CRESCENT REAL ESTATE EQUITIES CO - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR QUARTER ENDED June 30, 2004
COMMISSION FILE NO. 1-13038

CRESCENT REAL ESTATE EQUITIES COMPANY
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

TEXAS 52-1862813
- --------------------------------------------- ----------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification Number)

777 Main Street, Suite 2100, Fort Worth, Texas 76102
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(Address of principal executive offices)(Zip code)

Registrant's telephone number, including area code (817) 321-2100

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 twelve (12) months (or for such shorter period that the registrant
was required to file such report) and (2) has been subject to such filing
requirements for the past ninety (90) days.

YES X NO
----- -----

Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act).

YES X NO
----- -----

Number of shares outstanding of each of the registrant's classes of preferred
and common shares, as of July 30, 2004.

Series A Convertible Cumulative Preferred Shares, par value $0.01 per share: 14,200,000
Series B Cumulative Redeemable Preferred Shares, par value $0.01 per share: 3,400,000
Common Shares, par value $0.01 per share: 99,394,943

CRESCENT REAL ESTATE EQUITIES COMPANY
FORM 10-Q
TABLE OF CONTENTS

PART I

ITEM 1. FINANCIAL STATEMENTS

CRESCENT REAL ESTATE EQUITIES COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

The accompanying notes are an integral part
of these consolidated financial statements.

3

CRESCENT REAL ESTATE EQUITIES COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share data)
(unaudited)

The accompanying notes are an integral part
of these consolidated financial statements.

4

CRESCENT REAL ESTATE EQUITIES COMPANY
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(dollars in thousands)
(unaudited)

The accompanying notes are an integral part
of these consolidated financial statements.

5

CRESCENT REAL ESTATE EQUITIES COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)

The accompanying notes are an integral part
of these consolidated financial statements.

6

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND BASIS OF PRESENTATION

Crescent Real Estate Equities Company ("Crescent Equities") operates as
a real estate investment trust for federal income tax purposes (a "REIT") and,
together with its subsidiaries, provides management, leasing and development
services for some of its properties.

The term "Company" includes, unless the context otherwise indicates,
Crescent Equities, a Texas real estate investment trust, and all of its direct
and indirect subsidiaries.

The direct and indirect subsidiaries of Crescent Equities at June 30,
2004 included:

o CRESCENT REAL ESTATE EQUITIES LIMITED PARTNERSHIP
The "Operating Partnership."

o CRESCENT REAL ESTATE EQUITIES, LTD.
The "General Partner" of the Operating Partnership.

o SUBSIDIARIES OF THE OPERATING PARTNERSHIP AND THE
GENERAL PARTNER

Crescent Equities conducts all of its business through the Operating
Partnership and its other subsidiaries. The Company is structured to facilitate
and maintain the qualification of Crescent Equities as a REIT.

The following table shows the consolidated subsidiaries of the Company
that owned or had an interest in real estate assets and the real estate assets
that each subsidiary owned or had an interest in as of June 30, 2004.

Operating Partnership Wholly-owned assets - The Avallon IV,
Datran Center (two office properties),
Houston Center (three office properties and
the Houston Center Shops), and Dupont
Centre. These properties are included in
the Company's Office Segment.

Non wholly-owned assets, consolidated - 301
Congress Avenue (50% interest) and Fountain
Place (0.1%), included in the Company's
Office Segment. Sonoma Mission Inn (80.1%
interest), included in the Company's
Resort/Hotel Segment.

See Note 6, "Other Transactions," for a
description of the Fountain Place Office
Property transaction.

Non wholly-owned assets, unconsolidated -
Bank One Center (50% interest), Bank One
Tower (20% interest), Three Westlake Park
(20% interest), Four Westlake Park (20%
interest), Miami Center (40% interest), 5
Houston Center (25% interest), BriarLake
Plaza (30% interest) and Five Post Oak Park
(30% interest). These properties are
included in the Company's Office Segment.
Temperature-Controlled Logistics Properties
(40% interest in 87 properties), included
in the Company's Temperature-Controlled
Logistics Segment.

Hughes Center Entities(1) Wholly-owned assets - Hughes Center
Properties (seven office properties each
in a separate limited liability company).
These properties are included in the
Company's Office Segment.

Non wholly-owned asset, consolidated - 3770
Hughes Parkway (67% interest), included in
the Company's Office Segment.

