding shares of ARI's Common Stock. One Realco periodically
borrows money to meet its cash obligations. The line of credit bears interest
at 12.0% per annum. All principal and interest were due at maturity in February
2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in
principal and $416,000 in interest was collected. In December 2001, $21,000 in
principal and $804,000 in interest was collected. In February 2002, the line of
credit was increased to $18.0 million, accrued but unpaid interest of $217,000
was added to the principal and the maturity date was extended to February 2004.
In March 2002, ARI funded an additional $1.8 million, increasing the
outstanding principal balance to $15.5 million. In October 2002, $856,900 in
interest was collected, by the return of 85,690 shares of ARI Series A
Preferred Stock. All principal and interest are due at maturity. Ronald E.
Kimbrough, Acting Principal Executive Officer, Executive Vice President and
Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001
and 2002, Mr. Kimbrough did not participate in day-to-day operations or
management of One Realco.

In June 2002, ARI converted $4.5 million of its receivable from BCM to a
recourse note receivable. This transaction was to provide ARI with additional
security over that provided by an unsecured receivable. The note bears interest
at 10.0% per annum, matures in March 2004 and requires quarterly payments of
principal and accrued interest, beginning in December 2002.

Property Transactions

In May 2001, ARI exchanged with TCI two parcels of land, a 10.5 acre tract
of Vista Ridge land and an 8.88 acre tract of Hollywood Casino land, for the
168 unit Glenwood Apartments. The business purpose of the transaction was for
TCI to construct apartments on the Vista Ridge land and office buildings on the
Hollywood Casino land and for ARI to obtain a property that could be sold for
cash. ARI received net cash of $3.2 million on the subsequent sale of the
apartments. See NOTE 2. "REAL ESTATE."

In December 2001, TCI purchased 100% of the outstanding common shares of
National Melrose, Inc. ("NM"), a wholly-owned subsidiary of ARI, for $2.0
million. The purpose of the transaction was for TCI to make an equity
investment, anticipating a profitable return, in NM and for ARI to receive cash
for its equity investment. NM owns the Executive Court Office Building. ARI has
guaranteed that the asset will produce at least a 12% annual return on the
purchase price for a period of three years from the purchase date. If the asset
fails to produce the annual return, ARI will pay TCI any shortfall. In
addition, if the asset fails to produce the 12% return for a calendar year, TCI
may require ARI to repurchase the shares of NM for the purchase price. The
purchase price was determined based upon the market value of the property
exchanged, using a market rate multiple of net operating income. Management has
classified this related party transaction as a note payable to TCI.

36

In January 2002, IORI purchased 100% of the outstanding common shares of
Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1
million. The purchase price was determined based upon the market value of the
property exchanged, using a market rate multiple of net operating income.
Rosedale owned the Rosedale Towers Office Building. ARI guaranteed that the
asset would produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset failed to produce
the 12% return, ARI would pay IORI any shortfall. In addition, if the asset
failed to produce the 12% return for a calendar year, IORI could require ARI to
repurchase the shares of Rosedale for the purchase price. The business purpose
of the transaction was for IORI to make an equity investment in Rosedale,
anticipating a profitable return, and for ARI to receive cash for its equity
investment. Management classified this related party transaction as a note
payable to IORI. IORI sold the Rosedale Towers Office Building to an unrelated
buyer in December 2002. ARI owes $2.1 million to IORI for remaining principal
and 12% return.

In January 2002, TCI purchased 100% of the common shares of ART Two Hickory
Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4
million. The purchase price was determined based upon the market value of the
property exchanged, using a market rate multiple of net operating income. Two
Hickory owns the Two Hickory Centre Office Building. ARI has guaranteed that
the asset will produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset fails to produce the
12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the shares of Two Hickory for the purchase price. The business purpose of the
transaction was for TCI to make an equity investment in Two Hickory,
anticipating a profitable return, and for ARI to receive cash for its equity
investment. Management has classified this related party transaction as a note
payable to TCI.

In March 2002, ARI received $520,000 and exchanged with TCI a 24.5 acre
tract of Rasor land, a 16.89 acre tract of Lakeshore Villas Apartments land and
the 45,623 sq.ft. Oaktree Village Shopping Center for the 80,278 sq.ft. Plaza
on Bachman Creek Shopping Center. The exchange value prices for the shopping
centers were determined using a market rate multiple of net operating income,
and the values of the land parcels were determined using appraised rates. The
business purpose of the transaction was for TCI to construct apartments on the
Rasor and Lakeshore Villas land. To give ample value for the property TCI
exchanged, the Oaktree Village Shopping Center was added to the transaction.
ARI received $4.4 million on the subsequent financing of the shopping center.

In April 2002, TCI purchased all of the general and limited partnership
interest in Garden Confederate Point, L.P. ("Confederate Point") from ARI for
$1.9 million. The purchase price was determined based on the market value of
the property exchanged using a market rate multiple of net operating income.
Confederate Point owns the Confederate Point Apartments. ARI has guaranteed
that the asset will produce at least a 12% annual return on the purchase price
for a period of three years from the purchase date. If the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the interests in Confederate Point for the purchase price. The business purpose
of this transaction was for TCI to make an equity investment in Confederate
Point anticipating a profitable return and to reduce ARI's payable to BCM.
Management has classified this related party transaction as a note payable to
TCI. Failure to notify and receive approval from the lender for this
transaction may constitute an event of default under the terms of the debt
assumed by TCI.

In April 2002, TCI purchased all of the general and limited partnership
interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The
purchase price was determined based on the market values of the property
exchanged, using a market rate multiple of net operating income. Foxwood owns
the Foxwood Apartments. ARI has guaranteed that the asset will produce at least
a 12% annual return on the purchase price for a period of three years from the
purchase date. If the asset fails to produce the 12% return, ARI will pay TCI
any shortfall. In addition, if the asset fails to produce the 12% return for a
calendar year, TCI may require ARI to repurchase the interests in Foxwood for
the purchase price. The business purpose for the transaction was for TCI to
make an equity investment in Foxwood anticipating a profitable return and to
reduce ARI's payable to BCM. Management has classified this related party
transaction as a note payable to TCI. Failure to notify and receive

37

approval from the lender for this transaction may constitute an event of
default under the terms of the debt assumed by TCI.

In April 2002, TCI purchased all of the general and limited partnership
interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The
purchase price was determined based on the market value of the property
exchanged, using a market rate multiple of net operating income. Woodsong owns
the Woodsong Apartments. ARI has guaranteed that the asset will produce at
least a 12% annual return on the purchase price for a period of three years
from the purchase date. If the asset fails to produce the 12% return, ARI will
pay TCI any shortfall. In addition, if the asset fails to produce the 12%
return for a calendar year, TCI may require ARI to repurchase the interests in
Woodsong for the purchase price. The business purpose for the transaction was
for TCI to make an equity investment in Woodsong anticipating a profitable
return and to reduce ARI's payable to BCM. Management has classified this
related party transaction as a note payable to TCI. In July 2002, the Woodsong
Apartments was sold for $9.1 million. TCI received $2.6 million from the
proceeds of $2.8 million as payment of principal and accrued but unpaid
interest on the loan.

In April 2002, TCI purchased 100% of the common shares of ARI One Hickory
Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5
million. The purchase price was determined based on the market value of the
property exchanged, using a market rate multiple of net operating income. One
Hickory owns the One Hickory Centre Office Building. ARI has guaranteed that
the asset will produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset fails to produce the
12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the interests in One Hickory for the purchase price. The business purpose for
the transaction was for TCI to make an equity investment in One Hickory
anticipating a profitable return and to reduce ARI's payable to BCM. Management
has classified this related party transaction as a note payable to TCI. Failure
to notify and receive approval from the lender for this transaction may
constitute an event of default under the terms of the debt assumed by TCI.

In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the
Centura Tower Office Building, from ARI for $50.0 million. See NOTE 2. "REAL
ESTATE." The purchase price for the Centura Tower was determined based on
appraised value and replacement cost. The business purpose of the transaction
was for TCI to acquire a Class A office building with significant upside
potential anticipating a profitable return and for ARI to satisfy debt.

In June 2002, TCI purchased five parcels of unimproved land from ARI for
$30.0 million: the Hollywood Casino, Marine Creek, Mason Park, Nashville and
Monterrey land parcels. See NOTE 2. "REAL ESTATE." The purchase price of the
Hollywood Casino land was determined based on an appraised value of $9.10 per
square foot. The business purpose of the transaction was for TCI to consolidate
its holdings within the Mercer Crossing development. The purchase price for the
Marine Creek, Mason Park, Nashville and Monterrey land parcels was determined
based on appraised rates. The business purpose of the transaction was for TCI
to develop apartments on these four tracts of land and for ARI to satisfy debt.
Failure to notify and receive approval from the lender for this transaction may
constitute an event of default under the terms of the debt assumed by TCI.

In June 2002, ARI purchased all the general and limited partnership
interests in Chalet North, L.P. ("Chalet North") from BCM for $3.0 million.
Chalet North owns the Pinecrest Apartments. The purchase price was determined
based on the market value of the property exchanged, using a market rate
multiple of net operating income. ARI assumed debt of $1.4 million. ARI's
receivable from BCM was reduced by $1.6 million, and no cash was paid by ARI.
The business purpose of the transaction was to reduce the affiliate payable
owed by BCM to ARI.

In June 2002, ARI purchased the Tiberon Trails Apartments from BCM for $12.3
million. The purchase price was determined based on the market value of the
property exchanged, using a market rate multiple of net operating income. ARI
assumed debt of $6.4 million. ARI's receivable from BCM was reduced by $5.9
million,

38

and no cash was paid by ARI. The business purpose of the transaction was to
reduce the affiliate payable owed by BCM to ARI.

In June 2002, ARI purchased the Alta Mesa Shopping Center from BCM for $3.8
million. The purchase price was determined based on the market value of the
property exchanged, using a market rate multiple of net operating income. ARI
assumed debt of $1.8 million. ARI's receivable from BCM was reduced by $2.0
million, and no cash was paid by ARI. The business purpose of the transaction
was to reduce the affiliate payable owed by BCM to ARI.

On June 30, 2002, ARI obtained 74.31% interest in RAK from BCM for $6.0
million. The business purpose of the transaction was to reduce the affiliate
payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0
million, and no cash was paid by ARI. At the date of the acquisition, RAK's
assets consisted of $2.3 million in cash, $3.0 million in deposits and
marketable securities, and $225,000 in other assets. RAK's net equity was $5.5
million. ARI recorded $1.9 million in goodwill as a result of this transaction.

In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for
Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying
$764,000 after payment of closing costs and debt paydown and providing purchase
money financing of $8.4 million. One loan has a principal amount of $2.0
million. The loan is unsecured, and is guaranteed by Unified Housing
Foundation, Inc. ("Unified"), a related party. The second loan has a principal
amount of $6.4 million, and is secured by a pledge by Unified of 100% of the
Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature
in December 2009 and require quarterly payments beginning in March 2003.
Richard W. Humphrey, a director of ARI, is the President of Humble and the
President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a
director of ARI, is the General Manager of Unified.

In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the
Centura Holdings, Clark and Woolley land parcels, from ARI for $13.3 million.
See NOTE 2. "REAL ESTATE." The purchase price was determined based on an
appraised rate of $34.89 per share foot. The business purpose of the
transaction was for TCI to construct apartments on the land and for ARI to
satisfy debt.

In March 2003, TCI purchased the Bridgeview Plaza and Cullman shopping
centers from ARI for $8.7 million and $2.0 million, respectively. The business
purpose of the transaction was for ARI to satisfy debt. The purchase price was
determined using a market rate multiple of net operating income.

Environmental Matters

Under various federal, state and local environmental laws, ordinances and
regulations, ARI may be potentially liable for removal or remediation costs, as
well as certain other potential costs relating to hazardous or toxic substances
(including governmental fines and injuries to persons and property) where
property-level managers have arranged for the removal, disposal or treatment of
hazardous or toxic substances. In addition, certain environmental laws impose
liability for release of asbestos-containing materials into the air, and third
parties may seek recovery for personal injury associated with such materials.

Management is not aware of any environmental liability relating to the above
matters that would have a material adverse effect on ARI's business, assets or
results of operations.

Inflation

The effects of inflation on ARI's operations are not quantifiable. Revenues
from property operations tend to fluctuate proportionately with inflationary
increases and decreases in housing costs. Fluctuations in the rate of inflation
also affect the sales values of properties and the ultimate gains to be
realized from property sales. To the extent that inflation affects interest
rates, earnings from short-term investments and the cost of new financings as
well as the cost of variable interest rate debt will be affected.

39

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK

ARI's future operations, cash flow and fair values of financial instruments
are partially dependent upon the then existing market interest rates and market
equity prices. Market risk is the changes in the market rates and prices and
the affect of the changes on the future operations. Market risk is managed by
matching a property's anticipated net operating income to an appropriate
financing.

The following table contains only those exposures that existed at December
31, 2002. Anticipation of exposures of risk on positions that could possibly
arise was not considered. ARI's ultimate interest rate risk and its effect on
operations will depend on future capital market exposures, which cannot be
anticipated with a probable assurance level. Dollars in thousands.

2003 2004 2005 2006 2007 Thereafter Total
-------- ------- ------- ------- ------- ---------- --------

Assets
Trading Instruments--Equity
Price Risk
Marketable securities at market
value......................... $ 209

Notes receivable
Variable interest rate-fair
value......................... $ 4,766
Instrument's maturities......... $ -- $ 5,633 $ -- $ -- $ -- $ -- $ 5,633
Instrument's amortization....... -- -- -- -- -- -- --
Interest...................... 380 349 -- -- -- -- 729
Average rate.................. 6.8% 12.4% -- -- -- --
Fixed interest rate-fair value.. $ 65,263
Instrument's maturities......... $ 11,860 $45,722 $ 7,100 $ -- $ -- $ 8,363 $ 73,045
Instrument's amortization....... 2,971 1,443 -- -- -- -- 4,414
Interest...................... 5,286 3,816 1,530 962 962 1,923 14,479
Average rate.................. 7.5% 9.8% 12.8% 11.5% 11.5% 11.5%

Liabilities
Notes payable

Variable interest rate-fair value $ 70,672
Instrument's maturities......... $ 31,762 $21,580 $ 1,112 $ -- $ -- $ 1,029 $ 55,483
Instrument's amortization....... 1,404 1,286 1,294 102 110 1,972 6,168
Interest...................... 5,285 3,375 489 390 380 2,968 12,887
Average rate.................. 11.7% 19.8% 11.1% 12.4% 12.4% 12.0%

Fixed interest rate-fair value... $408,419
Instrument's maturities......... $122,584 $25,259 $45,754 $10,498 $40,548 $114,935 $359,578
Instrument's amortization....... 4,951 5,010 4,753 4,523 4,129 26,699 50,065
Interest...................... 33,906 22,068 18,047 15,118 13,043 30,760 132,942
Average rate.................. 9.9% 8.3% 8.0% 7.8% 8.0% 8.0%

40

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
----

Financial Statements
Report of Independent Certified Public Accountants........................................... 42
Consolidated Balance Sheets--December 31, 2002 and 2001...................................... 43
Consolidated Statements of Operations--Years Ended December 31, 2002, 2001 and 2000.......... 44
Consolidated Statements of Stockholders' Equity--Years Ended December 31, 2002, 2001 and 2000 45
Consolidated Statements of Cash Flows--Years Ended December 31, 2002, 2001 and 2000.......... 46
Notes to Consolidated Financial Statements................................................... 49

Financial Statement Schedules
Schedule III--Real Estate and Accumulated Depreciation....................................... 85
Schedule IV--Mortgage Loans on Real Estate................................................... 90

All other schedules are omitted because they are not required, are not
applicable or the information required is included in the Consolidated
Financial Statements or the notes thereto.

41

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors of
American Realty Investors, Inc.

We have audited the accompanying consolidated balance sheets of American
Realty Investors, Inc. and Subsidiaries as of December 31, 2002 and 2001 and
the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 2002.
We have also audited the schedules listed in the accompanying index. These
financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements and schedules are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements and schedules. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial
statements and schedules. We believe our audits provide a reasonable basis for
our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of American Realty Investors, Inc. and Subsidiaries as of December 31, 2002 and
2001, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2002, in conformity
with accounting principles generally accepted in the United States of America.

Also, in our opinion, the schedules referred to above present fairly, in all
material respects, the information set forth therein.

As described in Note 20, American Realty Investors, Inc.'s management has
indicated its intent to sell both land and operating properties and refinance
or extend debt coming due, to meet its liquidity needs.

As discussed in Note 1, ARI adopted the provisions of SFAS 144, Accounting
for Impairment of Long Lived Assets, in 2001.

As discussed in Note 24, ARI adopted the provision of SFAS 142, Goodwill and
Other Intangible Assets, in 2002.

BDO SEIDMAN, LLP

Dallas, Texas
April 11, 2003

42

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

December 31,
---------------------
2002 2001
-------- --------
(dollars in thousands,
except per share)

Assets
Real estate held for investment........................................................................ $378,080 $338,425
Less--accumulated depreciation......................................................................... (96,036) (90,355)
-------- --------
282,044 248,070
Real estate held for sale, net of depreciation......................................................... 181,713 340,133
Notes and interest receivable
Performing ($34,442 in 2002 and $18,896 in 2001 from affiliates)....................................... 77,354 22,612
Nonperforming ($6,838 in 2002 and $6,994 in 2001 from affiliates)...................................... 7,856 10,347
-------- --------
85,210 32,959
Less--allowance for estimated losses................................................................... (3,077) (2,577)
-------- --------
82,133 30,382
Pizza parlor equipment................................................................................. 12,557 10,454
Less--accumulated depreciation......................................................................... (4,562) (3,747)
-------- --------
7,995 6,707
Leasehold interest--oil and gas properties............................................................. -- 4,719
Less--accumulated depletion............................................................................ -- (1)
-------- --------
-- 4,718
Oilfield equipment..................................................................................... -- 511
Less--accumulated depreciation......................................................................... -- (21)
-------- --------
-- 490
Marketable equity securities, at market value.......................................................... 209 96
Cash and cash equivalents.............................................................................. 8,432 709
Investments in equity investees........................................................................ 80,990 77,933
Goodwill, net of accumulated amortization ($1,763 in 2002 and 2001).................................... 13,784 11,858
Other intangibles, net of accumulated amortization ($773 in 2002 and $903 in 2001)..................... 1,744 1,678
Other assets........................................................................................... 50,001 35,989
-------- --------
$709,045 $758,763
======== ========
Liabilities and Stockholders' Equity
Liabilities
Notes and interest payable ($15,600 in 2002 and $1,598 in 2001 to affiliate)........................... $349,740 $298,171
Margin borrowings...................................................................................... 8,558 28,040
Liabilities related to assets held for sale............................................................ 125,693 266,127
Accounts payable and other liabilities ($41,085 in 2002 and $11,389 in 2001 to affiliates)............. 127,872 48,960
-------- --------
611,863 641,298
Minority interest...................................................................................... 19,940 27,612
Series F, 3,968.75 shares in 2001 (liquidation preference $3,969)...................................... -- 3,969

Stockholders' equity
Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding
Series A, 3,226,858 shares in 2002 and 2,724,910 shares in 2001
(liquidation preference $32,269), including 900,000 shares in 2002 and 300,000 shares in 2001 held by
subsidiaries.......................................................................................... 4,654 4,850
Series E, 50,000 shares in 2002 and 2001 (liquidation preference $500)................................. 100 100
Common Stock, $.01 par value, authorized 100,000,000 shares; issued
11,375,127 shares in 2002 and 2001................................................................... 114 114
Paid-in capital........................................................................................ 93,954 97,140
Accumulated deficit.................................................................................... (24,784) (16,320)
Accumulated other comprehensive income................................................................. 3,204 --
-------- --------
77,242 85,884
-------- --------
$709,045 $758,763
======== ========

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

43

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
(dollars in thousands, except per share)

Property revenue
Rents........................ $ 89,543 $ 101,927 $ 120,609
Property operations expenses
($4,271 in 2002, $5,204 in
2001 and $5,356 in 2000 to
affiliates)................ 67,701 76,617 81,363
----------- ----------- -----------
Operating income........... 21,842 25,310 39,246
Land operations
Sales........................ 127,750 51,841 119,384
Cost of sales................ 75,718 45,348 90,383
Deferral of gains on current
period sales............... 36,135 895 --
Recognition of previously
deferred gains............. 830 -- --
----------- ----------- -----------
Gain on land sales......... 16,727 5,598 29,001
Pizza parlor operations
Sales........................ 36,741 34,211 32,551
Cost of sales................ 29,991 27,934 26,767
----------- ----------- -----------
Gross margin............... 6,750 6,277 5,784
Income from operations........ 45,319 37,185 74,031
Other income
Interest income ($2,515 in
2002, $2,239 in 2001 and
$1,843 in 2000 from
affiliates)................ 3,145 2,817 2,965
Equity in loss of investees.. (20,914) (13,352) (4,581)
Loss on sale of investments
in equity investees........ (286) (387) (8,744)
Gains on sale of real estate. -- 77,816 67,727
Equity in gain on sale of
real estate by equity
investees.................. -- 22,542 18,571
Other ($300 in 2002 from
affiliates)................ 5,445 (369) (926)
----------- ----------- -----------
(12,610) 89,067 75,012
Other expenses
Interest ($1,703 in 2002 and
$358 in 2000 to affiliates) 57,689 65,045 66,481
Depreciation and amortization 10,234 11,761 12,946
General and administrative
($2,546 in 2002, $2,845 in
2001 and $4,493 in 2000 to
affiliate)................. 12,479 12,743 17,131
Advisory fee to affiliate.... 5,899 6,715 5,891
Net income fee to affiliate.. -- 166 --
Incentive fee to affiliate... -- 3,827 1,646
Litigation settlement........ 916 100 --
Provision for loss........... -- -- 2,000
Writedown of assets held for
sale....................... 4,171 2,500 248
Minority interest............ 1,346 972 30,700
----------- ----------- -----------
92,734 103,829 137,043
----------- ----------- -----------
Net income (loss) from
continuing operations........ (60,025) 22,423 12,000
Discontinued operations (Note
20):
Loss from operations......... (4,214) (7,354) (9,321)
Gain on sale of real estate.. 31,706 -- --
Equity in gain on sale of
real estate by equity
investees.................. 24,069 -- --
----------- ----------- -----------
Net income (loss) from
discontinued operations...... 51,561 (7,354) (9,321)
Net income (loss)............. (8,464) 15,069 2,679
Preferred dividend requirement (2,401) (2,485) (2,327)
----------- ----------- -----------
Net income (loss) applicable
to Common shares............. $ (10,865) $ 12,584 $ 352
=========== =========== ===========
Earnings per share--basic and
diluted
Net income (loss) from
continuing operations...... $ (5.49) $ 1.70 $ .93
Discontinued operations...... 4.53 (.63) (.90)
----------- ----------- -----------
Net income (loss) applicable
to Common shares........... $ (.96) $ 1.07 $ .03
=========== =========== ===========
Weighted average Common
shares used in computing
earnings per share........... 11,375,127 11,714,374 10,399,890
=========== =========== ===========

Options to purchase 105,750, 183,750 and 210,750 shares of ARI's Common
Stock were excluded from the computation of diluted earnings per share for
2002, 2001 and 2000, respectively, because the effect of their inclusion would
be antidilutive.

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

44

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Accumulated
Series A Series E Other
Preferred Preferred Common Treasury Paid-in Accumulated Comprehensive Stockholders'
Stock Stock Stock Stock Capital Deficit Income Equity
--------- --------- ------ -------- ------- ----------- ------------- -------------
(dollars in thousands, except per share)

Balance, January 1, 2000...... $4,600 $ -- $135 $(28) $75,627 $(34,068) $ -- $46,266
Sale of Series E Preferred
Stock....................... -- 100 -- -- 400 -- -- 500
Series A Preferred Stock cash
dividend ($1.00 per share)... -- -- -- -- (2,298) -- (2,298)
Series A Preferred Stock
issued...................... 243 -- -- -- 970 -- -- 1,213
Series E Preferred Stock cash
dividend ($0.60 per share)... -- -- -- -- (29) -- -- (29)
Retirement of Treasury
Stock....................... -- -- (26) 46 (20) -- -- --
Repurchase of Common
Stock....................... -- -- -- -- (746) -- -- (746)
Common Stock issued in
exchange for partnership
units....................... -- -- 9 (35) 25,843 -- -- 25,817
Net income.................... -- -- -- -- -- 2,679 -- 2,679
------ ---- ---- ---- ------- -------- ------ -------

Balance, December 31, 2000.... 4,843 100 118 (17) 99,747 (31,389) -- 73,402
Series A Preferred Stock cash
dividend ($1.00 per share)... -- -- -- -- (2,455) -- -- (2,455)
Series A Preferred Stock
issued...................... 7 -- -- -- 29 -- -- 36
Series E Preferred Stock cash
dividend ($0.60 per share)... -- -- -- -- (30) -- -- (30)
Retirement of Treasury Stock.. -- -- -- 17 (17) -- -- --
Repurchase of Common
Stock....................... -- -- -- -- (133) -- -- (133)
Cancellation of Common
Stock....................... -- -- (4) -- 4 -- -- --
Common Stock dividends
(pre-merger)................ -- -- -- -- (5) -- -- (5)
Net income.................... -- -- -- -- -- 15,069 -- 15,069
------ ---- ---- ---- ------- -------- ------ -------

Balance, December 31, 2001.... 4,850 100 114 -- 97,140 (16,320) -- 85,884
Comprehensive income
Foreign currency translation
gain...................... -- -- -- -- -- -- 3,204 3,204
Net loss..................... -- -- -- -- -- (8,464) -- (8,464)
-------
(5,260)
Series A Preferred Stock cash
dividend ($1.00 per share)... -- -- -- -- (2,371) -- -- (2,371)
Series E Preferred Stock cash
dividend ($0.60 per share)... -- -- -- -- (30) -- -- (30)
Redemption of Preferred
Stock....................... (196) -- -- -- (784) -- -- (980)
Common Stock dividends
(pre-merger)................ -- -- -- -- (25) -- -- (25)
Other......................... -- -- -- -- 24 -- -- 24
------ ---- ---- ---- ------- -------- ------ -------

Balance, December 31, 2002.... $4,654 $100 $114 $ -- $93,954 $(24,784) $3,204 $77,242
====== ==== ==== ==== ======= ======== ====== =======

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

45

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For Years Ended December 31,
-----------------------------
2002 2001 2000
-------- -------- ---------
(dollars in thousands)

Cash Flows From Operating Activities
Rents collected........................................................ $109,783 $126,350 $ 138,212
Payments for property operations ($4,271 in 2002, $5,204 in 2001
and $1,792 in 2000 to affiliates)...................................... (88,269) (99,509) (105,523)
Pizza parlor sales collected........................................... 35,725 33,997 32,526
Payments for pizza parlor operations................................... (30,222) (27,563) (26,646)
Interest collected ($771 in 2002, $1,220 in 2001 and $1,490
in 2000 from affiliates)............................................... 1,559 1,772 4,393
Distributions from equity investees' operating activities.............. -- 53 1,823
Interest paid.......................................................... (54,400) (62,608) (66,955)
Advisory fee paid to affiliate......................................... (5,350) (6,715) (5,050)
Incentive fee paid to affiliate........................................ -- (1,646) --
Distributions to minority interest holders............................. (2,628) (4,114) (4,941)
General and administrative expenses paid ($2,044 in 2002, $2,845 in
2001 and $4,493 in 2000 to affiliate)................................ (11,977) (12,740) (18,139)
Other.................................................................. (6,914) 4,112 (4,278)
-------- -------- ---------
Net cash used in operating activities.............................. $(52,693) $(48,611) $ (54,578)

