TARRAGON REALTY INVESTORS INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark one)

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

For the quarterly period ended JUNE 30, 2002
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OR

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

For the transition period from....................to....................

Commission File Number 0-22999
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TARRAGON REALTY INVESTORS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Nevada 94-2432628
- --------------------------------- ---------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)

1775 Broadway, 23rd Floor, New York, NY 10019
---------------------------------------------------
(Address of principal executive offices) (Zip Code)

(212) 949-5000
----------------------------------------------------
(Registrant's telephone number, including area code)

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 the past 90 days. Yes X No
--- ---

Common Stock, $.01 per value 8,023,518
- ----------------------------- -------------------------------
(Class) (Outstanding at August 5, 2002)

1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements for the period ended June 30,
2002, have not been audited by independent certified public accountants, but, in
our opinion, all adjustments (consisting of normal recurring accruals) necessary
for a fair presentation of consolidated financial position, consolidated results
of operations, and consolidated cash flows at the dates and for the periods
indicated have been included.

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)

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

2

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
(Unaudited)

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

3

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(Dollars in thousands, except per share data)
(Unaudited)

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

4

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

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

5

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

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

6

TARRAGON REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

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

7

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying Consolidated Financial Statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America (GAAP) for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by GAAP for complete financial
statements. Operating results for the six month period ended June 30, 2002, are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. For further information, refer to the Consolidated
Financial Statements and Notes included in our Annual Report on Form 10-K for
the year ended December 31, 2001. Dollar amounts in tables are in thousands.
Certain 2001 balances have been reclassified to conform to the 2002
presentation.

NOTE 2. REAL ESTATE

In March 2002, we sold Collegewood Apartments for $5.2 million, receiving net
cash proceeds of $3 million after payoff of the mortgage and closing costs. We
recognized a gain on the sale of $2.3 million. In accordance with Statement of
Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," the operations of this property prior to its
sale and the gain on sale are reported in discontinued operations in the
accompanying Consolidated Statements of Operations.

In April 2002, we purchased a 19-acre tract of land in Orlando, Florida, for
$2.8 million. We plan to build a 296-unit apartment community on the land at a
total estimated cost of $19.7 million, of which $17.2 million will be funded by
a construction loan.

In January 2002, a property with a net carrying value of $14.1 million was
reclassified from real estate held for sale to for-sale housing inventory when
we began its conversion to condominiums. Also in January 2002, we reclassified a
property with a net carrying value of $6.3 million from real estate held for
sale to the held for investment category when our contract of sale was
terminated and we ceased marketing the property for sale. The estimated fair
values of these properties exceeded their net carrying values at the date of
reclassification, so no loss was incurred upon their reclassification.

During the six month period ended June 30, 2002, we sold 60 condominium units at
5600 Collins Avenue in Miami Beach, Florida, for an aggregate sale price of
$15.2 million. After closing costs and release payments on the mortgage, we
received net cash proceeds of $4.1 million. Due to an increase in estimated
costs to complete the condominium conversion, we have recorded a For-sale
housing inventory write-down in the second quarter of 2002 of $1.4 million.

8

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS

Investments in and advances to partnerships, accounted for using the equity
method, consisted of the following at June 30, 2002:

801 Pennsylvania Avenue ......................................................... $ 1
Ansonia Apartments, L.P. ........................................................ 465
Ansonia Liberty, L.L.C .......................................................... 884
Danforth Apartment Owners, L.L.C ................................................ 372
Guardian-Jupiter Partners, Ltd. ................................................. 4,119
Lake Sherwood Partners, L.L.C ................................................... 403
Larchmont Associates, L.P. ...................................................... 2,132
Merritt 8 Acquisitions, L.L.C ................................................... 2,656
Merritt Stratford, L.L.C ........................................................ 519
One Las Olas, Ltd. .............................................................. 9,014
100 East Las Olas, Ltd., and East Las Olas, Ltd. ................................ 4,184
Sacramento Nine ................................................................. 650
Stone Creek Associates I, L.L.C ................................................. 820
Summit/Tarragon Murfreesboro, L.L.C ............................................. 1,200
Tarragon Calistoga, L.L.C ....................................................... 115
Tarragon Savannah I & II, L.L.C ................................................. 3,076
Vineyard at Eagle Harbor, L.L.C ................................................. 514
-------------
$ 31,124
=============

We hold noncontrolling interests in each of the above partnerships or joint
ventures or our outside partners have significant participating rights, as
defined in the Financial Accounting Standard Board's Emerging Issues Task
Force's 96-16 Abstract. Therefore, we account for our investments in these
partnerships using the equity method.

In February 2002, Ansonia Apartments sold Meriden East, a 66-unit apartment
community, for $3.2 million and recognized a gain of $1.1 million. In April
2002, the partnership sold Foxon Woods, a 78-unit property, for $3.7 million and
recognized a gain of $669,000. In May 2002, the partnership sold Fox Run, a
172-unit property, for $7.8 million and recognized a gain of $343,000. All of
these properties were held for sale at December 31, 2001. Tarragon's
proportionate share of these gains was $1.5 million. Aggregate net cash proceeds
of $3.9 million were distributed to the partners, with Tarragon receiving $2.8
million. In April 2002, the partnership refinanced the mortgage on Gull Harbor
Apartments, receiving net cash proceeds of $341,000, of which $239,000 was
distributed to Tarragon. The cash distributed to the outside partners was used
to pay down their notes payable to Tarragon. The balance of these notes at June
30, 2002, was $1.4 million. Tarragon has guaranteed 50%, or $925,000, of the
Gull Harbor mortgage.