Crescent Real Estate Funding Wholly-owned assets - The Aberdeen, The
I, L.P. ("Funding I") Avallon I, II & III, Carter Burgess Plaza,
The Citadel, The Crescent Atrium, The
Crescent Office Towers, Regency Plaza One,
Waterside Commons and 125 E. John Carpenter
Freeway. These properties are included in
the Company's Office Segment.

Crescent Real Estate Funding Wholly-owned assets - Greenway Plaza Office
III, IV and V, L.P. Properties (ten Office Properties). These
("Funding III, IV and V")(2) properties are included in the Company's
Office Segment. Renaissance Houston Hotel
is included in the Company's Resort/Hotel
Segment.

Crescent Real Estate Wholly-owned asset - Canyon Ranch - Lenox,
Funding VI, L.P. included in the Company's Resort/Hotel
("Funding VI") Segment.

Crescent Real Estate Funding Wholly-owned assets - The Addison, Austin
VIII, L.P. ("Funding VIII") Centre, The Avallon V, Chancellor Park, 816
Congress, Greenway I & IA (two office
properties), Greenway II, Johns Manville
Plaza, Palisades Central I, Palisades
Central II, Stemmons Place, Trammell Crow
Center(3), 3333 Lee Parkway, 5050 Quorum,
44 Cook and 55 Madison. These properties
are included in the Company's Office
Segment. The Canyon Ranch - Tucson, Omni
Austin Hotel, and Ventana Inn & Spa, all of
which are included in the Company's
Resort/Hotel Segment.

Crescent Real Estate Funding Wholly-owned assets - Post Oak Central
X, L.P. ("Funding X") (three Office Properties). These properties
are included in the Company's Office
Segment.

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CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Crescent Real Estate Funding Wholly-owned assets - 12404 Park Central,
XII, L.P. ("Funding XII") Albuquerque Plaza, Barton Oaks Plaza,
Briargate Office and Research Center,
MacArthur Center I & II, Stanford Corporate
Center, and Two Renaissance Square. These
properties are included in the Company's
Office Segment. The Hyatt Regency
Albuquerque and the Park Hyatt Beaver Creek
Resort & Spa. These properties are
included in the Company's Resort/Hotel
Segment.

Crescent 707 17th Street, Wholly-owned assets - 707 17th Street,
L.L.C included in the Company's Office Segment,
and The Denver Marriott City Center,
included in the Company's Resort/Hotel
Segment.

Crescent Spectrum Center, Non wholly-owned asset, consolidated -
L.P. Spectrum Center (approximately 100%
interest), included in the Company's Office
Segment.

Crescent Colonnade, L.L.C. Wholly-owned asset - The BAC-Colonnade
Building, included in the Company's Office
Segment.

Mira Vista Development Corp. Non wholly-owned asset, consolidated - Mira
("MVDC") Vista (98% interest), included in the
Company's Residential Development Segment.

Houston Area Development Non wholly-owned assets, consolidated -
Corp. ("HADC") Falcon Point (98% interest), Falcon Landing
(98% interest) and Spring Lakes (98%
interest). These properties are included in
the Company's Residential Development
Segment.

Desert Mountain Development Non wholly-owned assets, consolidated -
Corporation ("DMDC") Desert Mountain (93% interest), included
in the Company's Residential Development
Segment.

Crescent Resort Development Non wholly-owned assets, consolidated -
Inc. ("CRDI") Brownstones (64% interest), Creekside at
Riverfront (64% interest), Cresta (60%
interest), Delgany (64% interest), Eagle
Ranch (60% interest), Gray's Crossing (71%
interest), Horizon Pass Lodge (64%
interest), Horizon Pass Townhomes (64%
interest), Hummingbird (64% interest),
Main Street Station (30% interest),
Northstar (57% interest), Old Greenwood
(71% interest), Park Place at Riverfront
(64% interest), Park Tower at Riverfront
(64% interest), Riverbend (60% interest),
Riverfront Park (64% interest). These
properties are included in the Company's
Residential Development Segment.

Non wholly-owned assets, unconsolidated -
Blue River Land Company, L.L.C. - Three
Peaks (30% interest) and EW Deer Valley,
L.L.C. (42% interest), included in the
Company's Residential Development Segment.

Crescent TRS Holdings Corp. Non wholly-owned assets, unconsolidated -
two quarries (56% interest). These
properties are included in the Company's
Temperature-Controlled Logistics Segment.

- ----------

(1) In addition, the Company owns nine retail parcels located in Hughes
Center.