Cash Flows From Investing Activities
Collections on notes receivable ($776 in 2002, $21 in 2001 and $17,324
in 2000 from affiliates)............................................. $ 7,416 $ 4,995 $ 36,039
Proceeds from sale of notes receivable................................. 7,641 -- 3,893
Notes receivable funded................................................ (2,169) (14,094) (14,674)
Proceeds from sale of real estate...................................... 102,772 136,171 148,141
Purchase of marketable equity securities............................... -- -- (5,316)
Proceeds from sale of marketable equity securities..................... 1,291 -- 5,252
Acquisitions of real estate............................................ (1,359) -- (15,882)
Real estate improvements............................................... (34,336) (19,581) (24,547)
Acquisition of EQK Realty Investors, I................................. -- -- (1,125)
Pizza parlor equipment purchased....................................... (2,869) (1,493) (1,087)
Proceeds from sale of pizza parlor equipment........................... 1,498 -- --
Acquisition of leasehold interests..................................... -- (400) --
Purchase of oilfield equipment......................................... -- (511) --
Earnest money deposits................................................. 331 (1,825) (7,703)
Settlement of interest rate swap contract.............................. (284) -- --
Investment in real estate entities..................................... (3,976) (39,505) 4,602
-------- -------- ---------
Net cash provided by investing activities.......................... $ 75,956 $ 63,757 $ 127,593
======== ======== =========

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

46

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)

For Years Ended December 31,
-------------------------------
2002 2001 2000
--------- --------- ---------
(dollars in thousands)

Cash Flows From Financing Activities
Proceeds from notes payable............................................... $ 103,701 $ 146,773 $ 177,144
Margin borrowings (payments), net......................................... (19,548) 14,389 (21,624)
Payments on notes payable................................................. (133,959) (171,531) (197,849)
Deferred borrowing costs.................................................. (7,170) (9,478) (10,528)
Net advances from (payments to) affiliates................................ 43,813 3,833 (15,887)
Redemption of Preferred Stock............................................. -- -- --
Sale of Preferred Stock................................................... -- -- 500
Dividends paid............................................................ (2,401) (2,467) (2,327)
Repurchase of Common Stock................................................ -- (133) (746)
Stock sale profits received from affiliate................................ 24 -- --
--------- --------- ---------
Net cash used in financing activities............................... (15,540) (18,614) (71,317)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents....................... 7,723 (3,468) 1,698
Cash and cash equivalents, beginning of year............................... 709 4,177 2,479
--------- --------- ---------
Cash and cash equivalents, end of year..................................... $ 8,432 $ 709 $ 4,177
========= ========= =========

Reconciliation of net income to net cash used in operating activities
Net income (loss)......................................................... $ (8,464) $ 15,069 $ 2,679
Adjustments to reconcile net income (loss) to net cash used in operating
activities..............................................................
Gain on sale of real estate............................................. (48,433) (83,414) (96,728)
Depreciation and amortization........................................... 14,245 17,707 16,879
Amortization of deferred borrowing costs................................ 8,930 14,335 10,382
Provision for loss...................................................... 4,171 2,500 2,248
Litigation settlement................................................... 916 100 --
Equity in income of investees........................................... (2,869) (8,803) (5,246)
Distributions from equity investees' operating activities............... -- 53 1,823
(Increase) decrease in accrued interest receivable...................... (1,586) (1,045) 1,428
(Increase) decrease in other assets..................................... (14,481) 1,517 (3,325)
Increase (decrease) in accrued interest payable......................... 2,437 (61) (2,441)
Increase (decrease) in accounts payable and other liabilities (includes
$(14,117) in 2002, $4,526 in 2001 and $1,645 in 2000)................. (6,277) (3,427) (8,036)
Increase (decrease) in minority interest................................ (1,282) (3,142) 25,759
--------- --------- ---------
Net cash used in operating activities............................... $ (52,693) $ (48,611) $ (54,578)
========= ========= =========

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

47

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)

For Years Ended December 31,
----------------------------
2002 2001 2000
------- ------- -------
(dollars in thousands)

Schedule of noncash investing and financing activities
Notes payable from acquisition of real estate.............................. $ -- $ 2,549 $ 6,262
Notes payable assumed by buyer upon sale of real estate.................... 80,729 34,293 40,460
Series A Preferred Stock issued in conjunction with the acquisition of EQK
Realty Investors, I...................................................... -- 36 1,213
Carrying value of real estate exchanged for other real estate.............. 7,224 3,726 2,971
Redemption of Series A Preferred Stock..................................... 980 -- --
Common Stock issued for minority interest in National Realty, L.P.......... -- -- 25,817
Purchase accounting write down............................................. -- -- 35,846
Notes receivable from sale of real estate.................................. 59,578 6,336 2,790
Series F Preferred Stock issued in conjunction with the acquisition of
leasehold interests in oil and gas properties............................ -- 3,969 --
Contribute new pizza restaurant to new venture............................. -- 210 --
Asset impairment writedown................................................. 4,171 2,500 --
Cancellation of Series F Preferred Stock................................... 3,969 -- --
Acquisition of property to satisfy debt.................................... 19,789 -- --
Disposal of property to satisfy debt....................................... 41,050 -- --
Foreign currency translation gain.......................................... 3,204 -- --

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

48

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements of American Realty
Investors, Inc. and consolidated subsidiaries have been prepared in conformity
with accounting principles generally accepted in the United States of America,
the most significant of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES." These, along with the remainder of the Notes to
Consolidated Financial Statements, are an integral part of the Consolidated
Financial Statements. The data presented in the Notes to Consolidated Financial
Statements are as of December 31 of each year and for the year then ended,
unless otherwise indicated. Dollar amounts in tables are in thousands, except
per share amounts.

Certain balances for 2000 and 2001 have been reclassified to conform to the
2002 presentation.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and business. In November 1999, American Realty Investors,
Inc. ("ARI"), a Nevada corporation, was formed, and in August 2000, ARI
acquired American Realty Trust, Inc. ("ART"), a Georgia corporation and
National Realty, L.P. ("NRLP"), a Delaware partnership that primarily invests
in real estate and real estate-related entities and purchases and originates
mortgage loans.

The acquisition of ART and NRLP by ARI was completed on August 2, 2000. NRLP
unitholders, except for ART, received one share of ARI Common Stock for each
unit of NRLP held. ART stockholders received .91 shares of ARI Common Stock for
each share of ART Common Stock held. Each share of ART Preferred Stock was
converted into one share of Preferred Stock of ARI, having substantially the
same rights as ART's Preferred Stock. The ART shares of Common Stock ceased
trading on the New York Stock Exchange on August 2, 2000. The NRLP units of
limited partner interest ceased trading on the American Stock Exchange on
August 2, 2000. ARI Common Stock commenced trading on the New York Stock
Exchange on August 3, 2000.

On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. ("TCI"),
and Income Opportunity Realty Investors, Inc. ("IORI") jointly announced a
preliminary agreement with the plaintiff's legal counsel of the derivative
action entitled Olive et al. V. National Income Realty Trust, et al. for
complete settlement of all disputes in the lawsuit (the "Olive Litigation"). In
February 2002, the court granted final approval of the proposed settlement (the
"Olive Settlement"). Under the Olive Settlement, ARI agreed to either (i)
acquire all of the outstanding shares of IORI and TCI not currently owned by
ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender
offer for all of the outstanding shares of IORI and TCI not currently owned by
ARI. On November 15, 2002, ARI commenced the tender offer for the IORI and TCI
shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash
per IORI share and $17.50 cash per TCI share for the stock held by
non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036
IORI shares and 1,213,226 TCI shares. The completion of the tender offer
fulfills the obligations under the Olive Settlement and the Olive Litigation
has been dismissed with prejudice. ARI has the same advisor as TCI and IORI,
and TCI and IORI have the same board of directors. Two of the directors of TCI
and IORI also serve as directors of ARI.

Basis of consolidation. The Consolidated Financial Statements include the
accounts of ARI, and all controlled subsidiaries and partnerships. All
significant intercompany transactions and balances have been eliminated.

Accounting estimates. In the preparation of these Consolidated Financial
Statements, in conformity with accounting principles generally accepted in the
United States of America it is necessary for management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the Consolidated
Financial Statements and the reported amounts of revenues and expense for the
year then ended. Actual results could differ materially from these estimates.

49

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Nonperforming notes receivable. ARI considers a note receivable to be
nonperforming when the maturity date has passed without principal repayment and
the borrower is not making interest payments. Any new note receivable that
results from a modification or extension of a note considered nonperforming
will also be considered nonperforming, without regard to the borrower's
adherence to payment terms.

Interest recognition on notes receivable. Interest income is not recognized
on notes receivable that have been delinquent for 60 days or more. In addition,
accrued but unpaid interest income is only recognized to the extent that the
net realizable value of the underlying collateral exceeds the carrying value of
the receivable.

Allowance for estimated losses. A valuation allowance is provided for
estimated losses on notes receivable considered to be impaired. Impairment is
considered to exist when it is probable that all amounts due under the terms of
the note will not be collected. Valuation allowances are provided for estimated
losses on notes receivable to the extent that the investment in the note
exceeds management's estimate of fair value of the collateral securing such
note.

Recent Accounting pronouncements. In April 2002, the FASB issued Statement
145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Correction" ("SFAS No. 145"). Statement 4,
"Reporting Gains and Losses from Extinguishment of Debt" ("SFAS No. 4"),
required that gains and losses from the extinguishment of debt that were
included in the determination of net income be aggregated and, if material,
classified as an extraordinary item. The provisions of SFAS No. 145 related to
the rescission of SFAS No. 4 will require ARI to reclassify prior period items
that do not meet the extraordinary classification. The provisions of SFAS No.
145 that relate to the rescission of SFAS No. 4 become effective in fiscal
years beginning after May 15, 2002. The adoption of SFAS No. 145 is not
expected to have a material impact on the consolidated financial position or
results of operations of ARI.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force ("EITF") Issued 94-3. ARI will adopt the
provisions of SFAS No. 146 for restructuring activities initiated after
December 31, 2002. SFAS No. 146 requires that the liability costs associated
with an exit or disposal activity be recognized when the liability is incurred.
Under EITF No. 94-3, a liability for an exit cost was recognized at the date of
a company's commitment to an exit plan. SFAS No. 146 also established that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future restructuring costs as
well as the amount recognized.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation, Transition and Disclosure, an amendment of FASB No. 123." SFAS
No. 148 provides alternative methods of transition for an entity that
voluntarily changes to the fair value method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of SFAS No. 123
to require prominent disclosure about the effects on reported net income of an
entity's accounting policy decisions with respect to stock-based employee
compensation. Finally, this statements amends APB Opinion No. 28, "Interim
Financial Reporting," to require disclosure about those effects in interim
financial information. Management currently believes that the adoption of SFAS
No. 148 will not have a material impact on the financial statements, as ARI
will continue to account for stock-based compensation using the intrinsic value
method.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which disclosures are effective for
financial statements issued after December 15, 2002. While ARI has various
guarantees included in

50

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

contracts in the normal course of business, these guarantees would not
represent significant commitments or contingent liabilities of the indebtedness
of entities outside of the consolidated company.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires the consolidation of
variable interest entities, as defined. FIN 46 is applicable to financial
statements to be issued by ARI after 2003; however, disclosures are required
currently if ARI expects to consolidate any variable interest entities. ARI
does not currently believe that any entities will be consolidated as a result
of FIN 46.

Real estate held for investment and depreciation. Real estate held for
investment is carried at cost. Statement of Financial Accounting Standards No.
144 ("SFAS No. 144") requires that a property be considered impaired, if the
sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the property. If impairment
exists, an impairment loss is recognized, by a charge against earnings, equal
to the amount by which the carrying amount of the property exceeds the fair
value less cost to sell the property. If impairment of a property is
recognized, the carrying amount of the property is reduced by the amount of the
impairment, and a new cost for the property is established. Such new cost is
depreciated over the property's remaining useful life. Depreciation is provided
by the straight-line method over estimated useful lives, which range from five
to 40 years.

Real estate held for sale. Foreclosed real estate is initially recorded at
new cost, defined as the lower of original cost or fair value minus estimated
costs of sale. SFAS No. 144 also requires that properties held for sale be
reported at the lower of carrying amount or fair value less costs of sale. If a
reduction in a held for sale property's carrying amount to fair value less
costs of sale is required, a provision for loss is recognized by a charge
against earnings. Subsequent revisions, either upward or downward, to a held
for sale property's estimated fair value less costs of sale is recorded as an
adjustment to the property's carrying amount, but not in excess of the
property's carrying amount when originally classified as held for sale. A
corresponding charge against or credit to earnings is recognized. Properties
held for sale are not depreciated.

Investments in equity investees. ARI may be considered to have the ability
to exercise significant influence over the operating and investment policies of
certain of its investees. Those investees are accounted for using the equity
method. Under the equity method, an initial investment, recorded at cost, is
increased by a proportionate share of the investee's operating income and any
additional investment and decreased by a proportionate share of the investee's
operating losses and distributions received.

Present value premiums/discounts. Present value premiums and discounts are
provided on notes receivable or payable that have interest rates that differ
substantially from prevailing market rates and such premiums and discounts are
amortized by the interest method over the lives of the related notes. The
factors considered in determining a market rate for notes receivable include
the borrower's credit standing, nature of the collateral and payment terms of
the note.

Revenue recognition on the sale of real estate. Sales of real estate are
recognized when and to the extent permitted by Statement of Financial
Accounting Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS No.
66"). Until the requirements of SFAS No. 66 for full profit recognition have
been met, transactions are accounted for using either the deposit, the
installment, the cost recovery, or the financing method, whichever is
appropriate.

Operating segments. Management has determined reportable operating segments
to be those that are used for internal reporting purposes, which disaggregates
operations by type of real estate.

51

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Fair value of financial instruments. The following assumptions were used in
estimating the fair value of its notes receivable, marketable equity securities
and notes payable. For performing notes receivable, the fair value was
estimated by discounting future cash flows using current interest rates for
similar loans. For nonperforming notes receivable the estimated fair value of
ARI's interest in the collateral property was used. For marketable equity
securities fair value was based on the year end closing market price of each
security. For notes payable the fair value was estimated using current rates
for mortgages with similar terms and maturities.

Cash equivalents. For purposes of the Consolidated Statements of Cash
Flows, all highly liquid investments purchased with an original maturity of
three months or less are considered to be cash equivalents.

Earnings (loss) per share. Income (loss) per share is presented in
accordance with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share". Income (loss) per share is computed based upon the weighted average
number of shares of Common Stock outstanding during each year.

Employee stock option plans. Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees," and related Interpretations are
utilized by management in accounting for the option plans. All share options
issued have exercise prices equal to the market price of the shares at the
dates of grant. Accordingly, no compensation cost has been recognized for the
option plans. Had compensation cost for the option plans been determined based
on the fair value at the grant dates consistent with the method of Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation," net income (loss) and net income (loss) per share would have
been the pro forma amounts indicated below.

2002 2001 2000
------------------ ---------------- --------------
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
-------- -------- -------- ------- -------- -----

Net income (loss) applicable to common shares. $(10,865) $(10,979) $12,584 $11,915 $352 $21
Net income (loss) applicable to common shares,
per share................................... (.96) (.97) 1.07 1.02 .03 --

The fair value of each option is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions:

2002 2001 2000
---- ---- ----

Dividend yield........... -- -- --
Expected volatility...... 69% 72% 43%
Risk-free interest rate.. 3.95% 1.25% 5.75%
Expected lives (in years) 10 10 10
Forfeitures.............. 10% 10% 10%

The weighted average fair value per share of options granted in 2002 was
$6.08.

52

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 2. REAL ESTATE

In 2002, ARI purchased the following property:

Units/ Purchase Net Debt Interest Maturity
Property Location Sq.Ft./Acres Price Cash Paid Incurred Rate Date
-------- ----------------- ------------- -------- --------- -------- -------- --------

Apartments
Pinecrest/(1)/..... North Augusta, SC 120 Units $ 2,979 $ -- $1,423/(3)/ 8.75% 03/03
Tiberon Trails/(1)/ Merrillville, IN 376 Units 12,336 -- 6,417/(3)/ 9.00 07/06

Shopping Center
Alta Mesa/(1)/..... Ft. Worth, TX 59,933 Sq.Ft. 3,797 -- 1,804/(3)/ 10.43 10/04
Plaza on Bachman
Creek/(2)/....... Dallas, TX 80,278 Sq.Ft. 3,103 -- -- -- --

Land
Pioneer Crossing... Austin, TX 79.4 Acres 1,165 1,213 -- -- --
Willow Springs..... Beaumont, CA 20.7 Acres 140 146 -- -- --

- --------
(1) Property received from Basic Capital Management, Inc. ("BCM"), a related
party, for forgiveness of debt. The purchase price was determined using a
market rate multiple of net operating income.
(2) Exchanged with Transcontinental Realty Investors, Inc. ("TCI"), a related
party, for the Oaktree Village Shopping Center, Rasor land parcel and
Lakeshore Villas land parcel.
(3) Assumed debt of seller.

In 2001, ARI purchased the following property:

Purchase Net Debt Interest Maturity
Property Location Units Price Cash Paid Incurred Rate Date
-------- ----------- --------- -------- --------- -------- -------- --------

Apartments
Glenwood.. Addison, TX 168 Units $6,246 $ -- / (1)/ $2,549/(2)/ 9.25% 10/04

- --------
(1) 8.88 acres of Hollywood Casino land and 10.5 acres of Vista Ridge land
given as consideration. Exchanged with TCI, a related party.
(2) Assumed debt of seller. Exchanged with TCI, a related party.

53

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In 2002, ARI sold the following properties:

Net Cash
Units/ Sales Received/ Debt Gain/(Loss)
Property Location Acres/Sq.Ft. Price (Paid) Discharged on Sale
-------- ------------------ -------------- ------- --------- ---------- -----------

Apartments
Conradi House........ Tallahassee, FL 98 Units $ 1,809 $ 388 $ 1,047 $ 435
Daluce............... Tallahassee, FL 112 Units 3,634 779 2,494/(3)/ 735
Grand Lagoon......... Panama City, FL 54 Units 2,750 285 2,083 1,572
Lakeshore Villas..... Harris County, TX 312 Units 21,957 (764) 13,593 8,942/(7)/
Lee Hills............ Tallahassee, FL 16 Units 445 355 -- 127
Mallard Lake/(1)/.... Greensboro, NC 336 Units 14,400 -- 7,362 --
Morning Star......... Tallahassee, FL 82 Units 2,217 718 1,187 618
Oak Hill............. Tallahassee, FL 92 Units 3,200 156/(4)/ 2,550 285
Pheasant Ridge....... Bellevue, NE 264 Units 10,400 2,576 6,237 6,763
Pinecrest West....... Tallahassee, FL 48 Units 1,600 (48) 1,386 653
Regency.............. Tampa, FL 78 Units 3,200 851 1,710 541
Stonebridge.......... Florissant, MO 100 Units 4,340 1,142 2,893 3,081
Stonegate............ Tallahassee, FL 83 Units 1,785 486 1,026 (320)
Valley Hi............ Tallahassee, FL 54 Units 1,452 75 1,159 413
Villas............... Plano, TX 208 Units 8,525 3,701 4,023 5,615
Westwood Parc........ Tallahassee, FL 94 Units 2,523 817 1,370 759
White Pines.......... Tallahassee, FL 85 Units 764 10 593 (127)
Woodsong............. Smyrna, GA 190 Units 9,200 2,573 8,196 7,128

Office Building
Centura.............. Dallas, TX 410,901 Sq.Ft. 50,000 -- 43,739/(3)/ 5,762/(5)/
Melrose Business Park Oklahoma City, OK 124,200 Sq.Ft. 1,890 953 816 1,399
Rosedale Towers...... Minneapolis, MN 84,798 Sq.Ft. 7,235 3,324 7,665 2,028/(8)/

Shopping Center
Alta Mesa............ Fort Worth, TX 59,933 Sq.Ft. 3,617 1,399 1,791 --
Oaktree Village/(2)/. Lubbock, TX 45,623 Sq.Ft. 2,302 131 1,389/(10)/ --

Land
Centura Holdings..... Farmers Branch, TX 5.1 Acres 7,747 -- 7,242/(3)/ 1,236/(5)/
Clark................ Farmers Branch, TX 3.3 Acres 4,961 -- -- 2,675/(5)/
Desert Wells......... Palm Desert, CA 171.1 Acres 11,900 1,421 1,000 5,955
Desert Wells......... Palm Desert, CA 238.0 Acres 23,785 321 1,050 15,024/(9)/
Eldorado Parkway..... Collin County, TX 8.8 Acres 1,180 1,030 50 104
Elm Fork............. Denton County, TX 14.5 Acres 2,745 (105) 2,633 1,615
Elm Fork............. Denton County, TX 14.2 Acres 1,526 (54) 701 527
Elm Fork............. Denton County, TX 16.7 Acres 1,617 (299) 1,554 429
Frisco Bridges....... Collin County, TX 10.8 Acres 1,881 151 1,500 (94)
Hollywood Casino..... Farmers Branch, TX 42.8 Acres 16,987 -- 6,222/(3)/ 7,520/(5)/
Katrina.............. Palm Desert, CA 2.1 Acres 1,323 (40) 1,237 978
Katrina.............. Palm Desert, CA 80.0 Acres 6,778 (1,382) 2,500 (2,032)
Katrina.............. Palm Desert, CA 1.8 Acres 700 648 -- 464
Lakeshore Villas/(2)/ Harris County, TX 16.9 Acres 1,499 215 -- --
Marine Creek......... Ft. Worth, TX 54.2 Acres 3,700 -- 1,500/(10)/ 1,334/(5)/
Mason Goodrich....... Houston, TX 7.9 Acres 672 46 554 268
Mason Goodrich....... Houston, TX 10.3 Acres 1,444 93 1,225 895
Mason Goodrich....... Houston, TX 18.0 Acres 2,790 -- 2,690/(10)/ 1,982/(5)/
Mason Goodrich....... Houston, TX 13.0 Acres 1,150 (445) 400 521
Mason Goodrich....... Houston, TX 31.5 Acres 2,800 132 1,425 324
Mason Goodrich....... Houston, TX 7.0 Acres 760 93 593 396
Messick.............. Palm Desert, CA 71.0 Acres 6,015 (163) 1,300 2,056
Monterrey............ Riverside, CA 61.0 Acres 4,625 -- -- 61/(6)/
Nashville............ Nashville, TN 16.6 Acres 1,890 -- 955/(10)/ 1,016/(5)/

54

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Net Cash
Sales Received/ Debt Gain/(Loss)
Property Location Acres Price (Paid) Discharged on Sale
-------- ------------------ ------------- ------ --------- ---------- -----------

Land--Continued
Nashville...... Nashville, TN 1.0 Acres $ 140 $ (4) $ 125 $ 73
Rasor/(2)/..... Plano, TX 24.5 Acres 1,211 174 -- --
Thompson II.... Dallas County, TX .2 Acres 21 20 -- (11)
Varner Road.... Riverside, CA 129.7 Acres 3,700 671 -- 1,413
Vista Ridge.... Lewisville, TX 10.0 Acres 1,525 130 1,220 401
Vista Ridge.... Lewisville, TX 3.9 Acres 630 1 531 170
Willow Springs. Beaumont, CA 1,503.0 Acres 9,800 (1,345) 2,600 4,872/(9)/
Woolley........ Farmers Branch, TX 0.4 Acres 637 -- -- 466/(5)/

- --------
(1) Exchanged for Governor's Square, Grand Lagoon, Park Avenue, Greenbriar,
Regency and Westwood Apartments.
(2) Exchanged with TCI, a related party, for the Plaza on Bachman Creek
Shopping Center.
(3) Debt assumed by purchaser.
(4) Represents dividends on and redemption of Innovo Preferred Stock. See NOTE
7. "NOTES PAYABLE."
(5) Sold to TCI, a related party, to satisfy debt. Gain deferred until sale to
unrelated party.
(6) Sold to TCI, a related party, to satisfy debt. In September 2002, gain of
$34,000 recognized upon sale of 36 acres to unrelated party. Remaining gain
of $27,000 deferred until sale to unrelated party.
(7) Sold to Housing for Seniors of Humble, LLC, a related party. Gain deferred
until sale to unrelated party.
(8) The cash received from the sale was not sufficient to repay the entire
amount of the financing obtained from IORI in January 2002. ARI owes $2.1
million to IORI for remaining principal and 12% return.
(9) Gain deferred until collection of mortgage note receivable in March 2003.
See NOTE 25. "SUBSEQUENT EVENTS."
(10) Failure to notify and receive approval from the lender for this
transaction may constitute an event of default under the terms of the debt.

In 2001, ARI sold the following properties:

Units/ Sales Net Cash Debt Gain/(Loss)
Property Location Sq.Ft. Price Received Discharged on Sale
-------- ---------------- ------------- ------- -------- ---------- -----------

Apartments
Ashford........... Tampa, FL 56 Units $ 2,145 $ 593 $ 1,182 $ (985)
Bent Tree......... Addison, TX 292 Units 12,050 2,480 8,867 7,081
Blackhawk......... Ft. Wayne, IN 209 Units 7,100 904 4,030 5,110
Carriage Park..... Tampa, FL 46 Units 2,005 757 1,069 663
Chalet I.......... Topeka, KS 162 Units 5,650 1,288 4,109/(1)/ 3,952
Chalet II......... Topeka, KS 72 Units 2,100 485 1,550/(1)/ 434
Club Mar.......... Sarasota, FL 248 Units 8,500 1,905 6,199/(1)/ 2,328
Covered Bridge.... Gainesville, FL 176 Units 7,900 2,463 4,339 6,042
Crossing at Church Tampa, FL 52 Units 1,880 750 948 623
Glenwood.......... Addison, TX 168 Units 6,650 3,166 2,549 (581)
Kimberly Woods.... Tucson, AZ 279 Units 8,450 1,667 6,191/(1)/ 6,053
Nora Pines........ Indianapolis, IN 254 Units 9,850 2,548 5,574 6,957
Place One......... Tulsa, OK 407 Units 12,935 3,310 7,539 8,623
Rockborough....... Denver, CO 345 Units 16,675 3,654 12,215/(1)/ 13,471
Shadowood......... Addison, TX 184 Units 7,125 1,980 4,320 4,644
Timbercreek....... Omaha, NE 180 Units 7,500 1,871 4,517 5,219
Woodstock......... Dallas, TX 320 Units 9,600 3,877 4,542 5,951

Shopping Center
Regency Pointe.... Jacksonville, FL 67,410 Sq.Ft. 7,350 5,126 1,500 2,232

55

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Net Cash
Sales Received/ Debt Gain/(Loss)
Property Location Acres Price (Paid) Discharged on Sale
-------- ------------------ ----------- ------ --------- ---------- -----------

Land
Chase Oaks.... Plano, TX 22.3 Acres $2,875 $ 663 $2,027 $ 871
Chase Oaks.... Plano, TX 4.9 Acres 1,973 1,832 -- 1,416
Elm Fork...... Denton County, TX 10.0 Acres 1,002 (30) 958 283
Elm Fork...... Denton County, TX 107.0 Acres 5,600 (168) 5,316 (1,616)
Frisco Bridges Collin County, TX 27.8 Acres 4,500 4,130 -- 25
Katrina....... Palm Desert, CA 20.0 Acres 2,831 (124) 596 830/(2)/
Katrina....... Palm Desert, CA 20.0 Acres 2,940 78 -- 616
Katrina....... Palm Desert, CA 6.1 Acres 1,196 1,108 -- 570
Katrina....... Palm Desert, CA 2.2 Acres 800 (24) 737 514
Katrina....... Palm Desert, CA 1.4 Acres 284 (9) 253 93
Las Colinas... Las Colinas, TX 1.7 Acres 825 233 400 539
Mason/Goodrich Houston, TX 22.1 Acres 4,168 (34) 3,750 2,896
Nashville..... Nashville, TN 2.0 Acres 26 (1) 24 (82)
Nashville..... Nashville, TN 1.2 Acres 8 -- 4 (59)
Nashville..... Nashville, TN 4.2 Acres 600 (53) 561 302
Plano Parkway. Plano, TX 11.3 Acres 1,445 312 950 --
Plano Parkway. Plano, TX 12.0 Acres 740 672 -- (991)
Rasor......... Plano, TX 6.6 Acres 350 267 -- 34
Santa Clarita. Santa Clarita, CA 12.7 Acres 2,100 1,791 -- 952
Santa Clarita. Santa Clarita, CA 6.7 Acres 500 608 -- (501)
Scoggins...... Tarrant County, TX 232.8 Acres 2,913 892 1,800 181
Scout......... Tarrant County, TX 408.0 Acres 5,087 1,586 3,200 2,969
Tree Farm..... Dallas County, TX 10.4 Acres 2,888 (87) 2,644 75
Vista Ridge... Denton County, TX 27.4 Acres 871 (26) 812 (1,993)
Watersedge.... Gulfport, MS .4 Acres 80 78 -- 65/(3)/
Yorktown...... Harris County, TX 120.4 Acres 5,239 (160) 4,991 (1,497)

- --------
(1) Debt assumed by purchaser.
(2) Gain deferred until 2002, when ARI-provided financing was collected.
(3) Sold to TCI, a related party. Gain of $65 deferred until sale to unrelated
party.