In February 2002, Devonshire sold its only property, Villages at Gateway, a
768-unit apartment community, for $33.2 million and recognized a gain of $25.2
million. This property was also held for sale at December 31, 2001. Net cash
proceeds of $8.35 million were distributed to the partners, with Tarragon
receiving $8 million. Tarragon's share of the gain was $8.3 million, which is
reduced by income recognized in 2000 resulting from distributions from
Devonshire in excess of our investment.

9

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

In March 2002, Tarragon Savannah I & II placed a supplemental mortgage of
$250,000 on the first phase of Links at Georgetown and replaced the construction
loan on the second phase with a permanent mortgage of $5.5 million. Payoff of
the construction loan and closing costs of the new loans required cash of
$732,000 which was advanced by Tarragon.

In March 2002, One Las Olas closed a $90 million construction loan and a $25
million mezzanine loan on its Las Olas River House condominium project. Tarragon
advanced $1.6 million for expenses and closing costs in connection with the
loans. At closing, $5 million was funded under the construction loan. In June
2002, the partnership borrowed $11.3 million under the mezzanine loan and
distributed $11 million to Tarragon as a partial repayment of advances. Tarragon
has guaranteed the $90 million construction loan, which had a balance at June
30, 2002, of $5 million.

Tarragon formed a new joint venture, 100 East Las Olas and East Las Olas, with
our partners in One Las Olas in February 2002. Tarragon contributed $4.2 million
to this joint venture in connection with its purchase of approximately one acre
of land adjacent to the Las Olas River House condominium development. This joint
venture plans to build a second phase of the Las Olas River House project on the
land. Tarragon has a 70% interest in this joint venture, and its investment will
be repaid from sales of the planned future development or from sale of the land.

In April 2002, Tarragon made a contribution of $80,000 to Tarragon Calistoga,
which owns a 5% interest in Calistoga Ranch Owners, in connection with its
acquisition of a 25% interest in CR Tarragon Palm Springs. CR Tarragon Palm
Springs will develop a golf course and club house, hotel, fractional ownership
units, whole ownership condominium units, and single family detached residences
and lots on 891.9 acres to be acquired in Palm Springs, California. Tarragon
Calistoga has agreed to make contributions of up to $1 million, of which
Tarragon Realty Investors has committed to fund $800,000.

The accompanying Consolidated Financial Statements as of June 30, 2002, and for
the three months then ended reflect two partnerships, Antelope Pines Estates,
L.P., and Woodcreek Garden Apartments, L.P., on the consolidation method of
accounting because we now have a controlling interest in each. Total assets of
these partnerships were approximately $40 million at June 30, 2002.

10

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS (Continued)

Below are summarized financial data for Ansonia, Devonshire, and all other
partnerships as of and for the six months ended June 30, 2002 (unaudited):

11

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 4. NOTES AND INTEREST PAYABLE

In the first half of 2002, we obtained variable rate first mortgage financing on
three apartment communities totaling $43.4 million, receiving net cash proceeds
of $8.2 million after the payoff of $34 million in existing debt, funding
escrows for taxes, insurance, replacements, and repairs, and paying the
associated closing costs.

In connection with one of the financings, we purchased an interest rate cap (as
required by the lender) with a notional value of $8.3 million that caps the
30-day LIBOR at 5.72% and matures in May 2005. In accordance with SFAS 133, the
$79,000 cost of the cap was recorded as an asset, and the carrying value of the
cap has been reduced to its fair value at June 30, 2002, with a charge of
$20,000 to interest expense.

In connection with the 2001 refinancing of the mortgage debt of Antelope Pines
and Woodcreek Garden, we purchased interest rate caps on each property as
required by the lenders. The cap purchased for Antelope Pines for $74,000 has a
notional value of $11.7 million, caps the Bond Market Association Municipal Swap
Index (the "BMA Index") at 6.34%, and matures in November 2006. The cap
purchased for Woodcreek Garden for $89,000 has a notional value of $13.3
million, caps the BMA Index at 6.28%, and matures in December 2006. In
accordance with SFAS 133, the caps were recorded at cost as assets, with the
carrying values of the caps adjusted to their fair values quarterly. During the
six months ended June 30, 2002, the fair values of the caps decreased by $83,000
and $93,000, respectively, with charges to interest expenses in these amounts.

During the first half of 2002, we also closed two construction loans totaling
$31.6 million to fund the construction of a 216-unit apartment community in
Charleston, South Carolina, and a 296-unit apartment community in Orlando,
Florida.

In May 2002, we obtained a $2 million line of credit secured by shares of
Tarragon treasury stock. Advances under the line of credit bear interest at
LIBOR plus 2% per annum, and payments of interest only monthly are due, with the
principal due at maturity of May 2004.

Also during the first half of 2002, we made net repayments totaling $243,000 of
advances from affiliates of William S. Friedman, our President and Chief
Executive Officer and Chairman of our Board of Directors, pursuant to a line of
credit arrangement. Advances under the line of credit, totaling $11.6 million as
of June 30, 2002, bear interest at LIBOR plus 1% per annum, and the line of
credit matures in January 2004.

12

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 5. EARNINGS PER COMMON SHARE

Income (loss) per common share has been computed based on the weighted average
number of shares of common stock outstanding for the three and six month periods
ended June 30, 2002 and 2001. The information presented for 2001 has been
restated to give effect to the stock dividend declared in December 2001 and
recorded in March 2002. The effect of stock options on weighted average shares
of common stock outstanding - assuming dilution for the six month period ended
June 30, 2001, and the three month period ended June 30, 2002, is not reflected
because their effect is anti-dilutive due to net losses in those periods.

NOTE 6. COMMITMENTS AND CONTINGENCIES

Tarragon is party to various claims and routine litigation arising in the
ordinary course of business. We do not believe that the results of such claims
and litigation, individually or in the aggregate, will have a material adverse
effect on our business, financial position, or results of operations.

Tarragon is not aware of any liability relating to federal, state, and local
environmental laws, ordinances, and regulations that would have a material
adverse effect on our business, financial position, or results of operations.

13

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING

Our business is divided into three principal segments - the operation of our
investment portfolio, property development, and for-sale housing (formerly
referred to as homebuilding). The operation of our investment portfolio of
stabilized apartment communities and commercial properties is the largest
segment and the one whose operation most resembles that of traditional real
estate investment trusts. Funds generated by the operation, sale, or refinancing
of properties in the investment portfolio support our overhead and finance our
development activities. The second segment is property development through which
we create new investment properties, primarily multifamily apartment
communities, which, upon stabilization, become part of our investment portfolio.
Our activities in the third segment, for-sale housing, encompass condominium
conversions of existing apartment properties and the development of town homes
and new, high-rise condominiums for sale to resident owners. In 2001, assets in
the for-sale housing group were included in our development group. In 2002, we
have begun to report on the assets in the for-sale housing category in a third
segment because we have expanded development of housing for sale. We will
reclassify properties from the development division to the investment division
once they have achieved stabilized operations (as defined below). We will
reclassify properties for which we have initiated renovation or reposition
activities from the investment division to the development division. We will
reclassify properties for which we have initiated condominium conversion
activities from the investment division to the for-sale housing division.

o Development. Assets in this division are under development or
in initial lease-up, under renovation, or land held for
construction development or sale. In 2001, this segment also
included 5600 Collins Avenue, an apartment property under
renovation and sale as condominiums, and Las Olas River House
in Ft. Lauderdale, a 42-story luxury condominium development.
In 2002, these properties are reported in the for-sale housing
division.

o Investment. This division includes properties with stabilized
operations. We consider a property "stabilized" when
development or renovation is complete and recurring operating
income exceeds operating expenses and debt service.

o For-Sale Housing. Assets in this division include luxury
high-rise condominiums, senior housing communities, and
townhouses under development and existing apartment properties
under conversion to condominiums.

The following table summarizes apartment units and commercial square footage in
the development and investment divisions. The for-sale housing division includes
two consolidated apartment properties with 392 units which are scheduled for
renovation and sale as condominiums and a 42-story luxury condominium project
under development owned through an unconsolidated joint venture.

14

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

The following tables summarize operating data through income (loss) from
continuing operations and identifiable assets of our real estate and investments
in partnerships for the three divisions and funds from operations for our
investment division. We use funds from operations to measure the performance of
our investment division. We measure the performance of our development and
for-sale housing divisions primarily by net profit from third party and
intercompany sales. Intercompany sales for 2002 include transfers on January 1,
2002, from the development division to the investment division of properties
with 2,970 apartment units and 355,737 square feet of commercial space that were
stabilized during 2001 and transfers on April 1, 2002, from the development
division to the investment division of properties with 737 apartment units and
34,381 square feet of commercial space that were stabilized in the first quarter
of 2002. Intercompany sales for 2001 include transfers on January 1, 2001, from
the development division to the investment division of properties with 2,172
apartment units that were stabilized during 2000. The sale prices for these
properties are their estimated fair market values as of the date of transfer,
and the cost of sales is their net carrying values as of the same date. Three
commercial properties with 253,460 square feet were targeted for reposition in
2001. The January 1, 2001, transfer of these properties from the investment
division to the development division is shown as an intercompany sale in the
operating data for the six months ended June 30, 2001. The gain to the
investment division is the excess of the properties' aggregate estimated fair
market values over their aggregate net carrying values as of December 31, 2000.
Gains on transfers of assets between segments do not represent gains
recognizable in accordance with GAAP and, accordingly, are eliminated for
purposes of consolidated reporting.

15

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

Dollar amounts in the following tables are in thousands. Operating data for 2001
has been restated to present the For-Sale Housing Division separately from the
Development Division consistent with the 2002 presentation.