NOTE 3. NOTES AND INTEREST RECEIVABLE

2002 2001
----------------- -----------------
Estimated Estimated
Fair Book Fair Book
Value Value Value Value
--------- ------- --------- -------

Notes receivable
Performing (including $33,260 in 2002 and $18,834 in 2001
from affiliates)............................................... $62,937 $76,068 $21,021 $22,470
Nonperforming (including $6,097 in 2002 and $5,802 in 2001
from affiliates)............................................... 7,092 7,114 8,762 8,943
------- ------- ------- -------
$70,029 83,182 $29,783 31,413
======= =======
Interest receivable (including $1,923 in 2002 and $1,254 in 2001
from affiliate)................................................ 2,028 1,546
------- -------
$85,210 $32,959
======= =======

Interest income is recognized on nonperforming notes receivable on a cash
basis. For the years 2002, 2001 and 2000 unrecognized interest income on such
nonperforming notes receivable totaled $706,000, $233,000 and $316,000,
respectively.

56

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Notes receivable at December 31, 2002, mature from 2000 to 2009 with
interest rates ranging from 0.00% to 14.0% per annum and a weighted average
rate of 9.3% per annum. Notes receivable are generally collateralized by real
estate or interests in real estate and personal guarantees of the borrower. A
majority of the notes receivable provide for principal to be paid at maturity.
Scheduled principal maturities of $5.8 million are due in 2003.

In May 2002, ARI sold its leasehold interests in various oil and gas mineral
development properties for $1.3 million, receiving a note from the buyer for
the purchase price. The note bore interest at 10.0% per annum, matured in May
2004 and required monthly payments of principal and accrued interest. See NOTE
4. "OIL AND GAS OPERATIONS." In November 2002, the note was sold to 10300
Gaywood Trust, a related party, for $1.3 million plus accrued but unpaid
interest, to satisfy debt. No cash was received by ARI for the sale of the note.

In August 2002, ARI sold a 14.2 acre tract of its Elm Fork land parcel for
$1.5 million, paying $54,000 after payment of closing costs and debt paydown
and providing purchase money financing of $763,000. The loan bore interest at
10.0% per annum and matured in October 2002. All principal and interest were
due at maturity. In October 2002, the note was collected in full, including
accrued but unpaid interest.

In September 2002, ARI sold its Messick land parcel and an 80.0 acre tract
of its Katrina land parcel for $12.8 million, paying $1.5 million after payment
of closing costs and debt paydown and providing purchase money financing of
$9.6 million. The loan bears interest at 8.0% per annum, matures in September
2004 and requires quarterly payments of accrued interest. All principal and
accrued interest are due at maturity. In February 2003, ARI accepted $7.4
million as full payment for $7.7 million in principal and accrued interest. In
March 2003, the remaining $1.9 million loan balance was sold to an unrelated
party for $1.8 million plus accrued and unpaid interest. See NOTE 25.
"SUBSEQUENT EVENTS."

In October 2002, ARI sold its Varner Road land parcel for $3.7 million,
receiving $671,000 after payment of closing costs and providing purchase money
financing of $2.8 million. The loan bears interest at 9.0% per annum, matures
in October 2004 and requires quarterly interest payments. All principal and
accrued but unpaid interest are due at maturity.

In December 2002, ARI sold its Willow Springs land parcel for $9.8 million,
paying $1.3 million after payment of closing costs and debt paydown and
providing purchase money financing of $7.8 million. The loan bore interest at
8.0% per annum, matured in December 2005 and required periodic interest
payments beginning in June 2003. In March 2003, the loan was sold to an
unrelated party for $7.5 million plus accrued and unpaid interest. See NOTE 25.
"SUBSEQUENT EVENTS."

Also in December 2002, ARI sold a 238.0 acre tract of its Desert Wells land
parcel for $23.8 million, receiving $321,000 after payment of closing costs and
debt paydown and providing purchase money financing of $21.4 million. The first
lien financing of $17.8 million bore interest at 8.0% per annum, matured in
December 2004 and required payments beginning in March 2003. In March 2003, the
loan was sold to an unrelated party for $17.1 million plus accrued and unpaid
interest. See NOTE 25. "SUBSEQUENT EVENTS." The second lien financing of $3.6
million bore interest at 8.0% per annum and matured on March 31, 2003. All
principal and interest were due at maturity.

In December 2002, ARI sold a 171.1 acre tract of its Desert Wells land
parcel for $11.9 million receiving $1.4 million after payment of closing costs
and debt paydown and providing purchase money financing of $8.9 million. The
loan bore no interest and matured in March 2003. The principal was due at
maturity. In December 2002, interest in $7.7 million of the loan was sold to an
unrelated party for $7.7 million. ARI retained a junior interest in $1.2
million of the loan. In March 2003, the note was collected in full.

57

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In March 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for
$2.8 million, receiving $700,000 in cash and providing purchase money financing
of the remaining $2.1 million of the sales price. The loan bore interest at
12.0% per annum and matured in July 2001. All principal and interest were due
at maturity. In January 2002, $274,000 in principal and $226,000 in interest
was collected. In March 2002, the note was collected in full, including accrued
but unpaid interest.

In April 2001, ARI sold a 20.0 acre tract of its Katrina land parcel for
$2.9 million, receiving $700,000 in cash and providing purchase money financing
of the remaining $2.2 million of the sales price. The loan bore interest at
10.0% per annum and matured in June 2001. In May 2001, ARI sold an 80% senior
interest in the note to a financial institution. In June 2001, the interest
rate was increased to 12.0% and the maturity date was extended to August 2001.
All principal and accrued but unpaid interest were due at maturity. In July
2001, the note was collected in full, including accrued but unpaid interest.

In November 2001, ARI sold a 12.71 acre tract of its Santa Clarita land
parcel for $1.9 million, receiving $1.5 million in cash and providing purchase
money financing of the remaining $437,000 of the sales price. The loan bore
interest at 8.00% per annum and matured in November 2002. In November 2002, the
note was collected in full, including accrued but unpaid interest.

Also in November 2001, ARI sold the Blackhawk Apartments for $7.1 million
receiving $1.5 million in cash after the assumption of $4.0 million of mortgage
debt and providing purchase money financing of the remaining $1.6 million of
the sales price. The loan bore interest at 10.00% per annum and matured in May
2002. Monthly principal and interest payments were required. In April 2002, the
note was collected in full, including accrued but unpaid interest.

In July 2000, ARI sold a 749.1 acre tract of its Keller land parcel for
$10.0 million, receiving $8.7 million in cash and providing purchase money
financing of the remaining $1.3 million of the sales price. The loan bore
interest at 12.0% per annum. A payment of $500,000 principal and interest was
collected in September 2000 and all remaining principal and interest was due
July 31, 2001. The loan was secured by 100% of the shares of DM Development,
Inc. and an assignment of proceeds. In March 2001, $850,000 in principal and
interest was collected. In June 2001, the loan was collected in full, including
accrued but unpaid interest.

In September 1999, in conjunction with the sale of two apartments in Austin,
Texas, $2.1 million in purchase money financing was provided, secured by
limited partnership interests in two limited partnerships owned by the buyer.
The financing bore interest at 16.0% per annum, required monthly payments of
interest only at 6.0% per annum, beginning in February 2000 and required a
$200,000 principal paydown in December 1999, which was not received, and
matured in August 2000. ARI had the option of obtaining the buyer's general and
limited partnership interests in the collateral partnerships in full
satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing
on the collateral securing the note and released one of the partnership
interests, in exchange for a payment of $250,000 and executed deeds of trusts
on certain properties owned by the buyer. In March 2000, the borrower made a
$1.1 million payment, upon receipt of which ARI returned the deeds of trust.
The borrower executed a replacement promissory note for the remaining note
balance of $1.0 million, which is unsecured, non- interest bearing and matures
in April 2003. In April 2000, ARI funded a $100,000 loan to the borrower. The
loan was secured by five second lien deeds of trust, was non-interest bearing
and matured in September 2001. Payment was not received at maturity, and ARI
began accruing default interest. In December 2001, the $100,000 loan was
collected in full, including accrued but unpaid interest.

In December 1999, a note with a principal balance of $1.2 million and
secured by a pledge of a partnership interest in a partnership which owns real
estate in Addison, Texas, matured. The maturity date was extended to April 2000
in exchange for an increase in the interest rate to 14.0% per annum. All other
terms remained the

58

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

same. In February 2001, the loan amount was increased to $1.6 million and the
maturity date was extended to June 2001. In February 2002, $1.5 million in
principal and $87,000 in interest was collected. In July 2002, the note was
collected in full, including accrued but unpaid interest.

In August 1998, a $635,000 loan was funded to La Quinta Partners, LLC. The
loan was secured by interest bearing accounts prior to their being used as
escrow deposits toward the purchase of 956 acres of land in La Quinta,
California, and the personal guarantee of the manager of the borrower. The loan
had an extended maturity date of November 1999. All principal and interest were
due at maturity. In November and December 1998, $250,000 in principal paydowns
were received. In the second quarter of 1999, the loan was modified, increasing
the interest rate to 15.0% per annum and extending the maturity to November
1999. Accrued but unpaid interest was added to the principal balance,
increasing it by $42,000 to $402,000. In the fourth quarter of 1999, an
additional $2,000 was funded, increasing the loan balance to $404,000. In March
2000, $25,000 in interest was collected and the loan's maturity date was
further extended to April 2000. The borrower did not repay the loan at
maturity. In March 2001, a settlement was reached, whereby ARI collected
$410,000 in full satisfaction of the note.

Related Party. In June 2002, ARI converted $4.5 million of its receivable
from BCM, a related party, to a recourse note receivable. This transaction was
to provide ARI with additional security over that provided by an unsecured
receivable. The note bears interest at 10.0% per annum, matures in March 2004
and requires quarterly payments of principal and accrued interest, beginning in
December 2002.

In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for
Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying
$764,000 after payment of closing costs and debt paydown and providing purchase
money financing of $8.4 million. One loan has a principal amount of $2.0
million. The loan is unsecured, and is guaranteed by Unified Housing
Foundation, Inc. ("Unified"), a related party. The second loan has a principal
amount of $6.4 million, and is secured by a pledge by United of 100% of the
Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature
in December 2009 and require quarterly payments beginning in March 2003.
Richard W. Humphrey, a director of ARI, is the President of Humble and the
President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a
director of ARI, is the General Manager of Unified.

In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of
credit to One Realco Corporation ("One Realco"), which owns approximately 14.7%
of the outstanding shares of ARI's Common Stock. One Realco periodically
borrows money to meet its cash obligations. The line of credit bears interest
at 12.0% per annum. All principal and interest were due at maturity in February
2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in
principal and $416,000 in interest was collected. In December 2001, $21,000 in
principal and $804,000 in interest was collected. In February 2002, the line of
credit was increased to $18.0 million, accrued but unpaid interest of $217,000
was added to the principal and the maturity date was extended to February 2004.
In March 2002, ARI funded an additional $1.8 million, increasing the
outstanding principal balance to $15.5 million. In October 2002, $856,900 in
interest was collected, by the return of 85,690 shares of ARI Series A
Preferred Stock. All principal and interest are due at maturity. Ronald E.
Kimbrough, Acting Principal Executive Officer, Executive Vice President and
Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001
and 2002, Mr. Kimbrough did not participate in the day-to-day operations or
management of One Realco.

In December 2000, an unsecured loan with a current principal balance of $1.9
million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to
provide funds to purchase, renovate and expand a shopping center property in
Warwick, Rhode Island. All principal and interest were due at maturity. At

59

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 2002, the loan, and $188,000 of accrued interest, remained unpaid.
Richard D. Morgan, a Warwick shareholder, served as a director of ARI until
October 2001.

In December 2000, a loan with a current principal balance of $1.6 million to
Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide
funds to purchase and renovate a shopping center property in Oklahoma City,
Oklahoma, is secured by (1) a 100% interest in Bordeaux, which owns a shopping
center in Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux
Investments One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma
City, Oklahoma; and (3) the personal guarantees of the Bordeaux members. At
December 2002, the loan, and $710,000 of accrued interest, remained unpaid.
Richard D. Morgan, a Bordeaux member, served as a director of ARI until October
2001.

In March 2000, a loan with a current principal balance of $2.6 million to
Lordstown, L.P., matured. The loan, to provide funds to purchase for resale
various parcels of land, is secured by a second lien on land in Ohio and
Florida, by 100% of the general and limited partner interest in Partners
Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest
in subsequent land sales. At December 2002, the loan, and $1.1 million of
accrued interest, remained unpaid. A corporation controlled by Richard D.
Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a
director of ARI until October 2001.

In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an
affiliate. The loan, to provide funds for acquisitions or working capital
needs, was secured by all of the outstanding shares of common stock of American
Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and
matured in November 2001. In January 2000, $100,000 was collected. In November
2001, the maturity date was extended to November 2004. The collateral was
changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by
BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate
was changed to 2% over the prime rate, currently 6.25% per annum, and the
accrued but unpaid interest of $984,000 was added to the principal. The new
principal balance is $5.6 million. All principal and accrued interest are due
at maturity.

NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES

Activity in the allowance for estimated losses was as follows:

2002 2001 2000
------ ------ ------

Balance January 1,... $2,577 $2,577 $2,577
Increase in provision 500 -- --
------ ------ ------
Balance December 31,. $3,077 $2,577 $2,577
====== ====== ======

NOTE 5. OIL AND GAS OPERATIONS

In May 2001, ARI purchased the leasehold interests in 37 oil and gas mineral
development properties, which included 131 drilled wells. The total proved
reserves were 6.5 million barrels of oil and 3.3 billion cubic feet of natural
gas. The total purchase price was $4.7 million, plus a 40% profit
participation. The Operator's Interest was purchased for $375,000, with $25,000
cash paid at closing. ARI gave a note payable for the remaining $350,000. The
note bore no interest, and matured in May 2002. Monthly principal payments of
$25,000 were required. The Working Interests were purchased for $4.3 million,
with $125,000 cash paid at closing. ARI gave a note payable for $250,000. The
note bore no interest, and matured in November 2001. One-half of the principal
was paid in August 2001. The remaining $4.0 million was paid by issuing
3,968.75 shares of ARI Series F Preferred Stock, which was redeemable quarterly
in an amount equal to 20% of net cash flow from the oil and gas operations. The
stock had a liquidation value of $1,000 per share, and paid no dividends.

60

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In May 2002, ARI sold the leasehold interests for $1.3 million, receiving a
note from the buyer for the purchase price. The note bore interest at 10.0% per
annum, matured in May 2004 and required monthly payments of principal and
accrued interest. As part of the sale, the notes payable given by ARI for the
purchase of the Operator's Interest, ($350,000) and the Working Interests
($250,000) were canceled. The 3,968.75 shares of ARI Series F Preferred Stock
were also returned to ARI and canceled.

In November 2002, the note was sold to 10300 Gaywood Trust, a related party,
for $1.3 million plus accrued but unpaid interest, to satisfy debt. No cash was
received by ARI for the sale of the note.

NOTE 6. INVESTMENTS IN EQUITY INVESTEES

Investments in equity investees at December 31, 2002, consisted of two
publicly traded real estate companies, IORI and TCI and interests in real
estate joint venture partnerships. BCM, ARI's advisor, serves as advisor to
IORI and TCI.

The investments in IORI, TCI and the joint venture partnerships are
accounted for using the equity method as more fully described in NOTE 1.
"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Investments in equity investees."

A significant portion of ARI's investment in IORI and TCI is pledged as
collateral for borrowings. See NOTE 8. "NOTES AND INTEREST PAYABLE" and NOTE 9.
"MARGIN BORROWINGS."

Investments in equity investees consisted of the following:

Equivalent
Percentage of Carrying Value of Investee Book Market Value of
Ownership at Investment at Value at Investment at
Investee December 31, 2002 December 31, 2002 December 31, 2002 December 31, 2002
- -------- ----------------- ----------------- ----------------- -----------------

IORI... 28.49% $ 7,383 $ 10,628 $ 7,711
TCI.... 49.81 71,035 110,769 70,926
------- -------- -------
78,418 $121,397 $78,637
======== =======
Other.. 2,572
-------
$80,990
=======

Equivalent
Percentage of Carrying Value of Investee Book Market Value of
Ownership at Investment at Value at Investment at
Investee December 31, 2001 December 31, 2001 December 31, 2001 December 31, 2001
- -------- ----------------- ----------------- ----------------- -----------------
IORI... 28.49% $ 6,789 $ 10,034 $ 7,379
TCI.... 49.99 68,498 108,369 64,533
------- -------- -------
75,287 $118,403 $71,912
======== =======
Other.. 2,646
-------
$77,933
=======

On October 3, 2000, ARI and IORI entered into an agreement which provided
IORI and ARI with an option to purchase 1,858,900 shares of common stock of TCI
from a third party. On October 19, 2000, IORI assigned all of its rights to
purchase such shares to ARI. The total cost to purchase the TCI shares was
$30.8 million. In October 2000, ARI paid $5.6 million of the option price. In
April 2001, the remainder of the option price was paid, and ARI acquired the
TCI shares.

61

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

On November 15, 2002, ARI commenced a tender offer for the IORI and TCI
shares not already owned by ARI. The tender offer was completed on March 19,
2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the
stock by non-affiliated stockholders. Pursuant to the tender offer, ARI
acquired 265,036 IORI shares and 1,213,226 TCI shares. After the tender offers,
ARI owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding
shares of IORI (46.9% owned directly by ARI and 15.6% through TCI's ownership
of IORI shares). ARI will consolidate TCI's and IORI's accounts and operations
beginning January 1, 2003.

ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida
Public Funds II, in which ART Florida Portfolio II, Ltd. owned an interest,
sold Villas Continental Apartments. ARI received $1.3 million in cash from the
sale. ARI's share of the loss incurred on the sale was $286,000, which is
included in loss on sale of investments in equity investees in the Consolidated
Statements of Operations.

Elm Fork Ranch, L.P. In June 2000, ARI sold its partnership interests for
$2.0 million in cash, retaining an option to repurchase its interests. In
January 2001, ARI purchased 100% of the partnership interests for $9.2 million,
including financing of $9.0 million.

Set forth below are summary financial data for equity investees:

2002 2001
--------- ---------

Property and notes receivable, net. $ 862,190 $ 732,556
Other assets....................... 86,484 68,429
Notes payable...................... (653,784) (515,463)
Other liabilities.................. (35,189) (33,532)
--------- ---------
Equity............................. $ 259,701 $ 251,990
========= =========

2002 2001 2000
-------- --------- --------

Revenues................................... $121,055 $ 128,099 $143,330
Depreciation............................... (20,799) (19,021) (20,359)
Provision for losses....................... (4,316) (281) --
Interest................................... (43,679) (42,006) (49,217)
Operating expenses......................... (93,760) (100,334) (98,758)
Gain on sale of real estate................ -- 48,961 71,428
-------- --------- --------
Income (loss) from continuing operations... (41,499) 15,418 46,424
Income (loss) from discontinued operations. (2,675) 931 152
Gain from sale of discontinued operations.. 51,110 -- --
-------- --------- --------
Net income................................. $ 6,936 $ 16,349 $ 46,576
======== ========= ========

ARI's equity share of:
2002 2001 2000
-------- --------- --------
(Loss) before gains on sale of real estate. $(20,938) $ (13,646) $ (5,260)
Gains on sale of real estate............... 24,069 22,542 18,571
-------- --------- --------
Net income................................. $ 3,131 $ 8,896 $ 13,311
======== ========= ========

In 2001, ARI received $53,000 from TCI in accumulated dividends on shares of
CMET that should have been exchanged for TCI common stock in 1999.

62

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The cash flow from IORI and TCI is dependent on the ability of each of them
to make distributions. IORI and TCI ceased making quarterly distributions in
the fourth quarter of 2000.

ARI initially acquired its investment in IORI and TCI in 1989.

NOTE 7. MARKETABLE EQUITY SECURITIES--TRADING PORTFOLIO

Since 1994, ARI has purchased equity securities of entities other than those
of the IORI and TCI to diversify and increase the liquidity of its margin
accounts and its trading portfolio. The acquisition of RAK added $1.4 million
in marketable securities of which $1.3 million were sold in 2002. Trading
portfolio securities are carried at market value. In 2001, ARI did not purchase
or sell any trading portfolio securities. At December 31, 2002, ARI recognized
an unrealized decline in the market value of trading portfolio securities of
$25,000. In 2002, ARI realized no gains or losses from the sale of trading
portfolio securities and received no dividends. At December 31, 2001, ARI
recognized an unrealized decline in the market value of trading portfolio
securities of $55,000. In 2001, ARI realized no gains or losses from the sale
of trading portfolio securities and received no dividends. At December 31,
2000, ARI recognized an unrealized decline in the market value of trading
portfolio securities of $305,000. In 2000, ARI realized a net loss of $747,000
from the sale of trading portfolio securities and received $3,000 in dividends.
Unrealized and realized gains and losses in trading portfolio securities are
included in other income in the accompanying Consolidated Statements of
Operations.

NOTE 8. NOTES AND INTEREST PAYABLE

Notes and interest payable consisted of the following:

2002 2001
------------------- -------------------
Estimated Book Estimated Book
Fair Value Value Fair Value Value
---------- -------- ---------- --------

Notes payable
Mortgage loans........................ $455,888 $448,051 $559,367 $551,207
Borrowings from financial institutions 8,022 8,897 8,620 8,476
Notes payable to affiliates........... 15,181 14,346 1,733 1,598
-------- -------- -------- --------
$479,091 471,294 $569,720 561,281
======== ========
Interest payable...................... 4,139 3,017
-------- --------
$475,433 $564,298
======== ========

Scheduled principal payments on notes payable are due as follows:

2003...... $160,701
2004...... 53,135
2005...... 52,912
2006...... 15,123
2007...... 44,788
Thereafter 144,635
--------
$471,294
========

63

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Stated interest rates on notes payable ranged from 5.0% to 16.9% per annum
at December 31, 2002, and matured in varying installments between 2003 and
2043. At December 31, 2002, notes payable were collateralized by deeds of trust
on real estate with a net carrying value of $458.0 million.

In January 2002, the lender on three of ARI's residential properties located
in Florida commenced foreclosure actions, due to ARI's failure to pay the loans
at maturity on January 1, 2002. ARI has filed counterclaims asserting the
lender had abruptly withdrawn from discussions for refinancing. The balance
owed on the three loans is $7.2 million. In May 2002, the lender's claims were
dismissed voluntarily.

In February 2003, the lender on one of ARI's hotel properties located in
Virginia notified ARI that the loan on the property was in default, due to
ARI's failure to timely make debt service payments. The balance owed on the
loan is $11.6 million. In April 2003, the lender notified ARI that acceptance
of terms to cure the default and extend the maturity date of the loan would be
recommended to the lender's management for approval.

In 2002, ARI financed/refinanced or obtained second mortgage financing on
the following:

Net Cash
Units/ Debt Debt Received/ Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged (Paid) Rate Date
-------- ------------------ -------------- --------- ---------- --------- -------- --------

Apartments
Lee Hills............. Tallahassee, FL 16 Units $ 1,750/(2)/ $ 117 $ 590 6.625%/(1)/ 06/05
Valley Hi............. Tallahassee, FL 54 Units -- /(2)/ 878 -- -- --
White Pines........... Tallahassee, FL 85 Units -- /(2)/ -- -- -- --

Land
Desert Wells.......... Palm Desert, CA 244.3 Acres 9,500 9,500 959 10.250/(1)/ 12/04
Katrina............... Palm Desert, CA 201.7 Acres 3,000 5,735 (3,071) 10.250/(1)/ 12/03
Walker................ Dallas County, TX 90.6 Acres 8,500 8,500 (1,411) 11.250/(1)/ 01/03/(3)/

Shopping Center
Plaza on Bachman Creek Dallas, TX 80,278 Sq.Ft. 5,000 -- 4,444 6.625/(1)/ 04/04

Office Buildings
Four Hickory Centre... Farmers Branch, TX 226,911 Sq.Ft. 12,500 -- 3,399 13.000 05/03
Two Hickory Centre.... Farmers Branch, TX 96,127 Sq.Ft. 7,500 5,942 1,277 7.750 06/03
University Square..... Anchorage, AK 22,260 Sq.Ft. 1,250 -- 1,216 8.500/(1)/ 10/17

Related Party Transactions. In each of the following transactions, except
those footnoted as (6), a related party has purchased an entity, which owns the
listed property asset, from ARI. ARI has guaranteed that the asset will produce
at least a 12% return on the purchase price for a period of three years from
the purchase date. If the asset fails to produce the 12% return, ARI will pay
the purchaser any shortfall. In addition, if the asset fails to produce the 12%
return for a calendar year, the purchaser may require ARI to repurchase the
entity for the purchase price. Management has classified these related party
transactions as notes payable.