16

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

17

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

18

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

19

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

20

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

- ----------
(1) Tarragon considers funds from operations ("FFO") to be an appropriate
measure of the performance of our investment portfolio but not of our
other assets. FFO, as defined by the National Association of Real
Estate Investment Trusts ("NAREIT"), equals net income (loss), computed
in accordance with GAAP, excluding gains (or losses) from debt
restructuring and sales of property, plus depreciation and amortization
of real estate assets, and after adjustments for unconsolidated
partnerships and joint ventures. Adjustments for unconsolidated
partnerships and joint ventures are calculated to reflect FFO on the
same basis. Effective January 1, 2002, NAREIT clarified that FFO
related to assets held for sale, sold, or otherwise transferred and
included in results of discontinued operations should continue to be
included in consolidated FFO. FFO reported above has been computed in
accordance with this clarification. We believe that a clear
understanding of the operating results of our investment portfolio
requires examining FFO along with net income (loss) as shown in the
Consolidated Financial Statements and Notes. FFO does not represent
cash generated from operating activities in accordance with GAAP and is
not an alternative to net income as an indication of our operating
performance or to cash flow as a measure of liquidity, nor is it
necessarily indicative of cash available to fund cash needs and cash
dividends. Our calculation of FFO may be different from the methods
used by other companies and, therefore, may not be comparable to other
companies.

21

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. SEGMENT REPORTING (Continued)

NOTE 8. GOODWILL

Goodwill was recorded in connection with the acquisitions of Tarragon Realty
Advisors and Accord Properties Associates and, until December 31, 2001, was
amortized on the straight-line method. We adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," on January 1, 2002. SFAS No. 142 requires that
goodwill and other intangible assets with indefinite useful lives no longer be
amortized as expenses of operations but rather carried on the balance sheet as
permanent assets. These assets are subject to at least annual assessment for
impairment by applying a fair-value-based test. We have determined there is no
transitional impairment loss at January 1, 2002.

Following is a presentation of income (loss) from continuing operations, net
income (loss), earnings per common share, and earnings per common share -
assuming dilution adjusted to exclude amortization expense related to goodwill
and intangible assets that are no longer being amortized.

22

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 8. GOODWILL (Continued)

23

TARRAGON REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 9. ASSETS HELD FOR SALE

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which, among
other things, requires operating results for assets held for sale or sold to be
presented as discontinued operations for current and all prior years presented.
SFAS No. 144 also changes the rules for impairment testing of real estate held
for investment and requires the use of a probability weighted approach to
determine the holding period for purposes of estimating undiscounted cash flows.
We adopted this statement effective January 1, 2002. The adoption had no effect
on our reported net income (loss).

Assets held for sale and liabilities related to assets held for sale in the
accompanying Consolidated Balance Sheets include the following:

The operations of properties for which a plan of disposal was implemented after
the adoption of SFAS 144 have been reported in discontinued operations. Total
revenues included in discontinued operations were $218,000 for the six month
period ended June 30, 2002, and $162,000 and $362,000 for the three and six
month periods ended June 30, 2001. These operations were previously reported in
the investment segment.

NOTE 10. ACCOUNTING CHANGE

On July 1, 2002, we adopted the expense recognition provisions of recording the
fair value of stock options under the guidance of SFAS No 123, "Accounting for
Stock-Based Compensation." We have made no grants of stock options since the
adoption.

24

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

Please read this discussion along with the Consolidated Financial Statements and
Notes included elsewhere in this report.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of cash are property operations, borrowings, and proceeds
from the sale of properties. We believe these sources will continue to meet our
cash requirements, including debt service payments, property maintenance and
improvements, development costs for properties under construction, projected
purchases of existing properties, dividends on preferred stock, and planned
repurchases of common stock. Although we expect these sources of cash to be
sufficient to fund planned uses of cash, we make no assurance that the expected
sales and refinancings of properties will be completed as planned.

In the first six months of 2002, borrowings generated net proceeds of $26.1
million from the refinancing of mortgages on directly owned properties (after
existing loan payoffs), construction loan fundings, and borrowings under line of
credit facilities or other non-mortgage debt (net of $243,000 repayment of
advances from affiliates of William S. Friedman, President, Chief Executive
Officer, and Chairman of the Board of Directors of Tarragon).

Principal payments on notes payable totaling $53.2 million come due during the
remainder of 2002, including $46.6 million of balloon payments. Of this amount,
$3.3 million has been paid off since the end of the second quarter. We intend to
pay off or extend the loans as they come due largely through refinancings. We
estimate that refinancing will generate $16 million in net cash proceeds during
the remainder of 2002. We believe we can arrange such new financing as may be
needed to repay maturing notes.

We have guaranteed $4.5 million of mortgages on two unconsolidated properties.
We have also guaranteed construction loans totaling $167.2 million on four
unconsolidated properties, including the $90 million construction loan for the
Las Olas River House condominium development. This construction loan was closed
in March 2002 and has a current balance of $5 million. The aggregate current
balance of the other loans is $59.2 million.

In the first six months of 2002, we received $3 million in net cash proceeds
from the sale of an apartment property with a net carrying amount of $2.7
million after paying off a mortgage of $1.9 million. Additionally, we received
distributions of $10.7 million of proceeds from the sale of four joint venture
properties. We estimate proceeds from the projected sale of real estate will
provide approximately $8 million during the remainder of 2002.