Debt Debt Net Cash Interest Maturity
Property Location Units/Sq.Ft. Incurred Discharged Received Rate Date
-------- ---------------- ------------ -------- ---------- -------- -------- --------

Apartments
Bay Anchor....... Panama City, FL 12 Units $ 255 $ -- $ 203 5.000% 05/03/(6)(13)/
Confederate Point Jacksonville, FL 206 Units 1,929 -- -- 12.000 04/05/(7)/
Foxwood.......... Memphis, TN 220 Units 1,093 -- -- 12.000 04/05/(8)/
Governor Square.. Tallahassee, FL 168 Units 4,480 3,196 611 7.120 05/07/(6)/
Grand Lagoon..... Panama City, FL 54 Units 2,083 1,209 655 5.000 05/03/(6)(10)/
Oak Hill......... Tallahassee, FL 92 Units 2,550 1,875 478 5.000 05/03/(6)(12)/
Park Avenue...... Tallahassee, FL 121 Units 4,400 2,756 1,341 7.120 05/07/(6)/
Seville.......... Tallahassee, FL 62 Units 1,955 1,263 473 5.000 05/03/(6)(13)/
Westwood......... Mary Ester, FL 120 Units 3,382 2,327 1,023 7.570 05/12/(6)/
Windsor Tower.... Ocala, FL 64 Units 1,989 1,128 702 5.000 05/03/(6)/
Woodhollow....... San Antonio, TX 546 Units 8,160 5,349 2,775 7.120 05/07/(6)/
Woodsong......... Smyrna, GA 190 Units 2,544 -- -- 12.000 04/05/(9)/

64

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Debt Debt Net Cash Interest Maturity
Property Location Units/Sq.Ft. Incurred Discharged Received Rate Date
-------- ------------------ -------------- -------- ---------- -------- -------- --------

Office Building
One Hickory Centre Farmers Branch, TX 102,615 Sq.Ft. $4,468 $ -- $ -- 12.000% 04/05/(11)/
Rosedale Towers... Minneapolis, MN 84,798 Sq.Ft. 5,109 -- 5,109 12.000 01/05/(4)/
Two Hickory Centre Farmers Branch, TX 96,127 Sq.Ft. 4,448 -- 4,448 12.000 01/05/(5)/

- --------
(1) Variable interest rate.
(2) Single note with all properties as collateral.
(3) Maturity date extended to July 2004.
(4) IORI purchased 100% of the outstanding common shares of Rosedale
Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1
million. The purchase price was determined based upon the market value of
the property, using a market rate multiple of net operating income.
Rosedale owned the Rosedale Towers Office Building. The business purpose of
this transaction was for IORI to make an equity investment in Rosedale,
anticipating a profitable return, and for ARI to receive cash for its
equity investment. The property was sold to an unrelated buyer in December
2002. ARI owes $2.1 million to IORI for remaining principal and 12% return.
(5) TCI purchased 100% of the common shares of ART Two Hickory Corporation
("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4 million. The
purchase price was determined based upon the market value of the property,
using a market rate multiple of net operating income. Two Hickory owns the
Two Hickory Centre Office Building. The business purpose of this
transaction was for TCI to make an equity investment in Two Hickory,
anticipating a profitable return, and for ARI to receive cash for its
equity investment.
(6) Properties sold to partnerships controlled by Metra Capital, LLC ("Metra").
Innovo Group, Inc. ("Innovo") is a limited partner in the partnerships that
purchased the properties. Joseph Mizrachi, a Director of ARI, controls
approximately 11.67% of the outstanding common stock of Innovo. Management
has determined to treat this sale as a refinancing transaction. ARI will
continue to report the assets and the new debt incurred by Metra on its
financial statements. ARI also received $6.3 million of 8% non-recourse,
non-convertible Series A Preferred Stock ("Preferred Shares") of Innovo.
The dividend on the Preferred Shares will be funded entirely and solely
through member distributions from cash flows generated by the operation and
subsequent sale of the sold properties. In the event the cash flows for the
properties are insufficient to cover the 8% annual dividend, Innovo will
have no obligation to cover any shortfall.
The Preferred Shares have a mandatory redemption feature, and are redeemable
from the cash proceeds received by Innovo from the operation and sale of the
properties. All member distributions that are in excess of current and
accrued 8% dividends must be used by Innovo to redeem the Preferred Shares.
Since redemption of these shares is subject to the above future events,
management has elected to record no basis in the Preferred Shares.
(7) TCI purchased all of the general and limited partnership interests in
Garden Confederate Point, L.P. ("Confederate Point") from ARI for $1.9
million. The purchase price was determined based upon the market value of
the property, using a market rate multiple of net operating income.
Confederate Point owns the Confederate Point Apartments. The business
purpose of this transaction was for TCI to make an equity investment in
Confederate Point, anticipating a profitable return, and to reduce ARI's
payable to BCM. Failure to notify and receive approval from the lender for
this transaction may constitute an event of default under the terms of the
debt.
(8) TCI purchased all of the general and limited partnership interests in
Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The purchase
price was determined based upon the market value of the property, using a
market rate multiple of net operating income. Foxwood owns the Foxwood
Apartments. The business purpose of this transaction was for TCI to make an
equity investment in Foxwood, anticipating a profitable return, and to
reduce ARI's payable to BCM. Failure to notify and receive approval from
the lender for this transaction may constitute an event of default under
the terms of the debt.

65

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(9) TCI purchased all of the general and limited partnership interests in
Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The purchase
price was determined based upon the market value of the property, using a
market rate multiple of net operating income. Woodsong owns the Woodsong
Apartments. The business purpose of this transaction was for TCI to make an
equity investment in Woodsong, anticipating a profitable return, and to
reduce ARI's payable to BCM. TCI sold the Woodsong Apartments in July 2002.
(10) Sold to unrelated buyer in December 2002.
(11) TCI purchased 100% of the common shares of ART One Hickory Corporation
("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5 million. The
purchase price was determined based upon the market value of the property,
using a market rate multiple of net operating income. One Hickory owns the
One Hickory Centre Office Building. The business purpose of this
transaction was for TCI to make an equity investment in One Hickory,
anticipating a profitable return, and to reduce ARI's payable to BCM.
Failure to notify and receive approval from the lender for this
transaction may constitute an event of default under the terms of the debt.
(12) Sold to unrelated party in June 2002.
(13) Sold to unrelated party in January 2003. See NOTE 25. "SUBSEQUENT EVENTS."

In 2001, ARI financed/refinanced or obtained second mortgage financing on
the following:

Units/Sq.Ft. Debt Debt Net Cash Interest Maturity
Property Location Rooms/Acres Incurred Discharged Received Rate Date
-------- ---------------- -------------- -------- ---------- -------- -------- --------

Apartments
Sun Hollow.............. El Paso, TX 216 Units $ -- /(1)/ $ -- $ -- -- --
Waters Edge III......... Gulfport, MS 238 Units -- /(1)/ -- -- -- --
Woodlake................ Carrollton, TX 256 Units -- /(1)/ -- -- -- --

Office Building
Centura Tower........... Farmers Branch, TX 410,910 Sq.Ft. 28,739 28,384 (526) 10.50% 07/02
Executive Court......... Memphis, TN 41,840 Sq.Ft. 1,598 -- 1,598 12.00 12/04/(9)/
Four Hickory Centre..... Farmers Branch, TX 221,000 Sq.Ft. 5,000 -- 5,000 6.75/(5)/ 10/02
Rosedale Towers......... Minneapolis, MN 84,798 Sq.Ft. 7,500/(1)/ -- 7,500 5.00 07/02
University Square....... Anchorage, AK 22,260 Sq.Ft. 800 -- 777 15.00 06/02

Shopping Center
Cross County............ Mattoon, IL 307,174 Sq.Ft. 3,200 700 2,436 15.00 06/02
Cullman................. Cullman, AL 92,486 Sq.Ft. -- /(2)/ 129 -- -- --
Westwood................ Tallahassee, FL 149,244 Sq.Ft. 3,000 700 2,221 15.00 06/02

Hotel
Williamsburg Hospitality
House.................. Williamsburg, VA/(3)/ 296 Rooms 10,309 -- 9,851 36.00 01/02/(6)/

Land
Chase Oaks.............. Plano, TX 6.9 Acres 1,633 1,000 425 13.00 03/03
Hollywood Casino........ Farmers Branch, TX 51.7 Acres 2,500/(4)/ -- 1,916 9.00 04/03
Jeffries Ranch.......... Oceanside, CA 82.4 Acres 5,250/(2)/ 750 3,944 14.50 06/02
Katrina................. Palm Desert, CA 300.5 Acres 22,000 15,584 4,417 12.50/(5)/ 10/02
Marine Creek............ Fort Worth, TX 54.2 Acres 1,500 750 701 9.00 01/03
Mason/Goodrich.......... Houston, TX 235.0 Acres 6,750 -- 6,302 14.00 01/02/(7)/
Mercer Crossing......... Carrollton, TX 31.3 Acres 2,937 1,986 16 13.00 03/03
Pioneer Crossing........ Austin, TX 350.1 Acres 7,000 -- 6,855 16.90 03/05
Pioneer Crossing........ Austin, TX 14.5 Acres 2,500 -- 2,350 14.50 01/02/(8)/
Valwood................. Dallas County, TX 19.4 Acres -- /(4)/ -- -- -- --
Varner Road............. Riverside, CA 127.8 Acres 2,450 -- 2,333 9.00 10/02
Vista Ridge LI.......... Lewisville, TX 90.3 Acres 9,085 9,119 (101) 13.00 03/03
Vista Ridge MF.......... Lewisville, TX 23.0 Acres 1,345 1,000 228 13.00 03/03
Willow Springs.......... Beaumont, CA 1,485.7 Acres -- /(2)/ -- -- -- --

- --------
(1) Single note, with all properties as collateral.

66

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(2) Single note, with all properties as collateral.
(3) Also secured by 1,846,000 shares of TCI Common Stock.
(4) Single note, with all properties as collateral.
(5) Variable interest rate.
(6) Paid off in September 2001.
(7) Extended to April 2002.
(8) Extended to April 2002.
(9) In December 2001, TCI, a related party, purchased 100% of the outstanding
common shares of National Melrose, Inc. ("NM"), a wholly-owned subsidiary
of ARI, for $2.0 million. The purchase price was determined based upon the
market value of the property, using a market rate multiple of net operating
income. NM owns the Executive Court Office Building. The business purpose
of this transaction was for TCI to make an equity investment in NM,
anticipating a profitable return, and for ARI to receive cash for its
equity investment. ARI has guaranteed that the asset will produce at least
a 12% annual return on the purchase price for a period of three years from
the purchase date. If the asset fails to produce the annual return, ARI
will pay TCI any shortfall. In addition, if the asset fails to produce 12%
return for a calendar year, TCI may require ARI to repurchase the shares of
NM for the purchase price. Management has classified this related party
transaction as a note payable to TCI.

NOTE 9. MARGIN BORROWINGS

ARI has margin arrangements with various financial institutions and
brokerage firms which provide for borrowings of up to 50% of the market value
of marketable equity securities. The borrowings under such margin arrangements
are secured by the equity securities of IORI and TCI and ARI's trading
portfolio securities and bear interest rates ranging from 5.25% to 24.0% per
annum. Margin borrowings were $8.6 million at December 31, 2002 and $28.0
million at December 31, 2001, representing 14.7% and 39.2%, respectively, of
the market values of the equity securities at those dates.

In June 2000, 1.6 million shares of TCI common stock and 54,000 shares of
IORI common stock held as collateral on margin loans were sold to satisfy
margin calls resulting in losses totaling $7.9 million. These losses are
included in loss on sale of investments in equity investees in the Consolidated
Statements of Operations. See NOTE 6. "INVESTMENTS IN EQUITY INVESTEES."

In March 2001, ARI obtained a security loan in the amount of $3.5 million
from a financial institution. The loan bore interest at 16.0% per annum. In
April and May 2001, a total of $2.0 million in principal paydowns were made. In
July 2001, the loan was repaid in full, including accrued but unpaid interest.
The loan was secured by 472,000 shares of TCI common stock owned by ARI and
128,000 shares of ARI Common Stock owned by One Realco.

In September 2001, ARI obtained a security loan in the amount of $20.0
million from a financial institution. ARI received net cash of $16.1 million
after the payment of various closing costs and $3.4 million repayment of
principal and accrued interest on an existing loan with the same lender. Of the
total loan amount, $19.5 million bears interest at 24% per annum, while the
remaining $500,000 bears interest at 20% per annum. The loan required monthly
payments of interest only and matured in September 2002. In September 2002,
$15.0 million in principal was repaid. The loan is secured by 2,751,798 shares
of TCI common stock held by ARI and 920,507 shares of TCI common stock held by
BCM, ARI's advisor. The lender has informed ARI that the loan is in default.
ARI continues to pay monthly interest.

In October 2001, ARI obtained a security loan in the amount of $1.0 million
from a financial institution. The loan bears interest at 1% over the prime
rate, currently 5.25% per annum, requires monthly payments of interest only and
matures in October 2003. The loan is callable upon 60 days prior notice, and is
secured by 200,000 shares of ARI Common Stock held by BCM, ARI's advisor.

67

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In April 2000, ARI obtained a security loan in the amount of $5.0 million
from a financial institution. ARI received net cash of $4.6 million after
payment of various closing costs. The loan bore interest at 1% over the prime
rate, currently 5.25% per annum, required monthly payments of interest only and
matured September 2002. The loan was secured by 1,050,000 shares of ARI Common
Stock held by BCM, ARI's advisor. In December 2002, the loan was paid in full,
including accrued but unpaid interest.

NOTE 10. RELATED PARTY TRANSACTIONS

In January 2002, IORI purchased 100% of the outstanding common shares of
Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1
million. The purchase price was determined based upon the market value of the
property exchanged, using a market rate multiple of net operating income.
Rosedale owned the Rosedale Towers Office Building. ARI guaranteed that the
asset would produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset failed to produce
the 12% return, ARI would pay IORI any shortfall. In addition, if the asset
failed to produce the 12% return for a calendar year, IORI could require ARI to
repurchase the shares of Rosedale for the purchase price. The business purpose
of the transaction was for IORI to make an equity investment in Rosedale,
anticipating a profitable return, and for ARI to receive cash for its equity
investment. Management classified this related party transaction as a note
payable to IORI. IORI sold the Rosedale Towers Office Building to an unrelated
buyer in December 2002. ARI owes $2.1 million to IORI for remaining principal
and 12% return.

In January 2002, TCI purchased 100% of the common shares of ART Two Hickory
Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4
million. The purchase price was determined based upon the market value of the
property exchanged, using a market rate multiple of net operating income. Two
Hickory owns the Two Hickory Centre Office Building. ARI has guaranteed that
the asset will produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset fails to produce the
12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the shares of Two Hickory for the purchase price. The business purpose of the
transaction was for TCI to make an equity investment in Two Hickory,
anticipating a profitable return, and for ARI to receive cash for its equity
investment. Management has classified this related party transaction as a note
payable to TCI.

In March 2002, ARI received $520,000 and exchanged with TCI a 24.5 acre
tract of Rasor land, a 16.89 acre tract of Lakeshore Villas Apartments land and
the 45,623 sq.ft. Oaktree Village Shopping Center for the 80,278 sq.ft. Plaza
on Bachman Creek Shopping Center. The exchange value prices for the shopping
centers were determined using a market rate multiple of net operating income,
and the values of the land parcels were determined using appraised rates. The
business purpose of the transaction was for TCI to construct apartments on the
Rasor and Lakeshore Villas land. To give ample value for the property TCI
exchanged, the Oaktree Village Shopping Center was added to the transaction.
ARI received $4.4 million on the subsequent financing of the shopping center.

In April 2002, TCI purchased One Hickory Corporation, Garden Confederate
Point, L.P., Garden Foxwood, L.P. and Garden Woodsong, L.P. for $4.5 million,
$1.9 million and $2.5 million, respectively. These transactions were treated as
financings. The transactions reduced ARI's payable to BCM. See NOTE 8. "NOTES
AND INTEREST PAYABLE." Failure to notify and receive approval from the lender
for these transactions may constitute an event of default under the terms of
the debt assumed by TCI.

In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the
Centura Tower Office Building, from ARI for $50.0 million. See NOTE 2. "REAL
ESTATE." The purchase price for the Centura Tower was determined based on
appraised value and replacement cost. The business purpose of the transaction
was for TCI to acquire a Class A office building with significant upside
potential anticipating a profitable return and for ARI to satisfy debt.

68

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In June 2002, TCI purchased five parcels of unimproved land from ARI for
$30.0 million: the Hollywood Casino, Marine Creek, Mason Park, Nashville and
Monterrey land parcels. See NOTE 2. "REAL ESTATE." The purchase price of the
Hollywood Casino land was determined based on an appraised value of $9.10 per
square foot. The business purpose of the transaction was for TCI to consolidate
its holdings within the Mercer Crossing development. The purchase price for the
Marine Creek, Mason Park, Nashville and Monterrey land parcels was determined
based on appraised rates. The business purpose of the transaction was for TCI
to develop apartments on these four tracts of land and for ARI to satisfy debt.
Failure to notify and receive approval from the lender for this transaction may
constitute an event of default under the terms of the debt assumed by TCI.

In June 2002, ARI purchased all the general and limited partnership
interests in Chalet North, L.P. ("Chalet North") from BCM for $3.0 million.
Chalet North owns the Pinecrest Apartments. The purchase price was determined
based on the market value of the property exchanged, using a market rate
multiple of net operating income. ARI assumed debt of $1.4 million. ARI's
receivable from BCM was reduced by $1.6 million, and no cash was paid by ARI.
The business purpose of the transaction was to reduce the affiliate payable
owed by BCM to ARI.

In June 2002, ARI purchased the Tiberon Trails Apartments from BCM for $12.3
million. The purchase price was determined based on the market value of the
property exchanged, using a market rate multiple of net operating income. ARI
assumed debt of $6.4 million. ARI's receivable from BCM was reduced by $5.9
million, and no cash was paid by ARI. The business purpose of the transaction
was to reduce the affiliate payable owed by BCM to ARI.

In June 2002, ARI purchased the Alta Mesa Shopping Center from BCM for $3.8
million. The purchase price was determined based on the market value of the
property exchanged, using a market rate multiple of net operating income. ARI
assumed debt of $1.8 million. ARI's receivable from BCM was reduced by $2.0
million, and no cash was paid by ARI. The business purpose of the transaction
was to reduce the affiliate payable owed by BCM to ARI.

On June 30, 2002, ARI obtained 74.31% interest in RAK from BCM for $6.0
million. The business purpose of the transaction was to reduce the affiliate
payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0
million, and no cash was paid by ARI. At the date of acquisition, RAK's assets
consisted of $2.3 million in cash, $3.0 million in deposits and marketable
securities, and $225,000 in other assets. RAK's net equity was $5.5 million.
ARI recorded $1.9 million in goodwill as a result of this transaction.

In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for
Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying
$764,000 after payment of closing costs and debt paydown and providing purchase
money financing of $8.4 million. One loan has a principal amount of $2.0
million. The loan is unsecured, and is guaranteed by Unified Housing
Foundation, Inc. ("Unified"), a related party. The second loan has a principal
amount of $6.4 million, and is secured by a pledge by Unified of 100% of the
Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature
in December 2009 and require quarterly payments beginning in March 2003.
Richard W. Humphrey, a director of ARI, is the President of Humble and the
President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a
director of ARI, is the General Manager of Unified.

In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the
Centura Holdings, Clark and Woolley land parcels, from ARI for $13.3 million.
See NOTE 2. "REAL ESTATE." The purchase price was determined based on an
appraised rate of $34.89 per share foot. The business purpose of the
transaction was for TCI to construct apartments on the land and for ARI to
satisfy debt.

In January 2003, ARI's Board of Directors approved the payment to BCM of a
6% construction management fee on all construction projects in process at
December 31, 2002, to be applied to all labor and

69

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

materials costs incurred to date on each project. The resulting calculation of
$1.9 million was treated as an increase in the affiliate payable balance to BCM.

During 2002, ARI's Board of Directors authorized ARI's Chief Financial
Officer to advance funds either to or from ARI, through BCM, in an amount up to
$10.0 million and, subsequent to that, authorized ARI's Chief Financial Officer
to make additional advances, on the condition that such advances shall be
repaid in cash or transfers of assets within 90 days.

In June 2002, BCM partially repaid its affiliate payable to ARI by
transferring Alta Mesa Shopping Center, Pinecrest Apartments, Tiberon Trails
Apartments and Realty Advisors Korea, Ltd. to ARI.

Also in June 2002, BCM converted $4.5 million of its unsecured payable to
ARI to a note payable.

During 2002, ARI's payable to BCM was increased by advisory fees,
reimbursable expenses and insurance reimbursements of $549,000, $517,000 and
$435,000, respectively.

During 2002, ARI made payments on BCM's and TCI's behalf of $2.2 million and
$2.8 million, respectively, while BCM made payments on ARI's behalf of $4.1
million.

In November 2002, ARI sold its note receivable from the sale of leasehold
interest in oil and gas mineral development properties to 10300 Gaywood Trust
for a reduction of the affiliate payable to BCM in the amount of $1.3 million.

In July 2002, ARI sold Garden Woodsong to an unrelated party. The proceeds
of $2.8 million increased ARI's affiliate payable to TCI.

In December 2002, ARI sold the Rosedale Towers to an unrelated party. The
proceeds of $3.5 million increased ARI's affiliate payable with IORI.

The following table reconciles the beginning and ending balances of accounts
payable to affiliates as of December 31, 2002.

BCM TCI IORI
--------- ------- -------

Balance, December 31, 2001...................... $ (10,152) $ (57) $ --
Cash transfers to affiliates................. 135,171 400
Cash transfers from affiliates............... (168,883) (6,184) --
Repayments through property transfers by ARI. 41,050 -- --
Repayments through property transfers to ARI. (19,799) -- --
Fees and reimbursements payable to Advisor... (3,434) -- --
Payments on behalf of affiliate by ARI....... 2,286 2,754 --
Payments on behalf of ARI by affiliate....... (4,114) -- --
Funds received by affiliate on behalf of ARI. -- 107 --
Funds received by ARI on behalf of affiliate. -- (792) --
Sale of notes receivable..................... 1,252 -- --
Proceeds from sale of properties............. -- (2,846) (3,454)
--------- ------- -------
Balance, December 31, 2002...................... $ (26,623) $(6,618) $(3,454)
========= ======= =======

Also at December 31, 2002, ARI owed $2.8 million to affiliates for unbilled
loan arrangement fees and real estate brokerage commissions, and $1.6 million
to affiliates related to cash received upon the sale of apartments to Metra.

70

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Returns on Metra Properties. As described more fully in NOTE 8. "NOTES AND
INTEREST PAYABLE," ARI sold nine of its properties during 2002 to partnerships
controlled by Metra. The partnership agreement for each of these partnerships
states that the Metra Partners, as defined, receive cash flow distributions at
least quarterly in an amount sufficient to provide them with a 15% cumulative
compounded annual rate of return on their invested capital, as well as a
cumulative compounded annual amount of 0.50% of the average outstanding balance
of the mortgage indebtedness secured by any of these residential properties.
These distributions to the Metra Partners have priority over distributions to
any of the other partners.

NOTE 11. DIVIDENDS

During the second quarter of 1999, ARI's Board of Directors established a
policy that dividend declarations on Common Stock would be determined on an
annual basis following the end of each year. No dividends on Common Stock were
declared for 2001 or 2002. Future distributions to Common stockholders will be
dependent upon ARI's income, financial condition, capital requirements and
other factors deemed relevant by the Board.

NOTE 12. PREFERRED STOCK

There are 15,000,000 shares of Series A 10% Cumulative Convertible Preferred
Stock authorized, with a par value of $2.00 per share and liquidation
preference of $10.00 per share plus accrued and unpaid dividends. Dividends are
payable at the annual rate of $1.00 per share or $.25 per share quarterly to
stockholders of record on the last day of each March, June, September and
December when and as declared by the Board of Directors. The Series A Preferred
Stock may be converted after August 15, 2003, into ARI Common Stock at 90% of
the average daily closing price of ARI's Common Stock for the prior 20 trading
days. At December 31, 2002, 3,226,858 shares of Series A Preferred Stock were
outstanding and 1,808,879 shares were reserved for issuance as future
consideration in various business transactions. Of the outstanding shares,
300,000 shares are owned by ART Edina, Inc., and 600,000 are owned by ART Hotel
Equities, Inc., wholly-owned subsidiaries of ARI. Dividends are not paid on the
shares owned by ARI subsidiaries.

There are 80,000 shares of Series B 10% Cumulative Convertible Preferred
Stock authorized, with a par value of $2.00 per share and a liquidation
preference of $100.00 per share plus accrued but unpaid dividends. The Series B
Preferred Stock bears an annual dividend of $11.00 per share or $2.75 per
quarter to stockholders of record on the last day of each March, June,
September and December when and as declared by the Board of Directors. The
Series B Preferred Stock was reserved for conversion of the Class A limited
partner units of Valley Ranch, L.P. In March 1999, an agreement was reached for
ARI to acquire the eight million Class A units for $1.00 per unit. At December
31, 2002, all of the Class A units had been repurchased. At December 31, 2002,
no Series B Preferred Stock was outstanding.

There are 231,750 shares of Series C Cumulative Convertible Preferred Stock
authorized, with a par value of $2.00 per share and liquidation preference of
$100.00 per share plus accrued and unpaid dividends. The Series C Preferred
Stock bears a quarterly dividend of $2.25 per share through June 30, 2001 and
$2.50 per share thereafter, to stockholders of record on the last day of March,
June, September and December when and as declared by the Board of Directors.
The Series C Preferred Stock is reserved for conversion of the Class A limited
partner units of ART Palm, L.P. At December 31, 2002, 11,813,750 Class A units
were outstanding. The Class A units may be exchanged for Series C Preferred
Stock at the rate of 100 Class A units for each share of Series C Preferred
Stock. At December 31, 2000, shares of Series C Preferred Stock could be
converted into 25,000 shares of ARI Common Stock. At June 30, 2002, additional
shares of Series C Preferred Stock could be converted into 16,250 shares of ARI
Common Stock. On or after June 30, 2003, additional shares of Series C
Preferred Stock may be converted into 16,250 shares of ARI Common Stock. On or
after December 31, 2005, additional shares of Series C Preferred Stock may be
converted into 16,250 shares of ARI Common Stock. On or after December 31,
2006, all remaining outstanding shares of Series C Preferred Stock may be
converted into

71

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

ARI Common Stock. All conversions of Series C Preferred Stock in ARI Common
Stock will be at 90% of the average daily closing price of ARI's Common Stock
for the prior 20 trading days. In January 2001, 2.5 million Class A limited
partner units of ART Palm, L.P. were redeemed for $2.5 million in cash. In
December 2001, 7.2 million Class A limited partner units of ART Palm, L.P. were
redeemed for $5.8 million, including $2.5 million in cash. ARI gave a note
payable for the remaining $3.3 million. The note bore interest at 10.0% per
annum, with a payment of $1.9 million plus accrued but unpaid interest due in
June 2002, and the remaining principal and accrued but unpaid interest due at
maturity in December 2002. The note was paid in full in January 2003, including
accrued but unpaid interest. In July 2002, 1.6 million Class A limited partner
units of ART Palm, L.P. were redeemed for $1.6 million cash. At December 31,
2002, no Series C Preferred Stock was outstanding.

There are 91,000 shares of Series D 9.50% Cumulative Preferred Stock
authorized, with a par value of $2.00 per share, and a liquidation preference
of $20.00 per share. Dividends are payable at the annual rate of $1.90 per year
or $.475 per quarter to stockholders of record on the last day of each March,
June, September and December when and as declared by the Board of Directors.
The Series D Preferred Stock is reserved for the conversion of the Class A
limited partner units of Ocean Beach Partners, L.P. The Class A units may be
exchanged for Series D Preferred Stock at the rate of 20 Class A units for each
share of Series D Preferred Stock. No more than one-third of the Class A units
could be exchanged prior to May 31, 2001. Between June 1, 2001 and May 31, 2006
all unexchanged Class A units are exchangeable. At December 31, 2002, no shares
of Series D Preferred Stock were outstanding.

There are 500,000 shares of Series E 6% Cumulative Preferred Stock
authorized, with a par value $2.00 per share and a liquidation preference of
$10.00 per share. Dividends are payable at the annual rate of $.60 per share or
$.15 per quarter to stockholders of record on the last day of each March, June,
September and December when and as declared by the Board of Directors. At
December 31, 2002, 50,000 shares of Series E Preferred Stock were outstanding.

There are 10,000 shares of Series I 8% Cumulative Preferred Stock
authorized, with a par value of $2.00 per share and a liquidation preference of
$1,000.00 per share. Dividends are payable at the annual rate of $80.00 per
share or $20.00 per quarter to stockholders of record on the last date of each
March, June, September and December when and as declared by the Board of
Directors. At December 31, 2002, no shares of Series I were outstanding. In
February 2003, 10,000 shares were issued to ART Morgan, Inc., a wholly-owned
subsidiary of ARI. Dividends are not paid on these shares.

NOTE 13. STOCK OPTIONS

In January 1998, stockholders approved the 1997 Stock Option Plan (the
"Option Plan"). Under the Option Plan, options have been granted to certain ARI
officers and key employees of BCM and its affiliates. The Option Plan provides
for options to purchase up to 300,000 shares of Common Stock. All grants are
determined by the Option Committee of the Board of Directors. Options granted
pursuant to the Option Plan are exercisable, based upon vesting of 20% per
year, beginning one year after the date of grant and expire the earlier of
three months after termination of employment or ten years from the date of
grant. At December 31, 2002, 76,600 options were exercisable at an exercise
price of $16.35 per Common share and 2,400 shares were exercisable at an
exercise price of $18.53 per Common share.

In January 1999, stockholders approved the Director's Stock Option Plan (the
"Director's Plan") which provides for options to purchase up to 40,000 shares
of Common Stock. Options granted pursuant to the Director's Plan are
immediately exercisable and expire on the earlier of the first anniversary of
the date on which a Director ceases to be a Director or ten years from the date
of grant. Each Independent Director was granted an option to purchase 1,000
Common shares at an exercise price of $17.71 per Common share on January 11,
1999, the date stockholders approved the plan. On January 1, 2000, 2001, 2002
and 2003, each Independent Director

72

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

was granted an option to purchase 1,000 Common shares at exercise prices of
$18.53, $13.625, $9.87 and $8.09 per Common share, respectively. Each
Independent Director will be awarded an option to purchase an additional 1,000
Common shares on January 1 of each year. At December 31, 2002, 6,000 options
were exercisable at prices ranging from $9.87 to $18.53 per Common share.

2002 2001 2000
------------------------ ------------------------ ------------------------
Number Number Number
of Shares Exercise Price of Shares Exercise Price of Shares Exercise Price
--------- -------------- --------- -------------- --------- --------------

Outstanding at
January 1,.. 183,750 $ 16.35-18.53 210,750 $16.35-18.53 300,250 $ 16.35-18.53
Granted....... 3,000 $ 9.87 5,000 $ 13.63 4,000 $ 18.53
Canceled...... (81,000) $ 13.63-18.53 (32,000) $16.35-18.53 (93,500) $ 16.35
------- ------- -------
Outstanding at
December 31, 105,750 $ 9.87-18.53 183,750 $13.63-18.53 210,750 $ 16.35-18.53
======= ======= =======

NOTE 14. ADVISORY AGREEMENT

Although the Board of Directors is directly responsible for managing the
affairs of ARI and for setting the policies which guide it, the day-to-day
operations of ARI are performed by BCM, a contractual advisor under the
supervision of the Board. The duties of the advisor include, among other
things, locating, investigating, evaluating and recommending real estate and
mortgage loan investment and sales opportunities as well as financing and
refinancing sources. BCM as advisor also serves as a consultant in connection
with the preparation of ARI's business plan and investment policy decisions
made by the Board.

BCM, an affiliate, has been providing advisory services to ARI or ART since
February 6, 1989. BCM is indirectly owned by a trust for the children of Gene
E. Phillips. Mr. Phillips is not an officer or director of BCM, but serves as a
representative of the trust, is involved in daily consultation with the
officers of BCM and has significant influence over the conduct of BCM's
business, including the rendering of advisory services and the making of
investment decisions for itself and for ARI.

The Advisory Agreement provides that BCM shall receive base compensation at
the rate of 0.0625% per month (0.75% on an annualized basis) of ARI's Average
Invested Assets.

In addition to base compensation, the Advisory Agreement provides that BCM,
or an affiliate of BCM, receive an acquisition fee for locating, leasing or
purchasing real estate for ARI's benefit; a disposition fee for the sale of
each equity investment in real estate; a loan arrangement fee; an incentive fee
equal to 10% of net income for the year in excess of a 10% return on
stockholders' equity, and 10% of the excess of net capital gains over net
capital losses, if any; and a mortgage placement fee, on mortgage loans
originated or purchased.

The Advisory Agreement further provides that BCM shall bear the cost of
certain expenses of its employees not directly identifiable to ARI's assets,
liabilities, operations, business or financial affairs; and miscellaneous
administrative expenses relating to the performance of its duties under the
Advisory Agreement.

If and to the extent that BCM or any director, officer, partner or employee
of BCM, shall be requested to render services to ARI other than those required
to be rendered by BCM under the Advisory Agreement, such additional services,
if performed, will be compensated separately on terms agreed upon between each
party from time to time.

The Advisory Agreement automatically renews from year to year unless
terminated in accordance with its terms. Management believes that the terms of
the Advisory Agreement are at least as fair as could be obtained from
unaffiliated third parties.

73

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 15. PROPERTY MANAGEMENT

Affiliates of BCM provided property management services to ARI. Currently,
Triad Realty Services, Ltd. ("Triad"), an affiliate, and Carmel Realty, Inc.
("Carmel") provide property management services to ARI's properties for a fee
of 5% or less of the monthly gross rents collected on the residential
properties under its management and 3% or less of the monthly gross rents
collected on the commercial properties under its management. Triad and Carmel
subcontract with other entities for property-level management services at
various rates. The general partner of Triad is BCM. The limited partner of
Triad is Highland Realty Services, Inc. ("Highland"), a related party. Until
December 2002, Triad subcontracted the property-level management and leasing of
12 of ARI's commercial properties (shopping centers, office buildings and a
merchandise mart) and eight of its hotels to Regis Realty, Inc. ("Regis"), a
related party, which was a company owned by GS Realty Services, Inc. ("GS
Realty"). Regis was entitled to receive property and construction management
fees and leasing commissions in accordance with the terms of its property-level
management agreement with Triad. Since January 1, 2003, Regis Realty I, LLC
("Regis I"), has provided these services. Regis I is owned by Highland. Regis
Hotel Corporation, a related party, managed ARI's eight hotels, until December
2002. Since January 1, 2003, Regis Hotel I, LLC, has managed ARI's eight
hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland. Carmel
is a company owned by First Equity Properties, Inc., which is a company
affiliated with BCM.

NOTE 16. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.

Fees and cost reimbursements to BCM and its affiliates were as follows:

2002 2001 2000
------ ------- -------

Fees
Advisory fee..................................... $5,899 $ 6,715 $ 5,049
Net income fee................................... -- 166 --
Incentive fee.................................... -- 3,827 1,646
Loan arrangement................................. 689 1,221 1,186
Brokerage commissions............................ -- -- 1,152
Property acquisition fees........................ 13 -- --
Property and construction management and leasing
commissions*................................... -- -- 1,385
------ ------- -------
$6,601 $11,929 $10,418
====== ======= =======
Cost reimbursements................................. $2,546 $ 2,845 $ 5,335
====== ======= =======

Fees paid to Triad, an affiliate, and GS Realty and Highland, related
parties:

2002 2001 2000
------- ------ ------

Fees
Real estate brokerage............... $ 5,322 $5,883 $5,777
Construction supervision fee........ 1,937 -- --
Property and construction management
and leasing commissions*............ 4,325 3,919 2,011
------- ------ ------
$11,584 $9,802 $7,788
======= ====== ======

- --------
* Net of property management fees paid to subcontractors, other than
affiliates of BCM.

74

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 17. INCOME TAXES

ARI had a loss for federal income tax purposes after the use of net
operating loss carryforwards in 2002 and losses for federal income tax purposes
for 2001 and 2000; therefore, it recorded no provision for income taxes. ARI's
tax basis in its net assets differs from the amount at which its net assets are
reported for financial statement purposes, principally due to the accounting
for gains and losses on property sales, the difference in the allowance for
estimated losses, depreciation on owned properties, and investments in equity
method real estate entities. At December 31, 2002, ARI's tax basis in its net
real and personal property assets was exceeded by their basis for financial
statement purposes by $19.2 million. This amount is more than offset by notes
payable and deferred revenue which have a financial statement basis that
exceeds their tax basis by $118.7 million. As a result, aggregate future income
for income tax purposes will be less than such amount for financial statement
purposes. Additionally, at December 31, 2002, ARI had carryforward capital and
net operating losses of $132.1 million expiring through the year 2021. Certain
of the net operating and capital loss carryforwards may be subject to
limitation under the current tax laws.

At December 31, 2002, ARI had a net deferred tax asset of $62.6 million due
to tax deductions available to it in future years. However, as management
cannot determine that it is more likely than not that ARI will realize the
benefit of the deferred tax asset, a 100% valuation allowance has been
established.

NOTE 18. RENTS UNDER OPERATING LEASES

ARI's operations include the leasing of commercial properties (office
buildings, shopping centers and a merchandise mart). The leases thereon expire
at various dates through 2012. The following is a schedule of minimum future
rents under non-cancelable operating leases as of December 31, 2002:

2003...... $11,498
2004...... 9,031
2005...... 7,184
2006...... 5,608
2007...... 3,587
Thereafter 7,170
-------
$44,078
=======

Milano Restaurants International, Inc. ("MRI") conducts its operations from
leased facilities which include office space, a warehouse, and 58 pizza parlor
locations for which a lease was signed and the pizza parlor was either open at
December 31, 2002 or scheduled to open thereafter. The leases expire over the
next 19 years. MRI also leases vehicles under operating leases.

The following is a schedule of minimum future rent commitments under
operating leases as of December 31, 2002:

2003...... $ 2,239
2004...... 2,140
2005...... 1,901
2006...... 1,623
2007...... 1,350
Thereafter 3,952
-------
$13,205
=======

Total facilities and automobile rent expense relating to these leases was
$2.5 million in 2002, $2.2 million in 2001 and $2.5 million in 2000.

75

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 19. OPERATING SEGMENTS

Significant differences among the accounting policies of the operating
segments as compared to the Consolidated Financial Statements principally
involve the calculation and allocation of administrative expenses. Management
evaluates the performance of each of the operating segments and allocates
resources to them based on their net operating income and cash flow. Items of
income that are not reflected in the segments are equity in loss of investees,
loss on sale of investments in equity investees, equity in gain on sale of real
estate by equity investees and other income which totaled $8.3 million in 2002,
$8.4 million in 2001 and $4.3 million in 2000. Expenses that are not reflected
in the segments are general and administrative expenses, minority interest,
incentive fees, advisory fees, net income fees, litigation settlement expenses,
provision for loss, writedown of assets held for sale and discontinued
operations, which totaled $29.0 million in 2002, $34.4 million in 2001 and
$66.9 million in 2000. Excluded from operating segment assets are assets of
$141.2 million in 2002, $118.7 million in 2001 and $97.8 million in 2000 which
are not identifiable with an operating segment. There are no intersegment
revenues and expenses and ARI conducted all of its business within the United
States, with the exception of Hotel Sofia (Bulgaria), which began operations in
2001 and Realty Advisors Korea, Ltd. (South Korea), which ARI acquired in 2002.
See NOTE 2. "REAL ESTATE" and NOTE 3. "NOTES AND INTEREST RECEIVABLE."

76

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Presented below is the operating income of each operating segment and each
segment's assets for 2002, 2001 and 2000.

Commercial Receivables/
Properties Apartments Hotels Land MRI Other Total
---------- ---------- ------- -------- ------- ------------ --------

2002
Operating revenue............. $ 27,952 $ 29,080 $31,690 $ 575 $36,741 $ 246 $126,284
Interest income............... -- -- -- -- -- 3,145 3,145
Operating expenses............ 17,842 19,141 23,893 6,001 29,991 824 97,692
-------- -------- ------- -------- ------- ------- --------
Operating income (loss)....... $ 10,110 $ 9,939 $ 7,797 $ (5,426) $ 6,750 $ 2,567 $ 31,737
======== ======== ======= ======== ======= ======= ========
Depreciation and amortization. $ 4,523 $ 2,257 $ 2,148 $ -- $ 1,267 $ 39 $ 10,234
Interest...................... 11,235 10,258 4,337 20,828 840 10,191 57,689
Capital expenditures.......... 15,567 16,203 832 1,733 2,869 -- 37,204
Assets........................ 135,750 92,322 90,540 145,145 21,912 82,133 567,802

Commercial
Properties Apartments Land Total
---------- ---------- -------- --------
Property Sales
Sales price................... $ 63,524 $ 79,800 $127,750 $271,074
Cost of sales................. 52,690 42,579 75,718 170,987
Deferred current gain......... 5,320 8,942 36,135 50,397
Recognized prior deferred gain -- -- 830 830
-------- -------- -------- --------
Gains on sale................. $ 5,514 $ 28,279 $ 16,727 $ 50,520
======== ======== ======== ========

Commercial Receivables/
Properties Apartments Hotels Land MRI Other Total
---------- ---------- ------- -------- ------- ------------ --------
2001
Operating revenue............. $ 27,765 $ 41,214 $31,999 $ 253 $34,211 $ 696 $136,138
Interest income............... -- -- -- -- -- 2,817 2,817
Operating expenses............ 15,906 26,262 25,243 8,577 27,934 629 104,551
-------- -------- ------- -------- ------- ------- --------
Operating income (loss)....... $ 11,859 $ 14,952 $ 6,756 $ (8,324) $ 6,277 $ 2,884 $ 34,404
======== ======== ======= ======== ======= ======= ========
Depreciation and amortization. $ 4,904 $ 2,952 $ 2,575 $ -- $ 1,320 $ 10 $ 11,761
Interest...................... 10,798 13,876 4,483 28,885 940 6,063 65,045
Capital expenditures.......... 9,838 166 7,754 1,823 1,493 511 21,585
Assets........................ 172,712 111,008 89,940 214,543 20,976 30,872 640,051

Commercial
Properties Apartments Land Total
---------- ---------- -------- --------
Property Sales
Sales price................... $ 7,350 $128,580 $ 51,841 $187,771
Cost of sales................. 5,118 52,996 45,348 103,462
Deferred current gain......... -- -- 895 895
-------- -------- -------- --------
Gains on sale................. $ 2,232 $ 75,584 $ 5,598 $ 83,414
======== ======== ======== ========

77

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Commercial Receivables/
Properties Apartments Hotels Land MRI Other Total
---------- ---------- ------- -------- ------- ------------ --------

2000
Operating revenue............ $ 28,696 $ 54,977 $33,134 $ 296 $32,551 $ 3,506 $153,160
Interest income.............. -- -- -- -- -- 2,965 2,965
Operating expenses........... 16,143 31,344 24,127 9,727 26,767 22 108,130
-------- -------- ------- -------- ------- ------- --------
Operating income (loss)...... $ 12,553 $ 23,633 $ 9,007 $ (9,431) $ 5,784 $ 6,449 $ 47,995
======== ======== ======= ======== ======= ======= ========
Depreciation and amortization $ 4,403 $ 4,501 $ 2,707 $ -- $ 1,330 $ 5 $ 12,946
Interest..................... 11,607 15,356 4,837 26,389 1,135 7,157 66,481
Capital expenditures......... 5,309 7,518 979 2,076 1,087 -- 16,969
Assets....................... 165,781 147,070 97,682 242,969 21,679 14,073 689,254

Commercial
Properties Apartments Land Total
---------- ---------- -------- --------
Property Sales
Sales price.................. $ 37,516 $ 72,700 $119,384 $229,600
Cost of sales................ 15,652 26,837 90,383 132,872
-------- -------- -------- --------
Gains on sale................ $ 21,864 $ 45,863 $ 29,001 $ 96,728
======== ======== ======== ========

NOTE 20. DISCONTINUED OPERATIONS

Effective January 1, 2002, ARI adopted Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," which established a single accounting model for the impairment or
disposal of long-lived assets, including discontinued operations. This
statement requires that the operations related to properties that have been
sold or properties that are intended to be sold be presented as discontinued
operations in the statement of operations for all periods presented, and
properties intended to be sold are to be designated as "held-for-sale" on the
balance sheet.

For 2002, 2001 and 2000, income (loss) from discontinued operations relates
to 23 properties and leasehold interests in oil and gas properties that ARI
sold during 2002 and eight properties that ARI sold during 2003 that are
classified as held-for-sale at December 31, 2002. The following table
summarizes revenue and expense information for these properties sold and
held-for-sale.

2002 2001 2000
------- ------- -------

Revenue
Rental.................................................... $21,346 $27,432 $17,551
Property operations....................................... 13,405 16,837 12,718
------- ------- -------
7,941 10,595 4,833
Expenses
Interest.................................................. 8,144 12,003 10,221
Depreciation.............................................. 4,011 5,946 3,933
------- ------- -------
12,155 17,949 14,154
Net loss from discontinued operations........................ (4,214) (7,354) (9,321)
Gain on sale of real estate............................... 31,706 -- --
Equity in gain on sale of real estate by equity investees. 24,069 -- --
------- ------- -------
Net income (loss) from discontinued operations............... $51,561 $(7,354) $(9,321)
======= ======= =======

78

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Discontinued operations have not been segregated in the consolidated
statements of cash flows. Therefore, amounts for certain captions will not
agree with respective consolidated statements of operations.

NOTE 21. QUARTERLY RESULTS OF OPERATIONS

The following is a tabulation of quarterly results of operations for the
years 2002 and 2001 (unaudited):

Three Months Ended
---------------------------------------------
March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------

2002
Operating income......................................... $ 5,650 $ 5,469 $ 6,740 $ 3,983
Gain on land sales....................................... 2,199 1,164 2,618 10,746
Pizza parlor gross margin................................ 1,587 1,942 1,629 1,592
-------- -------- --------- ---------
Income from operations................................... 9,436 8,575 10,987 16,321
Equity in loss of investees.............................. (4,012) (5,221) (4,790) (6,891)
Loss on sale of investments in equity investees.......... (531) -- -- 245
Interest and other income................................ 796 927 699 6,168
-------- -------- --------- ---------
Total other income....................................... (3,747) (4,294) (4,091) (478)
Total other expenses..................................... 23,502 23,362 21,587 24,283
-------- -------- --------- ---------
Net loss from continuing operations...................... (17,813) (19,081) (14,691) (8,440)
Discontinued operations:
Loss from operations..................................... (870) (1,856) (402) (1,086)
Gain on sale of real estate.............................. 5,615 2,150 15,375 8,566
Equity in gain on sale of real estate by equity investees 4,131 4,149 6,616 9,173
-------- -------- --------- ---------
Net income from discontinued operations.................. 8,876 4,443 21,589 16,653
Net income (loss)........................................ (8,937) (14,638) 6,898 8,213
Preferred dividend requirement........................... (611) (589) (601) (600)
-------- -------- --------- ---------
Net income (loss) attributable to Common shares.......... $ (9,548) $(15,227) $ 6,297 $ 7,613
======== ======== ========= =========

Earnings per share
Net income (loss) from continuing operations............. $ (1.62) $ (1.73) $ (1.34) $ (.80)
Discontinued operations.................................. .78 .39 1.90 1.46
-------- -------- --------- ---------
Net income (loss) attributable to Common shares.......... $ (.84) $ (1.34) $ .56 $ .66
======== ======== ========= =========

79

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Three Months Ended
--------------------------------------------
March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------

2001
Operating income.......................................... $ 7,776 $ 4,538 $ 8,071 $ 4,925
Gain (loss) on land sales................................. 3,789 924 3,547 (2,662)
Pizza parlor gross margin................................. 1,404 1,604 1,559 1,710
------- ------- ------- -------
Income from operations.................................... 12,969 7,066 13,177 3,973
Equity in (loss) of investees............................. (1,447) (3,841) (3,137) (4,927)
Gain on sale of real estate............................... 16,426 25,840 12,334 23,216
Equity in gains on sale of real estate by equity investees 1,442 9,938 6,589 4,573
Loss on sale of investments in equity investees........... -- (387) -- --
Interest and other income................................. 417 820 818 393
------- ------- ------- -------
Total other income........................................ 16,838 32,370 16,604 23,255
Total other expenses...................................... 25,657 29,577 25,735 22,860
------- ------- ------- -------
Net income from continuing operations..................... 4,150 9,859 4,046 4,368
Loss from discontinued operations......................... (1,760) (1,326) (2,980) (1,288)
Net income................................................ 2,390 8,533 1,066 3,080
Preferred dividend requirement............................ (642) (606) (620) (617)
------- ------- ------- -------
Net income attributable to Common shares.................. $ 1,748 $ 7,927 $ 446 $ 2,463
======= ======= ======= =======
Earnings per share
Net income from continuing operations..................... $ .30 $ .79 $ .29 $ .32
Discontinued operations................................... (.15) (.11) (.26) (.11)
------- ------- ------- -------
Net income attributable to Common shares.................. $ .15 $ .68 $ .03 $ .21
======= ======= ======= =======

NOTE 22. DERIVATIVE FINANCIAL INSTRUMENTS

During the first quarter of 2002, ARI entered into an interest rate swap
agreement with a bank. This agreement contained a notional amount of $13.1
million and required ARI to pay the bank a fixed rate of 4.3%, and required the
bank to pay to ARI based on the 30 day LIBOR rate. This agreement was entered
into in order to effectively fix the rate on ARI's debt associated with the
Lakeshore Villas property. The swap agreement expires on December 25, 2004.

ARI did not designate the interest rate swap agreement as a hedge, as
defined within Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities," and, as such, changes in
the fair value of the swap agreement were recognized in earnings during the
period of change and reflected in the statement of operations as interest
expense.

Amounts paid or received under the swap agreement were settled monthly and
were reflected as a reduction in the liability when paid. Interest expense for
2002 was increased by $912,000, representing both amounts paid to the bank
under the agreement and changes in the fair value of the related liability.

In December 2002, ARI sold the Lakeshore Villas property to Housing for
Seniors of Humble, LLC, a related party. See NOTE 2. "REAL ESTATE." The swap
agreement was assumed by the purchaser.

80

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 23. COMMITMENTS AND CONTINGENCIES AND LIQUIDITY

Liquidity. Although management anticipated that ARI would generate excess
cash from operations in 2002, such excess cash did not materialize and,
therefore, was not sufficient to discharge all of ARI's debt obligations as
they became due. ARI relied on additional borrowings, and sales of land and
income producing properties to meet its cash requirements. In 2003, ARI will
rely on aggressive land sales, selected income producing property sales and, to
the extent necessary, additional borrowings to meet its cash requirements.

Commitments. In March 1999, an agreement was reached with the Class A
unitholders of Valley Ranch, L.P. to acquire their eight million Class A units
for $1.00 per unit. In 1999, three million units were purchased. Additionally
one million units were purchased in January 2000 and two million units were
purchased in May 2001. ARI purchased the remaining two million units in 2002.
See NOTE 11. "PREFERRED STOCK."

On October 3, 2000, ARI and IORI entered into an agreement which provided
IORI and ARI with an option to purchase 1,858,900 shares of common stock of TCI
from a third party. On October 19, 2000, IORI assigned all of its rights to
purchase such shares to ARI. The total cost to purchase the TCI shares was
$30.8 million. In October 2000, ARI paid $5.6 million of the option price. In
April 2001, the remainder of the option price was paid, and ARI acquired the
TCI shares.

During 2002, MRI sold two restaurants to a corporation owned in part by an
officer of MRI. In conjunction with the sale of these restaurants, MRI
guaranteed the bank debt incurred by the related party. The guaranty applies to
all current debt, and to all future debt of the related party until such time
as the guaranty is terminated by MRI. The amount of the debt outstanding that
is subject to the guaranty is $1,250,000 at December 31, 2002.

Litigation. In August 2002, ARI obtained a favorable jury verdict in the
legal action entitled American Realty Trust v. Matisse Partners, L.L.C.
("Matisse"). However, the judge set aside the jury verdict and imposed a
judgment against ARI in excess of $6.0 million. The judgment is being appealed,
and, in the opinion of ARI's management and legal counsel, there is a
reasonable probability that the adverse judgment will be set aside and the jury
verdict reinstated. Therefore, ARI has not recognized any expense nor
established any reserve for this judgment. In November 2002, ARI posted a $6.0
million supercedeas bond. In April 2003, an additional judgment was issued
against ARI for $1.2 million in legal fees. ARI will also appeal this judgment
and will post an additional bond in this amount.

In addition to Matisse, ARI is involved in various lawsuits arising in the
ordinary course of business. In the opinion of management the outcome of these
lawsuits will not have a material impact on ARI's financial condition, results
of operations or liquidity.

NOTE 24. GOODWILL AND OTHER INTANGIBLES--ADOPTION OF SFAS 142

In June 2001, the Financial Accounting Standards Board finalized Statement
of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS
141"), and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS
141 requires the use of the purchase method of accounting and prohibits the use
of the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS 141 also requires that ARI recognize
acquired intangible assets apart from goodwill if the acquired intangible
assets meet certain criteria. SFAS 141 applies to all business combinations
initiated after June 30, 2001. It also requires, upon adoption of SFAS 142,
that ARI reclassify the carrying amounts of intangible assets and goodwill
based on the criteria in SFAS 141.

SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that ARI identify reporting units in order to
assess potential future impairment of goodwill, reassess the useful lives of
other existing recognized

81

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

intangible assets, and cease amortization of intangible assets with an
indefinite useful life. SFAS 142 requires that an intangible asset with an
indefinite useful life be tested for impairment in accordance with specified
guidelines. SFAS 142 is required to be applied in fiscal years beginning after
December 15, 2001 to all goodwill and other intangible assets recognized at
that date, regardless of when those assets were initially recognized. SFAS 142
required ARI to complete a transitional goodwill impairment test six months
from the date of adoption. ARI was also required to reassess the useful lives
of other intangible assets within the first interim quarter after adoption of
SFAS 142.

The adoption of SFAS 141 did not have a material impact on ARI's results of
operations and financial position. ARI adopted SFAS 142 on January 1, 2002, and
accordingly ceased amortizing costs in excess of net assets acquired. In
connection with the adoption of SFAS 142, ARI completed the first step of the
goodwill impairment test during the quarter ended June 30, 2002. Based on the
results of this step, ARI believes that the fair value of its reporting unit
that carries goodwill exceeds its carrying amount. Since the first step of the
goodwill impairment test indicates that goodwill is not impaired, the second
step of the goodwill impairment test is not necessary.

Transitional Disclosures. Net income (loss) and earnings per share,
including the after-tax effect of amortization expense related to costs in
excess of net assets acquired for 2002, 2001 and 2000 are as follows:

2002 2001 2000
------- ------- ------

Net income (loss)......................................... $(8,464) $15,069 $2,679
Add back:
Amortization of costs in excess of net assets acquired. -- 344 340
------- ------- ------
Adjusted net income (loss) applicable to Common shares. $(8,464) $14,725 $2,339
======= ======= ======

Earnings per share:
Net income (loss)...................................... $ (.74) $ 1.29 $ 26
Amortization of costs in excess of net assets acquired. -- .03 .03
------- ------- ------
Adjusted net income (loss) applicable to Common shares. $ (.74) $ 1.26 $ 23
======= ======= ======

Acquisitions. On June 30, 2002, ARI acquired RAK from BCM, a related party,
for $6.0 million. ARI recorded $1.9 million in goodwill as a result of this
transaction. See NOTE 10. "RELATED PARTY TRANSACTIONS." ARI made no
acquisitions resulting in goodwill during 2001.

82

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

NOTE 25. SUBSEQUENT EVENTS

In 2003, ARI sold the following property:

Net Cash
Units/Sq. Ft./ Sales Received/ Debt Gain
Property Location Acres/Rooms Price (Paid) Discharged on Sale
-------- --------------- -------------- ------- --------- ---------- -------

Apartments
Bay Anchor....... Panama City, FL 12 Units $ 369 $ 36 $ 255 $ 139
Georgetown....... Panama City, FL 44 Units 1,175 323 789 76
Northside Villas. Tallahassee, FL 81 Units 5,575 1,806 2,784 547
Rolling Hills.... Tallahassee, FL 134 Units 5,061 1,361 2,785 1,189
Seville.......... Tallahassee, FL 62 Units 2,795 405 1,955 489

Shopping Centers
Bridgeview Plaza. LaCrosse, WI 116,008 Sq.Ft. 8,700 -- -- 8,700/(1)/
Cullman.......... Cullman, AL 92,466 Sq.Ft. 2,000 -- 2,650 1,118/(1)/

Land
Katrina.......... Palm Desert, CA 89.3 Acres 8,550 (240) 2,840 --

Hotels
Grand Hotel Sofia Sofia, Bulgaria 136 Rooms 24,750 6,258 4,209 3,304

- --------
(1) Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.