As of June 30, 2002, we had entered into contracts for the sale of 24 of the
remaining 66 apartments at the 5600 Collins condominium conversion for a total
of $6.7 million. During the first six months of 2002, we closed the sale of 60
condominium units for $15.2 million. After closing costs and release payments on
the mortgage, we received net cash proceeds of $4.1 million. During the first
six months of 2002, Tarragon spent $3.7 million on capital improvements and unit
renovations in connection with the condominium conversion.

In April 2002, we purchased a tract of land for development for $2.8 million.

In the first six months of 2002, Tarragon made capital improvements to its
consolidated real estate of $19.4 million, (excluding expenditures at 5600
Collins discussed above). Of this amount, $13.9 million was spent on
construction at our development properties. We expect to spend approximately
$32.8 million on construction of three apartment communities and one retail
property under development that are consolidated during the

25

remainder of 2002, $25.5 million of which will be funded by construction loans.
We plan to invest approximately $3.6 million in capital improvements to our
consolidated operating properties during the remainder of 2002.

During the first six months of 2002, Tarragon advanced $4.2 million to a new
joint venture that purchased land in Fort Lauderdale, Florida, adjacent to the
Las Olas River House condominium development. The joint venture plans to build a
second phase of this project on the land. During the same period, Tarragon
received net repayment of advances of $3.7 million from One Las Olas, which owns
the Las Olas River House condominium development.

In December 2001, the Board of Directors declared a 10% common stock dividend
payable on April 26, 2002, to holders of record on April 15, 2002. This stock
dividend was recorded in March 2002.

We paid cash dividends of $343,000 to preferred stockholders in the first six
months of 2002.

The Board of Directors has authorized a common stock repurchase program. We
intend to continue to repurchase shares of our common stock as long as we
believe the fair market value of our net assets per share is substantially
greater than the market price of our common stock. During the first six months
of 2002, Tarragon repurchased 114,359 shares of its common stock in open market
and negotiated transactions at a cost of $1.6 million. Subject to market
conditions, we expect to repurchase shares of our common stock in 2002 at a rate
consistent with prior years. As of June 30, 2002, Tarragon had authority to
repurchase an additional 824,337 common shares.

RESULTS OF OPERATIONS

Equity in earnings of partnerships decreased $898,000 and increased $8.7 million
for the three and six month periods ended June 30, 2002. For the six month
period, Devonshire Apartment Owners, L.L.C., accounted for an increase of $8.2
million resulting from the sale of its only property and distribution of net
proceeds to its members. For the three month period, the sale of Devonshire's
property caused a $235,000 decrease. Ansonia Apartments, L.P., accounted for
increases for the three and six month periods of $708,000 and $1.5 million
resulted from recognizing our proportionate share of gains on sale of three of
its properties. Ansonia also accounted for a decrease of $550,000 in the three
month period due to lower operating income after the sales discussed above and
because Tarragon's share in its earnings has decreased since September 2001 when
the outside partners met their obligation to pay Tarragon 30% of the amounts it
contributed to Ansonia plus a preferred return. Decreases of $228,000 and
$245,000 came from two partnerships with properties recently completed or under
construction that began lease-up in 2002.

In the second quarter of 2002, we began consolidating two partnerships because
we now have a controlling interest in each. The consolidation resulted in an
increase in net rental income (rental revenue less property operating expenses)
of $895,000 for the three and six month periods. For the same periods, interest
expense increased $473,000, and depreciation increased $256,000. The outside
partner's interest in the partnerships' net income of $164,000 was recorded to
minority interest in the second quarter of 2002.

In May 2001, we deconsolidated three properties in connection with a change in
control upon forming joint ventures with Aetna Life Insurance Company. We
experienced decreases in net operating results of $100,000 and $30,000 for the
three and six month periods associated with these properties. These amounts
include decreases in consolidated net rental income of $557,000 and $2 million,
decreases in interest expense of $408,000 and $1.4 million, and decreases in
depreciation of $210,000 and $751,000. Additionally, we recorded losses of
$161,000 and $238,000 for the three and six month periods ended June 30, 2002,
representing our equity in the losses of these joint ventures for the periods.

26

We purchased two apartment communities in 2001 that contributed $130,000 and
$311,000 to net operating results for the three and six month periods. We sold a
10% interest in the Liberty Building to a third party in October 2001, and,
since that time, we have used the equity method of accounting to account for our
interest in this property. For the three and six month periods ended June 30,
2002, we recognized income of $104,000 and $211,000 representing our equity in
the income of the joint venture that owns this property. For the three and six
month periods ended June 30, 2001, this property contributed $1,500 and $5,200
to net operating results. These amounts were comprised of net rental income of
$171,000 and $353,000, interest expense of $131,000 and $272,000, and
depreciation of $38,000 and $76,000. The other property, Forest Park,
contributed $26,000 and $105,000 to net operating results for the three and six
month periods. These amounts were comprised of net rental income of $170,000 and
$386,000, interest expense of $99,000 and $194,000, and depreciation of $44,000
and $88,000.