In 2003, ARI financed/refinanced or obtained second mortgage financing on
the following:

Net Cash
Units/ Debt Debt Received/ Interest Maturity
Property Location Acres/Sq.Ft. Incurred Discharged (Paid) Rate Date
-------- ------------------ ------------ -------- ---------- --------- -------- --------

Land
Elm Fork.... Denton County, TX 101.0 Acres $5,000 $1,551 $2,935 10.750% 03/04
Nashville... Nashville, TN 113.8 Acres 6,059 807 4,734 14.000 03/04
Vineyards II Tarrant County, TX 18.6 Acres 3,280 3,750 (583) 6.750/(1)/ 02/06

- --------
(1) Variable interest rate.

In March 2003, ARI sold three mortgage notes receivable, with a balance of
$27.5 million, to a financial institution. The sales price was $26.4 million,
representing a discount of 4% from the original balance, plus accrued but
unpaid interest. ARI received $17.5 million in cash, after debt paydown of
$11.9 million.

Notes receivable. In March 2003, ARI sold the Grand Hotel Sofia for $24.8
million, receiving $6.3 million in cash after paying closing costs and debt
assumption and providing purchase money financing of $13.5 million. The loan is
non-interest-bearing for 90 days, then bears interest at 9.0% per annum for the
next 90 days and matures in September 2003. The purchaser has the right to
extend the note at 9.0% per annum for an additional 90 days by providing notice
of intent at least 15 days prior to maturity and paying a 1.5% extension fee on
the unpaid principal balance. After the 90 day interest-free period, monthly
interest payments are required.

Also in March 2003, ARI sold an 89.3 acre tract of its Katrina land parcel
for $8.5 million, paying $410,000 after payment of closing costs and debt
paydown and providing purchase money financing of $5.6 million. The note bears
interest at 8.0% per annum and matures three years after the recording of the
Deed of Trust. Interest begins accruing after improvements to the site have
been completed by ARI. The future costs to ARI to complete

83

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

the improvements are estimated to be $2.5 million. A principal payment of
$450,000 is due within ten days after a Tentative Parcel Map is recorded.
Interest payments will be due on the first day of each calendar quarter,
beginning with the first quarter following the completion of the site
improvements.

On November 15, 2002, ARI commenced a tender offer for the IORI and TCI
shares. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash
per IORI share and $17.50 cash per TCI share for the stock held by
non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036
IORI shares and 1,213,226 TCI shares. The completion of the tender offer
fulfills the obligations under the Olive Settlement, and the Olive Litigation
has been dismissed with prejudice. After the tender offer, ARI owned 64.8% of
the outstanding shares of TCI and 46.9% of the outstanding shares of IORI.

In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in
LaCrosse, Wisconsin, providing purchase money financing of $5.0 million in the
form of a wrap mortgage. In 1996, the first lienholder called a default under
the ARI wrap note, and directed future payments be made directly to them. ARI
began legal proceedings against the first lienholder. In December 1999, ARI
sold the note to BCM at its carrying value of $489,000, retaining the right to
receive any amounts collected by BCM in excess of the amount paid, plus accrued
interest. In 2002, ARI prevailed in its litigation and ARI's lien on the
property was restored. The borrower continued in default, and ARI foreclosed on
the property in March 2003.

84

SCHEDULE III

AMERICAN REALTY INVESTORS, INC.

REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2002

Cost
Capitalized
Subsequent to Gross Amounts of Which
Initial Cost Acquisition Carried at End of Year Accumu-
----------------- ------------- ------------------------- lated Date of
Encum- Building & Improve- Building & (1) Depreci- Construc-
Property/Location brances Land Improvements ments Other Land Improvements Total ation tion
- ----------------- ------- ---- ------------ -------- ----- ---- ------------ ------- -------- ---------
(dollars in thousands)

Operating Properties
Apartments
Arlington Place, Pasadena, TX......... $ 4,193 $330 $ 3,275 $ 752 $398/(4)/ $330 $ 4,425 $ 4,755 $3,273 1973
Bay Anchor, Panama City, FL........... 255 13 107 -- -- 13 107 120 2 1979
Bridgestone, Friendswood, TX.......... 2,061 169 1,780 192 227/(4/) 169 2,199 2,368 1,338 1979
Chateau, Bellevue, NE................. 3,305 130 1,723 141 270/(4)/ 130 2,134 2,264 1,313 1968
Chateau Bayou, Ocean Springs, MS...... 3,879 591 2,364 -- -- 591 2,364 2,955 286 1973
Confederate Point, Jacksonville, FL... 9,228 246 3,736 717 466/(4)/ 246 4,919 5,165 3,424 1969
Falcon House, Ft. Walton, FL.......... 1,989 219 1,817 -- -- 219 1,817 2,036 41 1969
Foxwood, Memphis, TN.................. 6,892 218 3,188 950 743/(4)/ 218 4,881 5,099 3,077 1974
Georgetown, Panama City, FL........... 794 114 948 -- -- 114 948 1,062 21 1974
Governor Square, Tallahassee, FL...... 4,458 245 2,207 -- -- 245 2,207 2,452 93 1974
Greenbriar, Tallahassee, FL........... 989 56 510 -- -- 56 510 566 -- 1985
La Mirada, Jacksonville, FL........... 7,302 392 5,454 1,675 649/(4)/ 392 7,778 8,170 5,436 1971
Lake Chateau, Thomasville, GA......... 1,050 153 1,275 -- -- 153 1,275 1,428 29 1972
Landings/Marina, Pensacola, FL........ 1,171 139 792 -- -- 139 792 931 26 1979
Marquis of Vista Ridge, Lewisville, TX 14,674 -- 16,331 15 -- -- 16,346 16,346 -- 2002
Mediterranean Villas, San Antonio, TX. 2,788 712 2,848 -- -- 712 2,848 3,560 344 1967
Northside Villas, Tallahassee, FL..... 2,792 414 3,864 -- -- 414 3,864 4,278 78 1973
Oak Tree, Grandview, MO............... 4,041 304 3,543 245 418/(4)/ 304 4,206 4,510 2,325 1968
Park Avenue, Tallahassee, FL.......... 4,378 172 1,550 -- -- /(4)/ 172 1,550 1,722 63 1985
Pinecrest, North Augusta, SC.......... 1,443 298 2,681 -- -- 298 2,681 2,979 39 1971
Quail Point, Huntsville, AL........... 3,655 184 2,716 267 217/(4)/ 184 3,200 3,384 2,465 1960
Regency, Lincoln, NE.................. 3,197 304 1,865 412 328/(4)/ 304 2,605 2,909 1,553 1973
Rolling Hills, Tallahassee, FL........ 2,791 335 2,768 45 -- 335 2,813 3,148 68 1972
Seville, Tallahassee, FL.............. 1,955 187 1,558 -- -- 187 1,558 1,745 32 1972
Sun Hollow, El Paso, TX............... 4,509 385 4,159 75 503/(4)/ 385 4,737 5,122 3,001 1977
Sunset, Odessa, TX.................... 1,767 345 1,383 -- -- 345 1,383 1,728 167 1981
Tiberon Trails, Merrillville, IN...... 6,353 667 11,669 -- -- 667 11,669 12,336 170 1975
Villa Del Mar, Wichita, KS............ 3,622 387 3,134 116 546/(4)/ 387 3,796 4,183 2,188 1971
Villager, Ft. Walton, FL.............. 522 125 1,146 -- -- 125 1,146 1,271 23 1972
Waters Edge III, Gulfport, MS......... 7,387 331 1,324 (14) -- 331 1,310 1,641 149 1968
Westwood, Mary Ester, FL.............. 3,515 149 1,338 -- -- 149 1,338 1,487 54 1972

Life on
Which
Depreciation
In Latest
Statement of
Date Operation
Property/Location Acquired is Computed
- ----------------- -------- ------------

Operating Properties
Apartments
Arlington Place, Pasadena, TX......... 11/76 10-40 years
Bay Anchor, Panama City, FL........... 03/02 7-40 years
Bridgestone, Friendswood, TX.......... 06/82 5-40 years
Chateau, Bellevue, NE................. 02/81 5-40 years
Chateau Bayou, Ocean Springs, MS...... 03/02 10-40 years
Confederate Point, Jacksonville, FL... 05/79 7-40 years
Falcon House, Ft. Walton, FL.......... 03/02 10-40 years
Foxwood, Memphis, TN.................. 08/79 7-40 years
Georgetown, Panama City, FL........... 03/02 7-40 years
Governor Square, Tallahassee, FL...... 03/02 10-40 years
Greenbriar, Tallahassee, FL........... 03/02 7-40 years
La Mirada, Jacksonville, FL........... 01/79 10-40 years
Lake Chateau, Thomasville, GA......... 03/02 7-40 years
Landings/Marina, Pensacola, FL........ 03/02 7-40 years
Marquis of Vista Ridge, Lewisville, TX 2002 N/A
Mediterranean Villas, San Antonio, TX. 1998 10-40 years
Northside Villas, Tallahassee, FL..... 03/02 10-40 years
Oak Tree, Grandview, MO............... 03/82 7-40 years
Park Avenue, Tallahassee, FL.......... 03/02 10-40 years
Pinecrest, North Augusta, SC.......... 07/02 7-40 years
Quail Point, Huntsville, AL........... 08/75 7-40 years
Regency, Lincoln, NE.................. 05/82 7-40 years
Rolling Hills, Tallahassee, FL........ 03/02 10-40 years
Seville, Tallahassee, FL.............. 03/02 10-40 years
Sun Hollow, El Paso, TX............... 09/79 7-40 years
Sunset, Odessa, TX.................... 03/02 10-40 years
Tiberon Trails, Merrillville, IN...... 07/02 7-40 years
Villa Del Mar, Wichita, KS............ 10/81 7-40 years
Villager, Ft. Walton, FL.............. 03/02 10-40 years
Waters Edge III, Gulfport, MS......... 1998 10-40 years
Westwood, Mary Ester, FL.............. 03/02 10-40 years

85

SCHEDULE III
(Continued)

AMERICAN REALTY INVESTORS, INC.

REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2002

Cost
Capitalized
Subsequent to Gross Amounts of Which
Initial Cost Acquisition Carried at End of Year Accumu-
------------------- ---------------- --------------------------- lated
Encum- Building & Improve- Building & (1) Depreci-
Property/Location brances Land Improvements ments Other Land Improvements Total ation
- ----------------- ------- ------ ------------ -------- ------- ------ ------------ ------- --------
(dollars in thousands)

Operating Properties--(Continued)
Apartments--(Continued)
Whispering Pines, Topeka, KS........... $ 7,387 $ 228 $ 4,331 $ 1,054 $ 653/(4)/ $ 228 $ 6,038 $ 6,266 $3,958
Windsor Tower, Ocala, FL............... 1,989 225 1,863 -- -- 225 1,863 2,088 38
Wood Hollow, San Antonio, TX........... 8,122 888 10,079 -- -- 888 10,079 10,967 7,062
Woodlake, Carrollton, TX............... 8,448 585 5,848 1,041 785/(4)/ 585 7,674 8,259 4,833
Office Building
56 Expressway, Oklahoma City, OK....... 1,541 406 3,976 655 (2,365)/(2)/ 406 2,014 2,420 2,061
(252)/(4)/
Cooley Building, Farmers Branch, TX.... 1,849 729 2,918 124 (307)/(4)/ 729 2,735 3,464 394
Encino, Encino, CA..................... 33,375 4,072 36,651 593 845 4,072 38,089 42,161 3,604
Executive Court, Memphis, TN........... 1,598 271 2,099 749 (6) 271 2,842 3,113 1,976
Five Hickory, Farmers Branch, TX....... -- -- -- 38 -- -- 38 38 --
Four Hickory Centre, Farmers Branch, TX 19,004 303 11,894 14,768 (689) 303 25,973 26,276 --
One Hickory Centre, Farmers Branch, TX. 11,909 335 7,651 3,549 -- 335 11,200 11,535 1,847
Two Hickory Centre, Farmers Branch, TX. 10,660 318 7,827 1,364 -- 318 9,191 9,509 953
University Square, Anchorage, AK....... 1,947 562 3,276 227 (1,881)/(2)/ 562 1,570 2,132 1,503
(52)/(4)/
Shopping Centers
Collection, Denver, CO................. 13,640 -- 20,791 321 (461) -- 20,651 20,651 2,824
Cross County Mall, Mattoon, IL......... 7,770 608 6,468 6,490 (810)/(4)/ 608 12,148 12,756 9,779
Cullman, Cullman, AL................... -- 400 1,830 256 (110)/(4)/ 400 1,976 2,376 1,482
Plaza on Bachman Creek, Dallas, TX..... 4,948 466 2,898 145 -- 466 3,043 3,509 127
Westwood, Tallahassee, FL.............. 4,788 1,172 6,338 109 (1,656)/(4)/ 1,172 4,791 5,963 4,138
Merchandise Mart
Denver Mart, Denver, CO................ 27,960 4,824 5,184 16,203 20 4,824 21,407 26,231 5,967

Hotels
Best Western Hotel, Virginia Beach, VA. 4,061 1,521 5,754 1,259 -- 1,521 7,013 8,534 1,553
Chateau Inn, Fresno, CA................ 2,074 -- 3,906 74 (33) -- 3,947 3,947 566
Clarion KC Airport, Kansas City, MO.... 4,955 1,110 4,535 3,161 -- 1,110 7,696 8,806 3,529

Life on
Which
Depreciation
In Latest
Date of Statement of
Construc- Date Operation
Property/Location tion Acquired is Computed
- ----------------- --------- -------- ------------

Operating Properties--(Continued)
Apartments--(Continued)
Whispering Pines, Topeka, KS........... 1972 02/78 7-40 years
Windsor Tower, Ocala, FL............... 1982 03/02 10-40 years
Wood Hollow, San Antonio, TX........... 1974 11/78 5-40 years
Woodlake, Carrollton, TX............... 1979 08/78 7-40 years
Office Building
56 Expressway, Oklahoma City, OK....... 1981 03/82 7-40 years

Cooley Building, Farmers Branch, TX.... 1996 1999 7-40 years
Encino, Encino, CA..................... 1986 05/99 7-40 years
Executive Court, Memphis, TN........... 1980 09/82 7-40 years
Five Hickory, Farmers Branch, TX.......
Four Hickory Centre, Farmers Branch, TX 2002 2002 7-40 years
One Hickory Centre, Farmers Branch, TX. 1998 1998 10-40 years
Two Hickory Centre, Farmers Branch, TX. 2000 2000 7-40 years
University Square, Anchorage, AK....... 1981 12/81 5-40 years

Shopping Centers
Collection, Denver, CO................. 1955 1997 10-40 years
Cross County Mall, Mattoon, IL......... 1971 08/79 5-40 years
Cullman, Cullman, AL................... 1979 02/79 7-40 years
Plaza on Bachman Creek, Dallas, TX.....
Westwood, Tallahassee, FL.............. 1980 10/83 5-40 years
Merchandise Mart
Denver Mart, Denver, CO................ 1965/ 1992 10-40 years
1986
Hotels
Best Western Hotel, Virginia Beach, VA. 1983 1996 10-40 years
Chateau Inn, Fresno, CA................ 1989 1997 10-40 years
Clarion KC Airport, Kansas City, MO.... 1974 1993 10-40 years

86

SCHEDULE III
(Continued)

AMERICAN REALTY INVESTORS, INC.

REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2002

Cost
Capitalized
Subsequent to Gross Amounts of Which
Initial Cost Acquisition Carried at End of Year
-------------------- ----------------- -----------------------------
Encum- Building & Improve- Building & (1)
Property/Location brances Land Improvements ments Other Land Improvements Total
- ----------------- -------- ------- ------------ -------- -------- ------- ------------ --------
(dollars in thousands)

Operating Properties--(Continued)
Hotels--(Continued)
Grand Hotel, Sofia, Bulgaria..... $ 4,712 $ 140 $ 11,884 $14,512 $ 1,862/(7)/ $ 140 $ 28,258 $ 28,398
Piccadilly Airport, Fresno, CA... 4,929 -- 7,834 490 -- -- 8,324 8,324
Piccadilly Shaw, Fresno, CA...... 5,723 2,392 9,567 958 -- 2,392 10,525 12,917
Piccadilly University, Fresno, CA 5,566 -- 12,011 297 (163) -- 12,145 12,145
Quality Inn, Denver, CO.......... 3,685 -- 302 2,512 -- -- 2,814 2,814
Williamsburg Hospitality House,
Williamsburg, VA............... 12,333 4,049 16,195 2,416 -- 4,049 18,611 22,660
Realty Advisors, Korea........... -- -- 49 -- -- -- 49 49
Single Family Residence
Tavel Circle, Dallas, TX......... 82 53 214 -- -- 53 214 267
-------- ------- -------- ------- -------- ------- -------- --------
332,010 33,971 307,226 78,953 145 33,971 386,324 420,295
Land Properties
Bonneau, Dallas County, TX....... -- /(6)/ 1,102 -- -- -- 1,102 -- 1,102
Chase Oaks, Plano, TX............ 1,633 4,511 -- 377 (3,898)/(4)/ 990 -- 990
Croslin, Dallas, TX.............. -- 327 -- 6 -- 333 -- 333
Dalho, Farmers Branch, TX........ -- /(6)/ 331 -- -- -- 331 -- 331
Elm Fork, Denton County, TX...... -- 17,294 -- 178 (7,555)/(3)/ 6,991 -- 6,991
(2,926)/(3)/
FRWM Cummings, Farmers Branch, TX -- 1,284 -- -- -- 1,284 -- 1,284
HSM, Farmers Branch, TX.......... 2,937 2,361 -- -- -- 2,361 -- 2,361
Jeffries Ranch, Oceanside, CA.... 2,650 1,178 -- -- -- 1,178 -- 1,178
JHL Connell, Carrollton, TX...... -- /(6)/ 1,451 -- -- (25)/(3)/ 1,426 -- 1,426
Katrina, Palm Desert, CA......... 11,530 40,211 -- 1,213 (11,939)/(3)/ 19,501 -- 19,501
(8,792)/(3)/
(1,192)/(2)/
Katy Road, Harris County, TX..... 4,250 5,919 -- 20 -- 5,919 20 5,939
Keller, Tarrant County, TX....... -- /(6)/ 6,847 -- 376 (6,593)/(3)/ 254 376 630
Kelly Lots, Collin County, TX.... 82 131 -- -- -- 131 -- 131
Lacy Longhorn, Farmers Branch, TX 6,300/(6)/ 1,908 -- -- -- 1,908 -- 1,908
Las Colinas I, Las Colinas, TX... 4,550 14,076 -- 28 (4,420)/(3)/ 9,684 -- 9,684
Leone, Irving TX................. 1,210 1,625 -- -- -- 1,625 -- 1,625

Life on
Which
Depreciation
Accumu- In Latest
lated Date of Statement of
Depreci- Construc- Date Operation
Property/Location ation tion Acquired is Computed
- ----------------- -------- --------- -------- ------------

Operating Properties--(Continued)
Hotels--(Continued)
Grand Hotel, Sofia, Bulgaria..... $ 3,962 1969 09/00 10-40 years
Piccadilly Airport, Fresno, CA... 1,262 1970 1997 10-40 years
Piccadilly Shaw, Fresno, CA...... 1,586 1973 1997 10-40 years
Piccadilly University, Fresno, CA 1,682 1984 1997 10-40 years
Quality Inn, Denver, CO.......... 522 1974 1994 10-40 years
Williamsburg Hospitality House,
Williamsburg, VA............... 3,346 1973 1997 10-40 years
Realty Advisors, Korea........... 12
Single Family Residence
Tavel Circle, Dallas, TX......... 36
--------
101,680
Land Properties
Bonneau, Dallas County, TX....... -- N/A 1998 --
Chase Oaks, Plano, TX............ -- N/A 1997 --
Croslin, Dallas, TX.............. -- N/A 1998 --
Dalho, Farmers Branch, TX........ -- N/A 1997 --
Elm Fork, Denton County, TX...... N/A 2001 --

FRWM Cummings, Farmers Branch, TX -- N/A 1998 --
HSM, Farmers Branch, TX.......... -- N/A 1998 --
Jeffries Ranch, Oceanside, CA.... -- N/A 1996 --
JHL Connell, Carrollton, TX...... -- N/A 1998 --
Katrina, Palm Desert, CA......... -- N/A 1998 --

Katy Road, Harris County, TX..... -- N/A 1997 --
Keller, Tarrant County, TX....... -- N/A 1997 --
Kelly Lots, Collin County, TX.... -- N/A 2000 --
Lacy Longhorn, Farmers Branch, TX -- N/A 1997 --
Las Colinas I, Las Colinas, TX... -- N/A 1995 --
Leone, Irving TX................. -- N/A 1996 --

87

SCHEDULE III
(Continued)

AMERICAN REALTY INVESTORS, INC.

REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2002

Initial Cost
---------------------
Encum- Building &
Property/Location brances Land Improvements
- ----------------- -------- -------- ------------

Land Properties--(Continued)
Mason/Goodrich, Houston, TX........... $ -- $ 10,983 $ --

McKinney Corners II, Collin County, TX 5,000 5,911 --
Mendoza, Dallas, TX................... -- 192 --
Nashville, Nashville, TN.............. 2,016 7,774 --

Pioneer Crossing, Austin, TX.......... 22,000 23,255 --
Scout, Tarrant County, TX............. -- 2,388 --
Sladek, Travis County, TX............. 342 764 --
Stagliano, Farmers Branch, TX......... -- /(6)/ 566 --
Thompson, Farmers Branch, TX.......... -- /(6)/ 948 --
Thompson II, Dallas County, TX........ -- 505 --
Tomlin, Farmers Branch, TX............ -- /(6)/ 1,878 --
Valley Ranch, Irving, TX.............. -- 16,592 --

Valley Ranch III, Irving, TX.......... -- 2,248 --
Valley Ranch IV, Irving, TX........... 850 2,187 --
Valley View 34, Farmers Branch, TX.... -- 1,652 --
Valwood, Dallas, TX................... 12,220 13,969 --
Vineyards, Grapevine, TX.............. 2,717 4,982 --
Vineyards II, Grapevine, TX........... 3,750 6,934 --
Vista Ridge, Lewisville, TX........... 7,866 16,322 --

Walker, Dallas County, TX............. 8,500 13,534 34
Other (5 properties).................. -- 755 --
-------- -------- --------
100,403 234,895 34
-------- -------- --------
$432,413 $268,866 $307,260
======== ======== ========

Cost
Capitalized
Subsequent to Gross Amounts of Which
Acquisition Carried at End of Year Accumu-
------------------ ------------------------------ lated Date of
Improve- Building & (1) Depreci- Construc- Date
Property/Location ments Other Land Improvements Total ation tion Acquired
- ----------------- -------- --------- -------- ------------ -------- -------- --------- --------

Land Properties--(Continued)
Mason/Goodrich, Houston, TX........... $ 185 $ (2,978)/(3)/ $ 4,257 $ -- $ 4,257 $ -- N/A 1998
(3,933)/(3)/
McKinney Corners II, Collin County, TX -- (5,328)/(3)/ 583 -- 583 -- N/A 1997
Mendoza, Dallas, TX................... -- -- 192 -- 192 -- N/A 1998
Nashville, Nashville, TN.............. -- (849)/(3)/ 5,999 -- 5,999 -- N/A 1999
(926)//
Pioneer Crossing, Austin, TX.......... 1,602 (6,135)/(3)/ 17,120 1,602 18,722 -- N/A 1997
Scout, Tarrant County, TX............. -- (2,106)/(3)/ 282 -- 282 -- N/A 1997
Sladek, Travis County, TX............. -- -- 764 -- 764 -- N/A 2000
Stagliano, Farmers Branch, TX......... -- -- 566 -- 566 -- N/A 1997
Thompson, Farmers Branch, TX.......... -- -- 948 -- 948 -- N/A 1997
Thompson II, Dallas County, TX........ -- (31)/(3)/ 474 -- 474 -- N/A 1998
Tomlin, Farmers Branch, TX............ -- -- 1,878 -- 1,878 -- N/A 1997
Valley Ranch, Irving, TX.............. -- (12,092)/(3)/ 584 -- 584 -- N/A 1996
(3,916)/(2)/
Valley Ranch III, Irving, TX.......... -- -- 2,248 -- 2,248 -- N/A 1997
Valley Ranch IV, Irving, TX........... -- -- 2,187 -- 2,187 -- N/A 1998
Valley View 34, Farmers Branch, TX.... 1,035 32 1,652 1,067 2,719 9 N/A 1996
Valwood, Dallas, TX................... 926 (2,608)/(3)/ 11,361 926 12,287 -- N/A 1996
Vineyards, Grapevine, TX.............. -- -- 4,982 -- 4,982 -- N/A 1997
Vineyards II, Grapevine, TX........... -- -- 6,934 -- 6,934 -- N/A 1999
Vista Ridge, Lewisville, TX........... 440 (6,588)/(3)/ 8,315 440 8,755 -- N/A 1998
(1,419)/(3)/
Walker, Dallas County, TX............. -- -- 13,534 34 13,568 -- N/A 1998
Other (5 properties).................. 56 (3)/(3)/ 808 -- 808 -- N/A Various
------- --------- -------- -------- -------- --------
6,442 (96,220) 140,686 4,465 145,151 9
------- --------- -------- -------- -------- --------
$85,395 $(96,075) $174,657 $390,789 $565,446 $101,689
======= ========= ======== ======== ======== ========

Life on
Which
Depreciation
In Latest
Statement of
Operation
Property/Location is Computed
- ----------------- ------------

Land Properties--(Continued)
Mason/Goodrich, Houston, TX........... --

McKinney Corners II, Collin County, TX --
Mendoza, Dallas, TX................... --
Nashville, Nashville, TN.............. --

Pioneer Crossing, Austin, TX.......... --
Scout, Tarrant County, TX............. --
Sladek, Travis County, TX............. --
Stagliano, Farmers Branch, TX......... --
Thompson, Farmers Branch, TX.......... --
Thompson II, Dallas County, TX........ --
Tomlin, Farmers Branch, TX............ --
Valley Ranch, Irving, TX.............. --

Valley Ranch III, Irving, TX.......... --
Valley Ranch IV, Irving, TX........... --
Valley View 34, Farmers Branch, TX.... --
Valwood, Dallas, TX................... --
Vineyards, Grapevine, TX.............. --
Vineyards II, Grapevine, TX........... --
Vista Ridge, Lewisville, TX........... --

Walker, Dallas County, TX............. --
Other (5 properties).................. --

- --------
(1) The aggregate cost for federal income tax purposes is $505.7 million.
(2) Write down of property to estimated net realizable value.
(3) Cost basis assigned to portion of property sold.
(4) Purchase accounting basis adjustment to Partnership properties.
(5) Acquisition of ground lease.
(6) Pledged as collateral on a loan primarily secured by another parcel of land.
(7) Impairment loss.

88

SCHEDULE III
(Continued)

AMERICAN REALTY INVESTORS, INC.

REAL ESTATE AND ACCUMULATED DEPRECIATION--(Continued)

2002 2001 2000
--------- --------- ---------
(dollars in thousands)

Reconciliation of Real Estate
Balance at January 1,..................... $ 709,999 $ 802,434 $ 936,213
Additions
Acquisitions and improvements...... 58,931 39,839 46,691
Foreclosures....................... -- -- --
Deductions
Sales of real estate............... (199,313) (129,774) (144,376)
Purchase accounting write down..... -- -- (35,846)
Property write down................ (4,171) (2,500) (248)
--------- --------- ---------
Balance at December 31,................... $ 565,446 $ 709,999 $ 802,434
========= ========= =========
Reconciliation of Accumulated Depreciation
Balance at January 1,..................... $ 121,796 $ 148,690 $ 164,583
Additions
Depreciation....................... 13,142 16,253 15,878
Deductions
Sales of real estate............... (33,249) (43,147) (31,771)
--------- --------- ---------
Balance at December 31,................... $ 101,689 $ 121,796 $ 148,690
========= ========= =========

89

SCHEDULE IV

AMERICAN REALTY INVESTORS, INC.

MORTGAGE LOANS ON REAL ESTATE
December 31, 2002

Principal Amount of
Final Carrying Loans Subject to
Interest Maturity Periodic Prior Face Amount Amounts of Delinquent
Description Rate Date Payment Terms Liens of Mortgage Mortgage (1)(2) Principal or Interest
- ----------- -------- -------- -------------- ----- ----------- --------------- ---------------------
(dollars in thousands)

FIRST MORTGAGE
Desert Wells 8.00% 12/04 First payment $ -- $17,839 $17,839 $ --
237, LLC...... due March 31,
First lien DOT 2003.
on 238 acres
in Palm
Desert, CA

The Preserve, 8.00% 12/05 Interest paid -- 7,800 7,800 --
LLC............ three times
First lien DOT per year in
on 1,503 the amount of
acres of land $160,000,
in Riverside, beginning June
CA known as 2003. $700,000
Willow principal
Springs. reduction due
June 2004.
Ponderosa 8.00% 09/04 Interest is -- 9,559 9,559 --
Homes II, Inc.. paid
Deed of Trust quarterly,
and beginning
assignment of December 26,
rents on 154 2002.
acres - Palm
Desert.

JUNIOR MORTGAGE
Palm Desert -- 03/03 Principal due -- 1,177 1,177 --
Redevelopment at maturity.
Agency.........
First lien DOT
on 171.5
acres in Palm
Desert Wells,
CA.

OTHER
Bordeaux 14.00% 12/00 All principal -- 1,591 1,612 1,612
Investments.... and interest
Secured by (1) are due at
a 100% maturity.
membership
interest in
Bordeaux,
which owns a
shopping
center in
Oklahoma
City, OK; (2)
100% of the
stock of
Bordeaux
Investments
One, Inc.,
which owns
6.5 acres of
undeveloped
land in
Oklahoma
City, OK; and
(3) the
personal
guarantees of
the Bordeaux
members.

Lordstown, L.P. 14.00% 03/00 All principal -- 2,138 2,590 2,590
Secured by and interest
100% are due at
partnership maturity.
interest in
Partner
Capital, Ltd.

Realty Advisors Prime 11/04 All principal -- 5,633 5,633 --
Secured by a +2.00% and interest
subordinate are due at
pledge of maturity.
850,000
shares of ARI
Common Stock
owned by BCM.
The shares
are also
pledged to a
lender on
ARI's behalf.

90

SCHEDULE IV
(Continued)

AMERICAN REALTY INVESTORS, INC.

MORTGAGE LOANS ON REAL ESTATE
December 31, 2002

Final
Interest Maturity Prior
Description Rate Date Periodic Payment Terms Liens
- ----------- -------- -------- ------------------------------------- ---------

Desert Wells 237, LLC...................... 8.00% 03/03 All principal and interest due at $ --
maturity.
Housing for Seniors of Humble, LLC......... 11.50% 12/09 Payments made quarterly, beginning --
Pledge by United Housing Foundation of March 2003. Payments equal 31.5% of
100% membership interest in Housing for surplus cash.
Seniors of Humble, LLC.

Davilla Family, LLC........................ 9.00% 10/04 Payments made quarterly, beginning 2,448
Second lien DOT on 129.7 acres in Riverside January 2003.
County, CA.

UNSECURED
One Realco................................. 12.00% 02/04 All principal and interest are due at --
maturity.
Treetops/Colony Meadows.................... -- % 04/03 All principal and interest are due at --
maturity.
Warwick Summit, Inc........................ 14.00% 12/00 All principal and interest are due at --
maturity.
Basic Capital Management, Inc.............. 10.00% 03/04 Interest paid quarterly, beginning --
December 2002. Quarterly principal
reduction is also due in amount of
$742,833.
Housing for Seniors of Humble, LLC......... 11.50% 12/09 Payments made quarterly beginning --
March
2003. Payments equal 68.5% of surplus
cash.
---------
$ 2,448
=========
Interest receivable........................
Discount...................................
Allowance for estimated losses.............

Principal Amount of
Carrying Loans Subject to
Face Amount Amounts of Delinquent
Description Periodic Payment Terms of Mortgage Mortgage (1)(2) Principal or Interest
- ----------- ------------------------------------- ----------- --------------- ---------------------

Desert Wells 237, LLC...................... All principal and interest due at $ 3,568 $ 3,568 $ --
maturity.
Housing for Seniors of Humble, LLC......... Payments made quarterly, beginning 6,363 6,363 --
Pledge by United Housing Foundation of March 2003. Payments equal 31.5% of
100% membership interest in Housing for surplus cash.
Seniors of Humble, LLC.

Davilla Family, LLC........................ Payments made quarterly, beginning 2,775 2,775 --
Second lien DOT on 129.7 acres in Riverside January 2003.
County, CA.

UNSECURED
One Realco................................. All principal and interest are due at 18,000 15,550 --
maturity.
Treetops/Colony Meadows.................... All principal and interest are due at 1,017 1,017 --
maturity.
Warwick Summit, Inc........................ All principal and interest are due at 1,886 1,895 1,895
maturity.
Basic Capital Management, Inc.............. Interest paid quarterly, beginning 4,457 3,714 --
December 2002. Quarterly principal
reduction is also due in amount of
$742,833.
Housing for Seniors of Humble, LLC......... Payments made quarterly beginning 2,000 2,000 --
March
2003. Payments equal 68.5% of surplus
cash.
-------- ------- --------
$85,803 83,092 $ 6,097
======== ========
Interest receivable........................ 2,028
Discount................................... 90
Allowance for estimated losses............. (3,077)
-------
$82,133
=======

- --------
(1) The aggregate cost for federal income tax purposes is $85.1 million.
(2) Interest rates and maturity dates shown are as stipulated in the loan
documents at December 31, 2002. Where applicable, these rates have been
adjusted at issuance to yield between 8% and 12%.

91

SCHEDULE IV
(Continued)

AMERICAN REALTY INVESTORS, INC.

MORTGAGE LOANS ON REAL ESTATE

2002 2001 2000
-------- ------- --------
(dollars in thousands)

Balance at January 1,.............. $ 31,413 $15,027 $ 38,895
Additions..........................
New mortgage loans.............. 63,273 6,349 11,937
Funding of existing loans....... 2,686 15,532 10,231
Deductions.........................
Collections of principal........ (14,280) (5,495) (42,143)
Conversion to property interest. -- -- (3,893)
-------- ------- --------
Balance at December 31,............ $ 83,092 $31,413 $ 15,027
======== ======= ========

92

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT

Directors

The affairs of American Realty Investors, Inc. ("ARI") are managed by a
Board of Directors. The Directors are elected at the annual meeting of
stockholders or are appointed by the incumbent Board and serve until the next
annual meeting of stockholders or until a successor has been elected or
appointed.

The Directors of ARI are listed below, together with their ages, terms of
service, all positions and offices with ARI or its advisor, Basic Capital
Management, Inc. ("BCM"), their principal occupations, business experience and
directorships with other companies during the last five years or more. The
designation "Affiliated" when used below with respect to a Director means that
the Director is an officer, director or employee of BCM or an officer or
employee of ARI. The designation "Independent", when used below with respect to
a Director, means that the Director is neither an officer or employee of ARI
nor a director, officer or employee of BCM, although ARI may have certain
business or professional relationships with such Director, as discussed in ITEM
13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS--Certain Business
Relationships."

TED P. STOKELY: Age 69, Director and Chairman of the Board (Independent)
(since November 2002).

General Manager (since January 1995) of ECF Senior Housing Corporation, a
nonprofit corporation; General Manager (since January 1993) of Housing
Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid
consultant (since January 1993) and paid consultant (April 1992 to December
1992) of Eldercare Housing Foundation ("Eldercare"), a nonprofit
corporation; General Manager (since April 2002) of Unified Housing
Foundation, Inc., a nonprofit corporation; Director (since April 1990) and
Chairman of the Board (since January 1995) of Income Opportunity Realty
Investors, Inc. ("IORI") and Transcontinental Realty Investors, Inc. ("TCI").

EARL D. CECIL: Age 73, Director (Independent) (since November 2001).

Financial and business consultant (since January 1994); Division Vice
President (February 1987 to December 1993) of James Mitchell & Company, a
financial services marketing organization; and Director (since March 2002)
of IORI and TCI.

RICHARD W. HUMPHREY: Age 55, Director (Affiliated) (since November 2001).

Real estate broker (since January 2003) of Regis Realty I, LLC, (December
1999 to December 2002) of Regis Realty, Inc. and (June 1992 to November
1999) of Carmel Realty, Inc.; and President and Treasurer (since November
2000) of Unified Housing Foundation.

JOSEPH MIZRACHI: Age 57, Director (Independent) (since August 2000).

Registered Investment Advisor and Principal and President (since 1980) of
PAZ Securities, Inc.; Chairman of the Board (since 1980) of Midwest
Properties Management, Inc.; Director (since June 2001) of Tarrant Apparel
Group; and Director of ART (June 2000 to August 2000).

Board Meetings and Committees

The Board of Directors held twenty meetings during 2002. For such year,
Joseph Mizrachi was the only incumbent Director who attended fewer than 75% of
the aggregate of (1) the total number of meetings held by

93

the Board during the period for which he or she had been a Director and (2) the
total number of meetings held by all committees of the Board on which he or she
served during the periods that he or she served.

The Board of Directors has an Audit Committee, the function of which is to
review ARI's operating and accounting procedures. The members of the Audit
Committee, all of whom are Independent Directors, are Messrs. Cecil, Mizrachi
and Stokely. The Audit Committee met nine times during 2002.

The Board of Directors has a Stock Option Committee the function of which is
to administer ARI's stock option plan. Mr. Cecil is the only member of the
Stock Option Committee. The Stock Option Committee did not meet in 2002.

The Board of Directors does not have nominating or compensation committees.

Executive Officers

The following persons currently serve as executive officers of ARI: Mark W.
Branigan, Executive Vice President--Residential; Louis J. Corna, Executive Vice
President--Tax; and Ronald E. Kimbrough, Acting Principal Executive Officer,
Executive Vice President and Chief Financial Officer. Their positions with ARI
are not subject to a vote of stockholders. Their ages, terms of service, all
positions and offices with ARI or BCM, other principal occupations, business
experience and directorships with other companies during the last five years or
more are set forth below.

MARK W. BRANIGAN: Age 48, Executive Vice President--Residential (since June
2001), Director (September 2000 to June 2001), and Executive Vice President and
Chief Financial Officer (August 2000 to June 2001).

Executive Vice President--Residential (since June 2001), Executive Vice
President and Chief Financial Officer (August 2000 to June 2001), Vice
President--Director of Construction (August 1999 to August 2000) and
Executive Vice President--Residential Management (January 1992 to October
1997) of BCM, TCI and IORI; Vice President--Director of Construction (August
1999 to August 2000) and Executive Vice President--Residential Asset
Management (January 1992 to October 1997) of ART; and real estate consultant
(November 1997 to July 1999).

LOUIS J. CORNA: Age 55, Executive Vice President--Tax (since October 2001),
Executive Vice President and Chief Financial Officer (June 2001 to October
2001), and Senior Vice President--Tax (December 2000 to June 2001).

Executive Vice President--Tax (since October 2001), Executive Vice
President and Chief Financial Officer (June 2001 to October 2001) and Senior
Vice President--Tax (December 2000 to June 2001) of BCM, TCI and IORI;
Private Attorney (January 2000 to December 2000); Vice President--Taxes and
Assistant Treasurer (March 1998 to January 2000) of IMC Global, Inc.; and
Vice President--Taxes (July 1991 to February 1998) of Whitman Corporation.

RONALD E. KIMBROUGH: Age 50, Acting Principal Executive Officer (since
February 2002) and Executive Vice President and Chief Financial Officer (since
January 2002).

Acting Principal Executive Officer, Executive Vice President and Chief
Financial Officer (since January 2002) of BCM, TCI and IORI; Controller
(September 2000 to January 2002) of BCM; Director, Vice President and
Treasurer (since February 2002) of First Equity Properties, Inc.; Vice
President and Treasurer (January 1998 to September 2000) of Syntek West,
Inc. and One Realco Corporation; and Consultant (1997).

Officers

Although not an executive officer, Robert A. Waldman currently serves as
Senior Vice President, Secretary and General Counsel. His position with ARI is
not subject to a vote of stockholders. His age, term of service,

94

all positions and offices with ARI or BCM, other principal occupations,
business experience and directorships with other companies during the last five
years or more is set forth below.

ROBERT A. WALDMAN: Age 50, Senior Vice President, Secretary and General
Counsel (since August 2000).

Senior Vice President and General Counsel (since January 1995), Vice
President (December 1990 to January 1995) and Secretary (December 1993 to
February 1997 and since June 1999) of IORI and TCI; Senior Vice President
and General Counsel (since November 1994), Vice President and Corporate
Counsel (November 1989 to November 1994) and Secretary (since November 1989)
of BCM; Senior Vice President and General Counsel (since January 1995), Vice
President (January 1993 to January 1995) and Secretary (since December 1989)
of ART; and Senior Vice President, Secretary and General Counsel (since
January 1998) of NMC.

In addition to the foregoing officer, ARI has several vice presidents and
assistant secretaries who are not listed herein.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

Under the securities laws of the United States, ARI's Directors, executive
officers, and any persons holding more than 10 percent of ARI's shares of
Common Stock are required to report their ownership and any changes in that
ownership to the Securities and Exchange Commission (the "Commission").
Specific due dates for these reports have been established and ARI is required
to report any failure to file by these dates during 2002. All of these filing
requirements were satisfied by ARI's Directors and executive officers and 10
percent holders. In making these statements, ARI has relied on the written
representations of its incumbent Directors and executive officers and its 10
percent holders and copies of the reports that they have filed with the
Commission.

The Advisor

Although the Board of Directors is directly responsible for managing the
affairs of ARI and for setting the policies which guide it, the day-to-day
operations of ARI are performed by BCM, a contractual advisor under the
supervision of the Board. The duties of the advisor include, among other
things, locating, investigating, evaluating and recommending real estate and
mortgage loan investment and sales opportunities as well as financing and
refinancing sources. BCM also serves as consultant in connection with ARI's
business plan and investment policy decisions made by the Board.

BCM, an affiliate, serves as advisor to ARI. BCM is indirectly owned by a
trust for the children of Gene E. Phillips. Mr. Phillips is not an officer or
director of BCM, but serves as a representative of the trust, is involved in
daily consultation with the officers of BCM and has significant influence over
the conduct of BCM's business, including the rendering of advisory services and
the making of investment decisions for itself and ARI. As of March 19, 2003,
BCM owned 6,666,744 shares of ARI's Common Stock, approximately 58.6% of the
shares then outstanding.

The Advisory Agreement provides for the advisor to receive monthly base
compensation at the rate of 0.0625% per month (0.75% on an annualized basis) of
Average Invested Assets.

In addition to base compensation, BCM, an affiliate of BCM, or a related
party receives the following forms of additional compensation:

(1) an acquisition fee for locating, leasing or purchasing real estate
for ARI in an amount equal to the lesser of (1) the amount of compensation
customarily charged in similar arm's-length transactions or (2) up to 6% of
the costs of acquisition, inclusive of commissions, if any, paid to
non-affiliated brokers;

(2) a disposition fee for the sale of each equity investment in real
estate in an amount equal to the lesser of (1) the amount of compensation
customarily charged in similar arm's-length transactions or (2) 3% of the
sales price of each property, exclusive of fees, if any, paid to
non-affiliated brokers;

95

(3) a loan arrangement fee in an amount equal to 1% of the principal
amount of any loan made to ARI arranged by BCM;

(4) an incentive fee equal to 10% of net income for the year in excess of
a 10% return on stockholders' equity, and 10% of the excess of net capital
gains over net capital losses, if any, realized from sales of assets;

(5) a mortgage placement fee, on mortgage loans originated or purchased,
equal to 50%, measured on a cumulative basis, of the total amount of
mortgage origination and placement fees on mortgage loans advanced by ARI
for the fiscal year.

The Advisory Agreement further provides that BCM shall bear the cost of
certain expenses of its employees, excluding fees paid to ARI's Directors; rent
and other office expenses of both BCM and ARI (unless ARI maintains office
space separate from that of BCM); costs not directly identifiable to ARI's
assets, liabilities, operations, business or financial affairs; and
miscellaneous administrative expenses relating to the performance by BCM of its
duties under the Advisory Agreement.

If and to the extent that ARI shall request BCM, or any director, officer,
partner or employee of BCM, to render services to ARI other than those required
to be rendered by BCM under the Advisory Agreement, such additional services,
if performed, will be compensated separately on terms agreed upon between such
party and ARI from time to time.

The Advisory Agreement automatically renews from year to year unless
terminated in accordance with its terms. ARI's management believes that the
terms of the Advisory Agreement are at least as fair as could be obtained from
unaffiliated third parties.

Situations may develop in which the interests of ARI are in conflict with
those of one or more Directors or officers in their individual capacities or of
BCM, or of their respective affiliates. In addition to services performed for
ARI, as described above, BCM actively provides similar services as agent for,
and advisor to, other real estate enterprises, including persons and entities
involved in real estate development and financing, including IORI and TCI. The
Advisory Agreement provides that BCM may also serve as advisor to other
entities.

As advisor, BCM is a fiduciary of ARI's public investors. In determining to
which entity a particular investment opportunity will be allocated, BCM will
consider the respective investment objectives of each entity and the
appropriateness of a particular investment in light of each such entity's
existing mortgage note and real estate portfolios and business plan. To the
extent any particular investment opportunity is appropriate to more than one
such entity, such investment opportunity will be allocated to the entity that
has had funds available for investment for the longest period of time, or, if
appropriate, the investment may be shared among various entities. See ITEM 13.
"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS--Certain Business
Relationships."

The directors and principal officers of BCM are set forth below:

Mickey N. Phillips: Director

Ryan T. Phillips: Director

Mark W. Branigan: Executive Vice President--Residential

Louis J. Corna: Executive Vice President--Tax

Ronald E. Kimbrough: Acting Principal Executive Officer, Executive
Vice President and Chief Financial Officer

Dan S. Allred: Senior Vice President--Land Development

Michael E. Bogel: Senior Vice President--Project Manager

Robert A. Waldman: Senior Vice President, General Counsel and
Secretary

96

Mickey N. Phillips is the brother of Gene E. Phillips and Ryan T. Phillips
is the son of Gene E. Phillips. Gene E. Phillips serves as a representative of
the trust established for the benefit of his children which owns BCM and, in
such capacity, has substantial contact with the management of BCM and input
with respect to its performance of advisory services for ARI.

Property Management and Real Estate Brokerage

Affiliates of BCM provided property management services to ARI. Currently,
Triad Realty Services, Ltd. ("Triad"), an affiliate, and Carmel Realty, Inc.
("Carmel") provide property management services to ARI's properties for a fee
of 5% or less of the monthly gross rents collected on the residential
properties under its management and 3% or less of the monthly gross rents
collected on the commercial properties under its management. Triad and Carmel
subcontract with other entities for the provision of the property-level
management services at various rates. The general partner of Triad is BCM. The
limited partner of Triad is Highland Realty Services, Inc. ("Highland"), a
related party. Until December 2002, Triad subcontracted the property-level
management and leasing of 12 of ARI's commercial properties (shopping centers,
office buildings and a merchandise mart) and eight of its hotels to Regis
Realty, Inc. ("Regis"), a related party, which was a company owned by GS Realty
Services, Inc. Regis was entitled to receive property and construction
management fees and leasing commissions in accordance with the terms of its
property-level management agreement with Triad. Since January 1, 2003, Regis
Realty I, LLC ("Regis I"), has provided these services. Regis I is owned by
Highland. Regis Hotel Corporation, a related party, managed eight of ARI's
hotels, until December 2002. Since January 1, 2003, Regis Hotel I, LLC, has
managed eight of ARI's hotels. The sole member of Regis I and Regis Hotel I,
LLC is Highland. Carmel is a company owned by First Equity Properties, Inc.,
which is a company affiliated with BCM.

Regis I, a related party, provides real estate brokerage services to ARI and
receives brokerage commissions in accordance with the Advisory Agreement.

ITEM 11. EXECUTIVE COMPENSATION

ARI has no employees, payroll or benefit plans and pays no compensation to
its executive officers. The Directors and executive officers of ARI who are
also officers or employees of BCM are compensated by BCM. Such affiliated
Directors and executive officers perform a variety of services for BCM and the
amount of their compensation is determined solely by BCM. BCM does not allocate
the cash compensation of its officers among the various entities for which it
serves as advisor. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF
THE REGISTRANT--The Advisor" for a more detailed discussion of compensation
payable to BCM by ARI.

The only direct remuneration paid by ARI is to those Directors who are not
officers or employees of BCM or its affiliated companies. Until December 31,
2000, each Independent Director was compensated at the rate of $20,000 per
year, plus $300 per Audit Committee meeting attended and the Chairman of the
Audit Committee received an annual fee of $500. Effective January 1, 2001, the
annual fee was increased from $20,000 to $45,000. In addition, each Independent
Director receives an additional fee of $1,000 per day for any special services
rendered outside of their ordinary duties as Director, plus reimbursement of
expenses. During 2002, $162,000 was paid to Independent Directors in total
Directors' fees for all services including the annual fee for service during
the period January 1, 2002 through December 31, 2002, and 2002 special service
fees as follows: Earl D. Cecil, $57,000; Collene C. Currie, $53,000; Joseph
Mizrachi, $47,000; and Ted P. Stokely, $5,000.

In January 1999, stockholders approved the Director's Stock Option Plan (the
"Director's Plan") which provides for options to purchase up to 40,000 shares
of Common Stock. Options granted pursuant to the Director's Plan are
immediately exercisable and expire on the earlier of the first anniversary of
the date on which a Director ceases to be a Director or ten years from the date
of grant. Each Independent Director was granted an option to purchase 1,000
shares at an exercise price of $17.71 per share on January 11, 1999, the date
stockholders approved the plan. On January 1, 2000, 2001 and 2002, each
Independent Director was granted an

97

option to purchase 1,000 shares at an exercise price of $18.53, $13.625 and
$9.87 per share, respectively. Each Independent Director will be awarded an
option to purchase an additional 1,000 shares on January 1 of each year. At
December 31, 2002, 1,000 options were exercisable at $18.53 per share, 2,000
options were exercisable at $13.625 per share and 3,000 options were
exercisable at $9.87 per share.

In January 1998, stockholders approved the 1997 Stock Option Plan (the
"Option Plan") which provides for options to purchase up to 300,000 shares of
Common Stock. At December 31, 2002, there were 99,750 options outstanding under
the Option Plan. No options were granted under the Option Plan in 2002.

Performance Graph

The following graph compares the cumulative total stockholder return on
ARI's shares (ART's shares prior to August 2000) of Common Stock with the Dow
Jones Equity Market Index ("DJ Equity Index") and the Dow Jones Real Estate
Investment Index ("DJ Real Estate Index"). The comparison assumes that $100 was
invested on December 31, 1997 in shares of Common Stock and in each of the
indices and further assumes the reinvestment of all dividends. Past performance
is not necessarily an indicator of future performance.

[CHART]
ARI DJ Equity Index DJ Real Estate Index
1997 100.00 100.00 100.00
1998 116.48 124.90 78.88
1999 121.26 153.28 74.69
2000 97.22 139.07 95.24
2001 70.40 122.50 106.49
2002 57.70 95.45 110.35

1997 1998 1999 2000 2001 2002
------ ------ ------ ------ ------ ------

ARI................. 100.00 116.48 121.26 97.22 70.40 57.70
DJ Equity Index..... 100.00 124.90 153.28 139.07 122.50 95.45
DJ Real Estate Index 100.00 78.88 74.69 95.24 106.49 110.35

98

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security Ownership of Certain Beneficial Owners. The following table sets
forth the ownership of ARI's Common Stock both beneficially and of record, both
individually and in the aggregate, for those persons or entities known by ARI
to be the owner of more than 5% of the shares of ARI's Common Stock as of the
close of business on March 19, 2003.

Amount and Nature of Percent of
Name and Address of Beneficial Owner Beneficial Ownership Class (1)
------------------------------------ -------------------- ----------

Basic Capital Management, Inc.......... 6,666,744(2) 58.6%
1800 Valley View Lane
Suite 300
Dallas, Texas 75234

One Realco Corporation................. 1,671,659(3) 14.7%
555 Republic Drive
Suite 490
Plano, Texas 75074

Transcontinental Realty Investors, Inc. 746,972(4) 6.6%
1800 Valley View Lane
Suite 300
Dallas, Texas 75234

Ryan T. Phillips....................... 6,694,346(2)(5) 58.9%
1800 Valley View Lane
Suite 300
Dallas, Texas 75234

- --------
(1) Percentages are based upon 11,375,127 shares outstanding as of March 19,
2003.
(2) Includes 6,666,744 shares owned by BCM over which each of the directors of
BCM, Ryan T. Phillips and Mickey Ned Phillips, may be deemed to be
beneficial owners by virtue of their positions as directors of BCM. The
directors of BCM disclaim beneficial ownership of such shares.
(3) Includes 1,437,209 shares owned by One Realco Corporation and 234,450
shares owned by New Starr Corp., which is a company owned by One Realco
Corporation. Each of the directors of One Realco Corporation, Ronald F.
Akin and F. Terry Shumate, may be deemed to be the beneficial owners by
virtue of their positions as directors of One Realco Corporation. Messrs.
Akin and Shumate disclaim beneficial ownership of such shares.
(4) Each of the directors of TCI, Henry A. Butler, Earl D. Cecil, Ted P.
Stokely and Martin L. White, may be deemed to be the beneficial owners by
virtue of their positions as Directors of TCI. The directors of TCI
disclaim such beneficial ownership.
(5) Includes 27,602 shares owned by the Gene E. Phillips' Children's Trust.
Ryan T. Phillips is a beneficiary of such trust.

99

Security Ownership of Management. The following table sets forth the
ownership of shares of ARI's Common Stock, both beneficially and of record,
both individually in the aggregate, for the Directors and executive officers of
ARI, as of the close of business on March 19, 2003.

Number of Shares Percent of
Name of Beneficial Owner Beneficially Owned Class (1)
- ------------------------ ------------------ ----------

Earl D. Cecil.............................................. 748,972(2)(3) 6.2%
Richard W. Humphrey........................................ 1,600(2) *
Joseph Mizrachi............................................ 3,000(2) *
Ted P. Stokely............................................. 747,972(2)(3) 6.2%
All Directors and Executive Officers as a group (7 persons) 7,421,316(4)(5) 65.2%

- --------
* Less than 1%.
(1) Percentage is based upon 11,375,127 shares outstanding as of March 19, 2003.
(2) Each of Messrs. Cecil, Humphrey, Mizrachi and Stokely have options to
purchase shares of Common Stock of ARI which are exercisable within 60 days
of March 19, 2003.
(3) Includes 746,972 shares owned by TCI over which Messrs. Cecil and Stokely
may be deemed to be the beneficial owners by virtue of their positions as
members of the Board of Directors of TCI. Messrs. Cecil and Stokely
disclaim beneficial ownership of such shares.
(4) Includes 746,972 shares owned by TCI over which the executive officers of
ARI may be deemed to be the beneficial owners by virtue of their positions
as executive officers of TCI. The executive officers of ARI disclaim
beneficial ownership of such shares.
(5) Includes 6,666,744 shares owned by BCM over which the executive officers of
ARI may be deemed to be the beneficial owners by virtue of their positions
as executive officers of BCM. The executive officers of ARI disclaim
beneficial ownership of such shares. Also includes 7,600 shares which may
be acquired by the Directors of ARI pursuant to stock option plans.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Policies with Respect to Certain Activities

Article ELEVENTH of ARI's Articles of Incorporation provides that ARI shall
not, directly or indirectly, contract or engage in any transaction with (1) any
director, officer or employee of ARI, (2) any director, officer or employee of
the advisor, (3) the advisor or (4) any affiliate or associate (as such terms
are defined in Rule 12b-2 under the Securities Exchange Act of 1934, as
amended) of any of the aforementioned persons, unless (a) the material facts as
to the relationship among or financial interest of the relevant individuals or
persons and as to the contract or transaction are disclosed to or are known by
ARI's Board of Directors or the appropriate committee thereof and (b) ARI's
Board of Directors or committee thereof determines that such contract or
transaction is fair to ARI and simultaneously authorizes or ratifies such
contract or transaction by the affirmative vote of a majority of independent
directors of ARI entitled to vote thereon.