The sale of two apartment communities, two commercial properties, and a portion
of another commercial property during 2001 reduced net operating results by
$152,000 and $212,000 for the three and six month periods. These decreases are
comprised of decreases in net rental income of $271,000 and $608,000, decreases
in interest expense of $111,000 and $348,000, and decreases in depreciation of
$8,000 and $48,000.

The operations of four recently completed consolidated apartment communities in
lease-up and one recently completed consolidated retail property which began
operations in 2001 or 2002 reduced our net operating results by $283,000 and
$514,000 for the three and six month periods. These amounts are comprised of
increases in net rental income of $1.1 million and $1.8 million, increases in
interest expense of $819,000 and $1.4 million, and increases in depreciation of
$550,000 and $926,000. As of August 4, 2002, occupancy at the four apartment
communities ranged from 61% to 93%, and the retail property was fully leased.

At June 30, 2002, Tarragon's consolidated apartment properties accounted for 88%
of its real estate and included 10,583 operating units, and our consolidated
operating commercial properties had an aggregate 1.2 million square feet.

The portfolio of 43 apartment properties with 8,777 units owned for all of 2002
and 2001 reported net rental income of $8 million and $15.8 million for the
three and six month periods ended June 30, 2002, compared with $7.3 million and
$14.5 million reported in the corresponding periods in 2001. Net rental income
as a percentage of rental revenue for the 8,777 units was 48.2% and 47.7% for
the three and six month periods in 2002 compared to 45.4% and 46.2% in 2001.
Rental revenue for the same store apartment properties increased $493,000, or
3.1%, and $1.7 million, or 5.5%, chiefly due to decreased vacancy losses at some
of the properties. Average monthly rental revenue per unit for the same store
properties increased 3.1% to $631 from $612 for the three month period and 5.5%
to $630 from $598 for the six month period. Property operating expenses on a
same store basis decreased $201,000, or 2.6% for the three months, and increased
$413,000, or 2.4%, for the six months primarily due to higher property insurance
costs. Average overall occupancy for apartment communities held in both years
increased slightly.

For properties held in both years, interest expense decreased $400,000 and $1.2
million primarily due to pay downs or pay offs of several mortgages and
decreases in interest rates on our variable rate debt.

Increases in depreciation of $209,000 and $422,000 resulted from resuming
depreciation of six properties reclassified from held for sale to held for
investment in 2001.

Property general and administrative expenses decreased $228,000 and $492,000 for
the three and six month periods in 2002 compared to the same periods in 2001,
primarily due to a change to third party property management for certain of our
properties and a related reduction in property management staff in March 2001.

27

In connection with the adoption of SFAS 142, on January 1, 2002, we ceased
amortizing goodwill and other intangible assets with indefinite useful lives.
Amortization for these assets in the three and six month periods ended June 30,
2001, was $207,000 and $415,000.

In March 2002, we recognized a gain of $2.3 million, presented with discontinued
operations, relating to the sale of one property. During 2001, we recognized
gains totaling $673,000 on the sale of portions of two properties. We also
recognized a previously deferred gain of $152,000 related to the sale of a
property.

We recognized extraordinary expenses of $390,000 resulting from exit fees,
prepayment penalties, and the write-off of deferred financing expenses
associated with refinancings during the six months ended June 30, 2002, and
$570,000 during the six months ended June 30, 2001.

During the first six months of 2002, we recognized gross revenue of $15.2
million on the sale of 60 condominium units at 5600 Collins Avenue. Due to an
increase in estimated costs to complete the condominium conversion, we have
recorded a For-Sale housing inventory write-down in the second quarter of 2002
of $1.4 million.

Investment Division

Net rental income for consolidated properties increased $3.8 million and $5.6
million for the three and six month periods ended June 30, 2002, compared to the
same periods in 2001. Net rental income for unconsolidated properties increased
$363,000 and $2.4 million for the three and six month periods. For both periods,
increases for consolidated properties and decreases for unconsolidated
properties of $895,000 are due to the consolidation of two partnerships because
we now hold controlling interests in each. The remaining increases were
primarily due to 16 properties (11 consolidated and five unconsolidated)
stabilized during 2001 or the first quarter of 2002 and moved from the
Development Division into the Investment Division in 2002. For consolidated
properties, increases of $3.2 million and $5.3 million came from the 11 recently
stabilized properties. Decreases of $448,000 and $991,000 resulted from the
reclassification of a property to the For-Sale Housing Division in 2002 upon
initiation of its conversion to condominiums. For unconsolidated properties,
increases of $2.3 million and $4.6 million came from the five recently
stabilized properties. Decreases of $1.1 million and $1.6 million resulted from
the sale of four unconsolidated Investment Division properties in 2002. Moving
these properties to the Investment Division also accounted for most of the
increases in interest and depreciation expense for both consolidated and
unconsolidated properties, although the 46 same store consolidated properties
reported decreases in interest expense of $340,000 and $880,000 resulting from
lower interest rates on variable rate debt.

Tarragon uses funds from operations ("FFO") along with net income or loss
computed in accordance with accounting principles generally accepted in the
United States of America ("GAAP") to measure the performance of the properties
in its Investment Division. See NOTE 7. "SEGMENT REPORTING" in the Notes to
Consolidated Financial Statements for the definition of FFO. The 62 same store
properties, both consolidated and unconsolidated, in the Investment Division
reported increases of $502,000, or 14%, and $1.4 million, or 21%, in FFO for the
three and six month periods ended June 30, 2002, compared to the same periods in
2001. Sixteen properties that were stabilized in 2001 or the first quarter of
2002 and moved into the Investment Division in 2002 contributed FFO in 2002 of
$2 million and $3.9 million for the three and six month periods. One property
acquired in October 2001 contributed $71,000 and $193,000 to FFO for the
Investment Division for the three and six month periods.

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Development Division

Tarragon measures the performance of its Development Division primarily by net
profit from third party and intercompany sales. Net profit from intercompany
sales is the excess of the properties' estimated fair values over their net
carrying values at the date they are determined to be stabilized and moved into
the investment division. Gains on transfers of assets between segments do not
represent gains recognizable in accordance with GAAP and, accordingly, are
eliminated for purposes of consolidated reporting.

In the first six months of 2002, the Development Division reported net profit of
$51.6 million on the transfer of 11 consolidated and five unconsolidated
properties to the Investment Division upon the determination that they were
stabilized. Of this amount, $12.9 million was reported in the second quarter of
2002. In the first six months of 2001, the Development Division reported net
profit of $12.2 million on the transfer of properties that had become stabilized
(five consolidated and five unconsolidated) to the Investment Division.

For-Sale Housing Division

Tarragon also measures the performance of its For-Sale Housing Division
primarily by net profit from third party and intercompany sales. Although it is
our smallest division, it is expected to be our most rapidly growing division.
Prior to 2002, the assets currently in our For-Sale Housing Division were
reported along with the Development Division.

CRITICAL ACCOUNTING POLICIES

Asset Impairment

We periodically review the carrying values of our properties. GAAP requires that
the carrying value of a property held for sale not exceed the lower of its cost
or its estimated fair value less costs to sell. In instances where a property's
estimated fair value less costs to sell is less than its carrying value at the
time of evaluation, we provide an allowance for loss by making a charge against
operations. Our review of properties held for sale generally includes selective
site inspections, comparing the property's current rents to market rents,
reviewing the property's expenses and maintenance requirements, discussions with
the property manager, and a review of the surrounding area. We may make
adjustments to estimated fair values based on future reviews.

We also evaluate our properties held for investment for impairment whenever
events or changes in circumstances indicate that a property's carrying value may
not be recoverable. This evaluation generally consists of reviewing the
property's cash flow and current and projected market conditions, as well as
changes in general and local economic conditions. If we conclude that a property
has been impaired, we reduce its carrying value by making a charge against
current earnings in the amount by which the carrying value of the property
exceeds its estimated fair value.

Investments in Joint Ventures Accounted for Using the Equity Method

We use the equity method to account for investments in partnerships and joint
ventures we do not control. Under the equity method, our initial investments are
increased by our proportionate share of the partnerships' operating income and
additional advances and decreased by our proportionate share of the
partnerships' operating losses and distributions received. All significant
intercompany transactions are eliminated.

We have investments in 17 partnerships or joint ventures in which we hold
noncontrolling interests or our outside partners have significant participating
rights, as defined by the Financial Accounting Standards Board's Emerging Issues
Task Force in its 96-16 Abstract. The net effect of not consolidating these
joint ventures has been to reduce consolidated total assets, total liabilities,
and gross revenues and expenses but has had no effect

29

on reported net income or loss except in instances where we have received
distributions from a joint venture in excess of our investment in the joint
venture, with the excess recorded as income.

Goodwill

Goodwill was recorded in connection with the acquisitions of Tarragon Realty
Advisors in 1998 and Accord Properties Associates in 2001 and, until December
31, 2001, was amortized on the straight-line method. We adopted Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets," on January 1, 2002. SFAS No. 142 requires that goodwill and other
intangible assets with indefinite useful lives no longer be amortized as
expenses of operations but rather carried on the balance sheet as permanent
assets. These assets are subject to at least annual assessment for impairment by
applying a fair-value-based test. As of the date of adoption, we had unamortized
goodwill of $2.7 million, which was subject to the transition provisions of SFAS
No. 142. We have determined there is no transitional impairment loss at January
1, 2002. Amortization of goodwill and other intangible assets with indefinite
useful lives was $207,000 and $415,000 for the three and six month periods ended
June 30, 2001.

Revenue Recognition

Rental, interest, and management fee revenue are recognized when earned. Revenue
from long term laundry and cable service contracts is deferred and amortized to
income on the straight-line basis over the terms of the contracts.

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

Recent Accounting Pronouncement

In April 2002, the Financial Accounting Standards Board issued SFAS No. 145,
"Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement No.
13, and Technical Corrections," which, among other things, rescinded SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt." SFAS No. 4 required
gains and losses from extinguishments of debt to be classified as extraordinary
items, if material. Under SFAS No. 145, gains and losses on extinguishments of
debt will no longer be classified as extraordinary unless they meet the unusual
in nature and infrequency of occurrence criteria in the Accounting Principles
Board's Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," which is expected to be rare.
SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. Upon
our adoption of SFAS No. 145 in January 2003, prepayment penalties or exit fees
and the write-off of deferred financing expenses in connection with repayment of
debt prior to maturity will no longer be classified as extraordinary items, but
there will be no impact on our reported net income or loss.