Article ELEVENTH defines an "Independent Director" as one who is neither an
officer or employee of ARI, nor a director, officer or employee of ARI's
advisor.

ARI's policy is to have such contracts or transactions approved or ratified
by a majority of the disinterested Directors with full knowledge of the
character of such transactions, as being fair and reasonable to the
stockholders at the time of such approval or ratification under the
circumstances then prevailing. Such Directors also consider the fairness of
such transactions to ARI. Management believes that, to date, such transactions
have represented the best investments available at the time and that they were
at least as advantageous to ARI as other investments that could have been
obtained.

ARI expects to enter into future transactions with entities the officers,
directors or stockholders of which are also officers, Directors or stockholders
of ARI, if such transactions would be beneficial to the operations of ARI

100

and consistent with ARI's then-current investment objectives and policies,
subject to approval by a majority of disinterested Directors as discussed above.

ARI does not prohibit its officers, Directors, stockholders or related
parties from engaging in business activities of the types conducted by ARI.

Certain Business Relationships

BCM, ARI's advisor, is a company for which Messrs. Branigan, Corna and
Kimbrough serve as executive officers. BCM is a company owned by a trust for
the benefit of the children of Gene E. Phillips.

The executive officers of ARI, also serve as executive officers of IORI and
TCI, and owe fiduciary duties to each of those entities as well as to BCM under
applicable law. IORI and TCI have the same relationship with BCM as does ARI.

ARI contracts with affiliates of BCM for property management services.
Currently, Triad, an affiliate, and Carmel provide such property management
services. The general partner of Triad is BCM. The limited partner of Triad is
Highland, a related party. Triad subcontracts the property-level management of
12 of ARI's commercial properties (office buildings, shopping centers and a
merchandise mart) and eight of its hotels to Regis I, a related party, which is
a company also owned by Highland. Regis I also provides real estate brokerage
services to ARI and receives brokerage commissions in accordance with the
Advisory Agreement. Carmel is a company owned by First Equity Properties, Inc.,
which is a company affiliated with BCM. ARI owns an equity interest in each of
IORI and TCI. See ITEM 2. "PROPERTIES--Investments in Real Estate Companies and
Real Estate Partnerships."

At December 31, 2002, ARI owned approximately 49.8% of TCI's outstanding
common stock and approximately 28.5% of IORI's outstanding common stock.

Related Party Transactions

Historically, ARI, TCI, IORI and BCM have each engaged in and may continue
to engage in business transactions, including real estate partnerships, with
related parties. Management believes that all of the related party transactions
represented the best investments available at the time and were at least as
advantageous to ARI as could have been obtained from unrelated parties.

Operating Relationships

In October 1997, ARI entered into leases with BCM and an affiliate of BCM
for space at the One Hickory Centre Office Building, construction of which was
completed in December 1998. The BCM leases, effective upon ARI obtaining
permanent financing of the building, were for 75,852 sq. ft. (approximately 75%
of the building), had terms of ten and fifteen years and provided for annual
base rent of $19.25 per sq. ft. for the first year. In January 2001, both
leases were terminated, and ARI entered into a new lease with BCM, effective
October 1, 2000. The new lease is for 59,463 sq. ft. (approximately 62% of the
building), has a term of three years, and provides for annual base rent of $1.3
million or $21.50 per sq.ft. Effective March 1, 2002, the lease was amended to
57,879 sq. ft. (approximately 59% of the building), with an annual base rent of
$1.2 million, or $21.50 per sq. ft. In April 2002, ARI sold the subsidiary
which owns the building to TCI.

In 2002, ARI paid BCM, its affiliates and a related party $5.9 million in
advisory fees, $689,000 in mortgage brokerage and equity refinancing fees,
$13,000 in property acquisition fees, $5.3 million in real estate brokerage
commissions, $1.9 million in construction supervision fees and $4.3 million in
property and construction management fees and leasing commissions, net of
property management fees paid to subcontractors, other than affiliates of BCM.
In addition, as provided in the Advisory Agreement, BCM received cost
reimbursements of $2.5 million.

101

Partnership Transactions

BCM has entered into put agreements with certain holders of the Class A
limited partner units of Ocean Beach Partners, L.P. The Class A units are
convertible into Series D Cumulative Preferred Stock of ARI. The put price of
the Series D Preferred Stock is $20.00 per share plus accrued but unpaid
dividends.

BCM entered into put agreements with the holders of the Class A limited
partner units of Valley Ranch, L.P. Such Class A units were convertible into
Series B Cumulative Convertible Preferred Stock of ARI which was further
convertible into Common Stock of ARI. The put price for the Class A units was
$1.00 per unit and the put price for either the Series B Preferred Stock or
ARI's Common Stock was 80% of the average daily closing price of ARI's Common
Stock for the prior 20 trading days. In March 1999, ARI reached agreement with
the Class A unitholders of Valley Ranch, L.P. to acquire their eight million
Class A units for $1.00 per unit. In 1999, three million units were purchased.
Additionally, one million units were purchased in January 2000 and two million
units were purchased in May 2001. ARI purchased the remaining two million units
in 2002.

BCM has entered into put agreements with the holders of the Class A units of
ART Palm, L.P. Such Class A units are convertible into Series C Cumulative
Convertible Preferred Stock of ARI. The put price for the Class A units is
$1.00 per unit and the put price for either the Series C Preferred Stock or
ARI's Common Stock is 90% of the average daily closing price of ARI's Common
Stock for the prior 20 trading days. The put agreement calls for ARI to
repurchase the outstanding Class A units as follows: June 30, 2003, 1,625,000
units; December 31, 2005, 1,625,000 units; and December 31, 2006, 8,563,750
units.

Advances and Loans

From time-to-time, ARI and its affiliates have made advances to each other,
which have not had specific repayment terms, do not bear interest, are
unsecured and have been reflected in ARI's financial statements as other assets
or other liabilities. At December 31, 2002, after accounting for affiliate
purchases and sales, amounts still owed by ARI were $26.6 million, $6.6
million, $3.5 million and $2.7 million to BCM, TCI, IORI and Regis,
respectively.

In October 1999, ARI funded a $4.7 million loan to Realty Advisors, Inc., an
affiliate. The loan, to provide funds for acquisitions or working capital
needs, was secured by all of the outstanding shares of common stock of American
Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and
matured in November 2001. In January 2000, $100,000 was collected. In November
2001, the maturity date was extended to November 2004. The collateral was
changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by
BCM. The shares are also pledged to a lender on ARI's behalf. The interest rate
was changed to 2% over the prime rate, currently 6.25% per annum, and the
accrued but unpaid interest of $984,000 was added to the principal. The new
principal balance is $5.6 million. All principal and accrued interest are due
at maturity.

In March 2000, a loan with a current principal balance of $2.6 million to
Lordstown, L.P., matured. The loan, to provide funds to purchase for resale
various parcels of land, is secured by a second lien on land in Ohio and
Florida, by 100% of the general and limited partner interest in Partners
Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest
in subsequent land sales. At December 2002, the loan, and $1.1 million of
accrued interest, remained unpaid. A corporation controlled by Richard D.
Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a
director of ARI until October 2001.

In December 2000, an unsecured loan with a current principal balance of $1.9
million to Warwick of Summit, Inc. ("Warwick") matured. The loan was made to
provide funds to purchase, renovate and expand a shopping center property in
Warwick, Rhode Island. All principal and interest were due at maturity. At
December 2002, the loan, and $188,000 of accrued interest, remained unpaid.
Richard D. Morgan, a Warwick shareholder, served as a director of ARI until
October 2001.

In December 2000, a loan with a current principal balance of $1.6 million to
Bordeaux Investments Two, L.L.C. ("Bordeaux"), matured. The loan, to provide
funds to purchase and renovate a shopping center in

102

Oklahoma City, Oklahoma, is secured by (1) a 100% interest in Bordeaux, which
owns a shopping center in Oklahoma City, Oklahoma; (2) 100% of the stock of
Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in
Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux
members. At December 2002, the loan, and $710,000 of accrued interest, remained
unpaid. Richard D. Morgan, a Bordeaux member, served as a director of ARI until
October 2001.

In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of
credit to One Realco Corporation ("One Realco"), which owns approximately 14.7%
of the outstanding shares of ARI's Common Stock. One Realco periodically
borrows money to meet its cash obligations. The line of credit bears interest
at 12.0% per annum. All principal and interest were due at maturity in February
2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in
principal and $416,000 in interest was collected. In December 2001, $21,000 in
principal and $804,000 in interest was collected. In February 2002, the line of
credit was increased to $18.0 million, accrued but unpaid interest of $217,000
was added to the principal and the maturity date was extended to February 2004.
In March 2002, ARI funded an additional $1.8 million, increasing the
outstanding principal balance to $15.5 million. In October 2002, $856,900 in
interest was collected, by the return of 85,690 shares of ARI Series A
Preferred Stock. All principal and interest are due at maturity. Ronald E.
Kimbrough, Acting Principal Executive Officer, Executive Vice President and
Chief Financial Officer of ARI, is a 10% shareholder of One Realco. During 2001
and 2002, Mr. Kimbrough did not participate in day-to-day operations or
management of One Realco.

In June 2002, ARI converted $4.5 million of its receivable from BCM to a
recourse note receivable. This transaction was to provide ARI with additional
security over that provided by an unsecured receivable. The note bears interest
at 10.0% per annum, matures in March 2004 and requires quarterly payments of
principal and accrued interest, beginning in December 2002.

Property Transactions

In May 2001, ARI exchanged with TCI two parcels of land, a 10.5 acre tract
of Vista Ridge land and an 8.88 acre tract of Hollywood Casino land, for the
168 unit Glenwood Apartments. The business purpose of the transaction was for
TCI to construct apartments on the Vista Ridge land and office buildings on the
Hollywood Casino land. ARI received net cash of $3.2 million on the subsequent
sale of the apartments. See NOTE 2. "REAL ESTATE."

In December 2001, TCI purchased 100% of the outstanding common shares of
National Melrose, Inc. ("NM"), a wholly-owned subsidiary of ARI, for $2.0
million. The purchase price was determined based upon the market value of the
property exchanged, using a market rate multiple of net operating income. NM
owns the Executive Court Office Building. ARI has guaranteed that the asset
will produce at least a 12% annual return on the purchase price for a period of
three years from the purchase date. If the asset fails to produce the annual
return, ARI will pay TCI any shortfall. In addition, if the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the shares of NM for the purchase price. The business purpose of the
transaction was for TCI to make an equity investment in NM, anticipating a
profitable return, and for ARI to receive cash for its equity investment.
Management has classified this related party transaction as a note payable to
TCI.

In January 2002, IORI purchased 100% of the outstanding common shares of
Rosedale Corporation ("Rosedale"), a wholly-owned subsidiary of ARI, for $5.1
million. The purchase price was determined based upon the market value of the
property exchanged, using a market rate multiple of net operating income.
Rosedale owned the Rosedale Towers Office Building. ARI guaranteed that the
asset would produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset failed to produce
the 12% return, ARI would pay IORI any shortfall. In addition, if the asset
failed to produce the 12% return for a calendar year, IORI could require ARI to
repurchase the shares of Rosedale for the purchase price. The business purpose
of the transaction was for IORI to make an equity investment in Rosedale,
anticipating a profitable

103

return, and for ARI to receive cash for its equity investment. Management
classified this related party transaction as a note payable to IORI. IORI sold
the Rosedale Towers Office Building to an unrelated buyer in December 2002. ARI
owes $2.1 million to IORI for remaining principal and 12% return.

In January 2002, TCI purchased 100% of the common shares of ART Two Hickory
Corporation ("Two Hickory"), a wholly-owned subsidiary of ARI, for $4.4
million. The purchase price was determined based upon the market value of the
property exchanged, using a market rate multiple of net operating income. Two
Hickory owns the Two Hickory Centre Office Building. ARI has guaranteed that
the asset will produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset fails to produce the
12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the shares of Two Hickory for the purchase price. The business purpose of the
transaction was for TCI to make an equity investment in Two Hickory,
anticipating a profitable return, and for ARI to receive cash for its equity
investment. Management has classified this related party transaction as a note
payable to TCI.

In March 2002, ARI received $520,000 and exchanged with TCI a 24.5 acre
tract of Rasor land, a 16.89 acre tract of Lakeshore Villas Apartments land and
the 45,623 sq. ft. Oaktree Village Shopping Center for the 80,278 sq. ft. Plaza
on Bachman Creek Shopping Center. The exchange value prices for the shopping
centers were determined using a market rate multiple of net operating income,
and the values of the land parcels were determined using appraised rates. The
business purpose of the transaction was for TCI to construct apartments on the
Rasor and Lakeshore Villas land. To give ample value for the property TCI
exchanged, the Oaktree Village Shopping Center was added to the transaction.
ARI received $4.4 million on the subsequent financing of the shopping center.
Failure to notify and receive approval from the lender for this transaction may
constitute an event of default under the terms of the debt assumed by TCI.

In April 2002, TCI purchased all of the general and limited partnership
interest in Garden Confederate Point, L.P. ("Confederate Point") from ARI for
$1.9 million. The purchase price was determined based on the market value of
the property exchanged using a market rate multiple of net operating income.
Confederate Point owns the Confederate Point Apartments. ARI has guaranteed
that the asset will produce at least a 12% annual return on the purchase price
for a period of three years from the purchase date. If the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the interests in Confederate Point for the purchase price. The business purpose
of this transaction was for TCI to make an equity investment in Confederate
Point anticipating a profitable return and to reduce ARI's payable to BCM.
Management has classified this related party transaction as a note payable to
TCI. Failure to notify and receive approval from the lender for this
transaction may constitute an event of default under the terms of the debt
assumed by TCI.

In April 2002, TCI purchased all of the general and limited partnership
interests in Garden Foxwood, L.P. ("Foxwood") from ARI for $1.1 million. The
purchase price was determined based on the market values of the property
exchanged, using a market rate multiple of net operating income. Foxwood owns
the Foxwood Apartments. ARI has guaranteed that the asset will produce at least
a 12% annual return on the purchase price for a period of three years from the
purchase date. If the asset fails to produce the 12% return, ARI will pay TCI
any shortfall. In addition, if the asset fails to produce the 12% return for a
calendar year, TCI may require ARI to repurchase the interests in Foxwood for
the purchase price. The business purpose for the transaction was for TCI to
make an equity investment in Foxwood anticipating a profitable return and to
reduce ARI's payable to BCM. Management has classified this related party
transaction as a note payable to TCI. Failure to notify and receive approval
from the lender for this transaction may constitute an event of default under
the terms of the debt assumed by TCI.

In April 2002, TCI purchased all of the general and limited partnership
interests in Garden Woodsong, L.P. ("Woodsong") from ARI for $2.5 million. The
purchase price was determined based on the market values of the property
exchanged, using a market rate multiple of net operating income. Woodsong owns
the Woodsong Apartments. ARI has guaranteed that the asset will produce at
least a 12% annual return on the purchase price for

104

a period of three years from the purchase date. If the asset fails to produce
the 12% return, ARI will pay TCI any shortfall. In addition, if the asset fails
to produce the 12% return for a calendar year, TCI may require ARI to
repurchase the interests in Woodsong for the purchase price. The business
purpose for the transaction was for TCI to make an equity investment in
Woodsong anticipating a profitable return and to reduce ARI's payable to BCM.
Management has classified this related party transaction as a note payable to
TCI. In July 2002, the Woodsong Apartments was sold for $9.1 million. TCI
received $2.6 million from the proceeds of $2.8 million as payment of principal
and accrued but unpaid interest on the loan.

In April 2002, TCI purchased 100% of the common shares of ARI One Hickory
Corporation ("One Hickory"), a wholly-owned subsidiary of ARI, for $4.5
million. The purchase price was determined based on the market values of the
property exchanged, using a market rate multiple of net operating income. One
Hickory owns the One Hickory Centre Office Building. ARI has guaranteed that
the asset will produce at least a 12% annual return on the purchase price for a
period of three years from the purchase date. If the asset fails to produce the
12% return, ARI will pay TCI any shortfall. In addition, if the asset fails to
produce the 12% return for a calendar year, TCI may require ARI to repurchase
the interests in One Hickory for the purchase price. The business purpose for
the transaction was for TCI to make an equity investment in One Hickory
anticipating a profitable return and to reduce ARI's payable to BCM. Management
has classified this related party transaction as a note payable to TCI. Failure
to notify and receive approval from the lender for this transaction may
constitute an event of default under the terms of the debt assumed by TCI.

In June 2002, TCI purchased Centura Tower, Ltd. partnership, which owns the
Centura Tower Office Building, from ARI for $50.0 million. See NOTE 2. "REAL
ESTATE." The purchase price for the Centura Tower was determined based on
appraised value and replacement cost. The business purpose of the transaction
was for TCI to acquire a Class A office building with significant upside
potential anticipating a profitable return and for ARI to satisfy debt.

In June 2002, TCI purchased five parcels of unimproved land from ARI for
$30.0 million: the Hollywood Casino, Marine Creek, Mason Goodrich, Nashville
and Monterrey land parcels. See NOTE 2. "REAL ESTATE." The purchase price of
the Hollywood Casino land was determined based on an appraised value. The
business purpose of the transaction was for TCI to consolidate its holdings
within the Mercer Crossing development. The purchase price for the Marine
Creek, Mason Goodrich, Nashville and Monterrey land parcels was determined
based on appraised rates. The business purpose of the transaction was for TCI
to develop apartments on these four tracts of land and for ARI to satisfy debt.
Failure to notify and receive approval from the lender for this transaction may
constitute an event of default under the terms of the debt assumed by TCI.

In June 2002, ARI purchased all the general and limited partnership
interests in Chalet North, L.P. ("Chalet North") from BCM for $3.0 million.
Chalet North owns the Pinecrest Apartments. The purchase price was determined
based on the market value of the property exchanged, using a market rate
multiple of net operating income. ARI assumed debt of $1.4 million. ARI's
receivable from BCM was reduced by $1.6 million, and no cash was paid by ARI.
The business purpose of the transaction was to reduce the affiliate payable
owed by BCM to ARI.

In June 2002, ARI purchased the Tiberon Trails Apartments from BCM for $12.3
million. The purchase price was determined based on the market value of the
property exchanged, using a market rate multiple of net operating income. ARI
assumed debt of $6.4 million. ARI's receivable from BCM was reduced by $5.9
million, and no cash was paid by ARI. The business purpose of the transaction
was to reduce the affiliate payable owed by BCM to ARI.

In June 2002, ARI purchased the Alta Mesa Shopping Center from BCM for $3.8
million. The purchase price was determined based on the market value of the
property exchanged, using a market rate multiple of net operating income. ARI
assumed debt of $1.8 million. ARI's receivable from BCM was reduced by $2.0
million, and no cash was paid by ARI. The business purpose of the transaction
was to reduce the affiliate payable owed by BCM to ARI.

105

On June 30, 2002, ARI obtained 74.31% interest in RAK from BCM for $6.0
million. The business purpose of the transaction was to reduce the affiliate
payable owed by BCM to ARI. ARI's receivable from BCM was reduced by $6.0
million, and no cash was paid by ARI. At the date of acquisition, RAK's assets
consisted of $2.3 million in cash, $3.0 million in deposits and marketable
securities, and $225,000 in other assets. RAK's net equity was $5.5 million.
ARI recorded $1.9 million in goodwill as a result of this transaction.

In December 2002, ARI sold the Lakeshore Villas Apartments to Housing for
Seniors of Humble, LLC ("Humble"), a related party, for $22.0 million, paying
$764,000 after payment of closing costs and debt paydown and providing purchase
money financing of $8.4 million. One loan has a principal amount of $2.0
million. The loan is unsecured, and is guaranteed by Unified Housing
Foundation, Inc. ("Unified"), a related party. The second loan has a principal
amount of $6.4 million, and is secured by a pledge by Unified of 100% of the
Member Interest in Humble. Both loans bear interest at 11.5% per annum, mature
in December 2009 and require quarterly payments beginning in March 2003.
Richard W. Humphrey, a director of ARI, is the President of Humble and the
President and Treasurer of Unified. Ted P. Stokely, Chairman of the Board and a
director of ARI, is the General Manager of Unified.

In December 2002, TCI purchased the NLP/CH, Ltd. partnership, which owns the
Centura Holdings, Clark and Woolley land parcels, from ARI for $13.3 million.
See NOTE 2. "REAL ESTATE." The purchase price was determined based on an
appraised rate. The business purpose of the transaction was for TCI to
construct apartments on the land and for ARI to satisfy debt.

In March 2003, TCI purchased the Bridgeview Plaza and Cullman shopping
centers from ARI for $8.7 million and $2.0 million, respectively, to satisfy
debt. The purchase price was determined using a market rate multiple of net
operating income.

106

PART IV

ITEM 14. CONTROLS AND PROCEDURES

(a) Within the 90 days prior to the date of this report, ARI carried out an
evaluation, under the supervision and with the participation of ARI's
management, including ARI's Acting Principal Executive Officer and Principal
Accounting Officer, of the effectiveness of the design and operation of ARI's
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based
upon the evaluation, ARI's Acting Principal Executive Officer and Principal
Accounting Officer concluded that ARI's disclosure controls and procedures are
effective in timely alerting him to material information relating to ARI
(including its consolidated subsidiaries) required to be included in ARI's
periodic SEC filings.

(b) There have been no significant changes in ARI's internal controls or in
other factors that could significantly affect ARI's internal controls
subsequent to the date ARI carried out this evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K

(a) The following documents are filed as part of this Report:

1. Consolidated Financial Statements

Report of Independent Certified Public Accountants

Consolidated Balance Sheets--December 31, 2002 and 2001

Consolidated Statements of Operations--Years Ended December 31,
2002, 2001 and 2000

Consolidated Statements of Stockholders' Equity--Years Ended
December 31, 2002, 2001 and 2000

Consolidated Statements of Cash Flows--Years Ended December 31,
2002, 2001 and 2000

Notes to Consolidated Financial Statements

2. Financial Statement Schedules

Schedule III--Real Estate and Accumulated Depreciation

Schedule IV--Mortgage Loans on Real Estate

All other schedules are omitted because they are not applicable or because
the required information is shown in the financial statements or the notes
thereto.

3. Incorporated Financial Statements

Consolidated Financial Statements of Income Opportunity Realty
Investors, Inc. (Incorporated by reference to Item 8 of Income
Opportunity Realty Investors, Inc.'s Annual Report on Form 10-K for
the year ended December 31, 2002).

Consolidated Financial Statements of Transcontinental Realty
Investors, Inc. (Incorporated by reference to Item 8 of
Transcontinental Realty Investors, Inc.'s Annual Report on Form 10-K
for the year ended December 31, 2002).

107

4. Exhibits

The following documents are filed as Exhibits to this Report:

Exhibit
Number Description
- ------ -----------

3.1 Certificate of Restatement of Articles of Incorporation of American Realty Investors, Inc., dated
August 3, 2000 (incorporated by reference to Exhibit 3.0 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2000).

3.2 Certificate of Correction of Restated Articles of Incorporation of American Realty Investors, Inc.,
dated August 29, 2000 (incorporate by reference to Exhibit 3.1 to the Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 2000).

3.3 By-laws of American Realty Investors, Inc. (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-4, filed on December 30, 1999).

4.1 Certificate of Designations, Preferences and Relative Participating or Optional or Other Special
Rights, and Qualifications, Limitations or Restrictions Thereof of Series F Redeemable Preferred
Stock of American Realty Investors, Inc., dated June 11, 2001 (incorporated by reference to Exhibit
4.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001).

4.2 Certificate of Withdrawal of Preferred Stock, Decreasing the Number of Authorized Shares of and
Eliminating Series F Redeemable Preferred Stock, dated June 18, 2002 (incorporated by reference to
Exhibit 3.0 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).

4.3 Certificate of Designation, Preferences and Rights of the Series I Cumulative Preferred Stock of
American Realty Investors, Inc., dated February 3, 2003, filed herewith.

10.1 Advisory Agreement between American Realty Investors, Inc. and Basic Capital Management, Inc.,
dated August 3, 2000 (incorporated by reference to Exhibit 10.3 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2000).

10.2 Second Amendment to Modification of Stipulation of Settlement dated October 17, 2001
(incorporated by reference to Exhibit 10.1 to Registrant's Registration Statement on Form S-4, dated
February 24, 2002).

99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, filed herewith.

(b) Reports on Form 8-K:

A Current Report on Form 8-K, dated November 11, 2002, was filed with
respect to Item 5. "Other Events," which reports the resignation of a
Director.

A Current Report on Form 8-K/A, dated August 30, 2002, was filed with
respect to Item 2. "Acquisition and Disposition of Assets," and Item 7.
"Financial Statements and Exhibits," which reports the disposition of 10
apartments and two commercial properties and 14 land parcels.

A Current Report on Form 8-K, dated March 18, 2003, was filed with
respect to Item 5. "Other Events," which reports the completion of a
cash tender offer to purchase any and all the issued and outstanding
common stock of IORI and TCI.

108

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

AMERICAN REALTY INVESTORS, INC.

Dated: April 14, 2003 By: /s/ RONALD E. KIMBROUGH
----------------------------------
Ronald E. Kimbrough
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer and Acting
Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.

Signature Title Date
--------- ----- ----

/s/ TED P. STOKELY Chairman of the Board and April 14, 2003
- ----------------------------- Director
Ted P. Stokely

/s/ EARL D. CECIL Director April 14, 2003
- -----------------------------
Earl D. Cecil

/s/ RICHARD W. HUMPHREY Director April 14, 2003
- -----------------------------
Richard W. Humphrey

/s/ JOSEPH MIZRACHI Director April 14, 2003
- -----------------------------
Joseph Mizrachi

/s/ RONALD E. KIMBROUGH Executive Vice President and April 14, 2003
- ----------------------------- Chief Financial Officer
Ronald E. Kimbrough (Principal Financial and
Accounting Officer and
Acting Principal Executive
Officer)

109

CERTIFICATION

I, Ronald E. Kimbrough, Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer and Acting Principal Executive
Officer) of American Realty Investors, Inc. ("ARI"), certify that:

1. I have reviewed this annual report on Form 10-K of ARI;

2. Based on my knowledge, this annual 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 annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;

4. I am responsible for establishing and maintaining internal controls and
procedures and have:

a. designed such internal controls to insure that material information
relating to ARI and its consolidated subsidiaries is made known to me by
others within those entities, particularly for the periods presented in
this quarterly report;

b. evaluated the effectiveness of ARI's internal controls as of a date
within 90 days prior to the filing date of this annual report; and

c. presented in this annual report my conclusions about the effectiveness
of the disclosure controls and procedures based on a date within 90 days
prior to the filing date of this annual report;

5. I have disclosed to ARI's auditors and Audit Committee of the Board of
Directors (or persons fulfilling the equivalent function):

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

6. I have indicated in this annual 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 my most recent
evaluation, including corrective actions with regard to significant
deficiencies and material weaknesses.

Dated: April 14, 2003 /s/ RONALD E. KIMBROUGH
----------------------------------
Ronald E. Kimbrough
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer and Acting
Principal Executive Officer)

110

ANNUAL REPORT ON FORM 10-K

EXHIBIT INDEX

For the Year Ended December 31, 2002

Exhibit Page
Number Description No.
- ------ ----------- ----

4.3 Certificate of Designation, Preferences and Rights of the Series I Cumulative Preferred Stock
of American Realty Investors, Inc., dated February 3, 2003.

99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

111