ENVIRONMENTAL MATTERS

Under federal, state, and local environmental laws, ordinances, and regulations,
Tarragon may be liable for removal or remediation costs, as well as other costs
(such as fines or injuries to persons and property) where our employees may have
arranged for removal, disposal, or treatment of hazardous or toxic substances.
In addition, environmental laws impose liability for release of
asbestos-containing materials into the air, and third parties can seek recovery
from Tarragon for personal injury associated with those materials. We are not
aware of any liability relating to these matters that would have a material
adverse effect on our business, financial position, or results of operations.

30

RISKS ASSOCIATED WITH FORWARD-LOOKING STATEMENTS INCLUDED IN THIS FORM 10-Q

In addition to historical information, this Form 10-Q contains forward-looking
statements. Forward-looking statements are expressions of our current beliefs
and expectations, based on information currently available to us, estimates, and
projections about our industry, and certain assumptions made by our management.
These statements are not historical facts. We use words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," and similar
expressions to identify our forward-looking statements.

Because we are unable to control or predict many of the factors that will
determine our future performance and financial results, including future
economic, competitive, and market conditions, our forward-looking statements are
not guarantees of future performance. They are subject to risks, uncertainties,
and errors in assumptions that could cause our actual results to differ
materially from those reflected in our forward-looking statements. We believe
that the assumptions underlying our forward-looking statements are reasonable.

However, you should not place undue reliance on these forward-looking
statements. They only reflect our view and expectations as of the date of this
Form 10-Q. We undertake no obligation to publicly update or revise any
forward-looking statement in light of new information, future events, or
otherwise.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Tarragon is exposed to market risk from changes in interest rates that may
adversely affect our financial position, results of operations, and cash flows.
In seeking to minimize the risks from interest rate fluctuations, we manage such
exposure through our regular operating and financing activities. We do not trade
or speculate in financial instruments.

In June 2002, we sold a put option for $10,000 to La Jolla Cove Investors, Inc.
("LJCI"), which is unaffiliated with us. During a period of one year expiring
June 24, 2003, LJCI has the right to sell and we have an obligation to purchase
all or any portion of our common stock then owned or held by LJCI, up to a total
of 100,000 shares, for a cash purchase price of $15 per share. Any exercise of
the put option by LJCI must be in a minimum amount of 5,000 shares per delivery.
The sale price will be recorded as a liability as of the date of sale. In
accordance with SFAS 133, if the price of our common stock falls below $15
during the term of the put option agreement, the difference between the market
price of the stock and the $15 put price multiplied by 100,000 shares will be
recorded as a charge to earnings and a corresponding increase to the liability.
At August 5, 2002, the closing ask price was $15.05.

Except as discussed above, there have been no material changes to Tarragon's
market risk since December 31, 2001.

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PART II. OTHER INFORMATION

ITEM 5. OTHER INFORMATION

In June 2002, we sold a put option for $10,000 to La Jolla Cove Investors, Inc.
("LJCI"), which is unaffiliated with us. During a period of one year expiring
June 24, 2003, LJCI has the right to sell and we have an obligation to purchase
all or any portion of our common stock then owned or held by LJCI, up to a total
of 100,000 shares, for a cash purchase price of $15 per share. Any exercise of
the put option by LJCI must be in a minimum amount of 5,000 shares per delivery.
The sale price will be recorded as a liability as of the date of sale. In
accordance with SFAS 133, if the price of our common stock falls below $15
during the term of the put option agreement, the difference between the market
price of the stock and the $15 put price multiplied by 100,000 shares will be
recorded as a charge to earnings and a corresponding increase to the liability.
At August 5, 2002, the closing ask price of our common stock was $15.05.

On July 1, 2002, we adopted the expense recognition provisions of recording the
fair value of stock options under the guidance of SFAS No 123, "Accounting for
Stock-Based Compensation." We have made no grants of stock options since the
adoption.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

(b) The following reports on Form 8-K or Form 8-K/A were filed during the
second quarter covered by this report or with respect to events
occurring after the period covered by this report but prior to the
filing of this report.

Date of Event Date Filed Items Reported
-------------- -------------- -------------------------------
August 5, 2002 August 8, 2002 Item 4. Changes in Registrant's
Certifying Accountant

August 5, 2002 August 16, 2002 Item 4. Changes in Registrant's
Certifying Accountant

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SIGNATURES

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

TARRAGON REALTY INVESTORS, INC.

Date: August 16, 2002 By: /s/ William S. Friedman
------------------------------- -----------------------------------
William S. Friedman
President, Chief Executive
Officer, Director, and Chairman
of the Board of Directors

Date: August 16, 2002 By: /s/ Erin D. Pickens
------------------------------- -----------------------------------
Erin D. Pickens
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)

33

INDEX TO EXHIBITS