(2) Funding III owns nine of the ten office properties in the Greenway
Plaza office portfolio and the Renaissance Houston Hotel; Funding IV
owns the central heated and chilled water plant building located at
Greenway Plaza; and Funding V owns 9 Greenway, the remaining office
property in the Greenway Plaza office portfolio.

(3) The Company owns the economic interest in Trammell Crow Center through
its ownership of fee simple title to the Property (subject to a ground
lease and a leasehold estate regarding the building) and two mortgage
notes encumbering the leasehold interests in the land and the building.

See Note 8, "Investments in Unconsolidated Companies," for a table that
lists the Company's ownership in significant unconsolidated joint ventures and
investments as of June 30, 2004.

See Note 9, "Notes Payable and Borrowings Under Credit Facility," for a
list of certain other subsidiaries of the Company, all of which are consolidated
in the Company's financial statements and were formed primarily for the purpose
of obtaining secured debt or joint venture financing.

SEGMENTS

The assets and operations of the Company were divided into four
investment segments at June 30, 2004, as follows:

o Office Segment;

o Resort/Hotel Segment;

o Residential Development Segment; and

o Temperature-Controlled Logistics Segment.

Within these segments, the Company owned in whole or in part the
following real estate assets (the "Properties") as of June 30, 2004:

o OFFICE SEGMENT consisted of 75 office properties (collectively
referred to as the "Office Properties"), located in 28
metropolitan submarkets in seven states, with an aggregate of
approximately 30.0 million net rentable square feet.
Sixty-five of the Office Properties are wholly-owned and ten
are owned through joint ventures, two of which are
consolidated and eight of which are unconsolidated.

8

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

o RESORT/HOTEL SEGMENT consisted of five luxury and destination
fitness resorts and spas with a total of 1,036 rooms/guest
nights and four upscale business-class hotel properties with a
total of 1,771 rooms (collectively referred to as the
"Resort/Hotel Properties"). Eight of the Resort/Hotel
Properties are wholly-owned and one is owned through a joint
venture that is consolidated.

o RESIDENTIAL DEVELOPMENT SEGMENT consisted of the Company's
ownership of common stock representing interests of 98% to
100% in four residential development corporations
(collectively referred to as the "Residential Development
Corporations"), which in turn, through partnership
arrangements, owned in whole or in part 28 upscale residential
development properties (collectively referred to as the
"Residential Development Properties").

o TEMPERATURE-CONTROLLED LOGISTICS SEGMENT consisted of the
Company's 40% interest in Vornado Crescent Portland
Partnership (the "Temperature-Controlled Logistics
Partnership") and a 56% non-controlling interest in the
Vornado Crescent Carthage and KC Quarry L.L.C. ("VCQ"). The
Temperature-Controlled Logistics Partnership owns all of the
common stock, representing substantially all of the economic
interest, of AmeriCold Realty Trust (the
"Temperature-Controlled Logistics Corporation"), a REIT. As of
June 30, 2004, the Temperature-Controlled Logistics
Corporation directly or indirectly owned 87
temperature-controlled logistics properties (collectively
referred to as the "Temperature-Controlled Logistics
Properties") with an aggregate of approximately 440.7 million
cubic feet (17.5 million square feet) of warehouse space. As
of June 30, 2004, VCQ owned two quarries and the related land.
The Company accounts for its interests in the
Temperature-Controlled Logistics Partnership and in VCQ as
unconsolidated equity entities.

See Note 3, "Segment Reporting," for a table showing selected financial
information for each of these investment segments for the three and six months
ended June 30, 2004 and 2003, and total assets, consolidated property level
financing, consolidated other liabilities, and minority interests for each of
these investment segments at June 30, 2004 and December 31, 2003.

BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
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 generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three- and six- month
periods ended June 30, 2004 are not necessarily indicative of the results that
may be expected for the year ended December 31, 2004.

The condensed consolidated balance sheet at December 31, 2003 has been
derived from the audited consolidated financial statements at that date but does
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.

You should read these consolidated financial statements in conjunction
with the consolidated financial statements and footnotes thereto in the
Company's annual report on Form 10-K for the year ended December 31, 2003.

Certain amounts in prior period financial statements have been
reclassified to conform to current period presentation.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This section should be read in conjunction with the more detailed
information regarding the Company's significant accounting policies contained in
the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

ADOPTION OF NEW ACCOUNTING STANDARD

EITF 03-1. At the March 17-18, 2004 meeting, consensus was reached by
the FASB Emerging Issues Task Force on EITF 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments." The
Consensus applies to investments in debt and equity securities within the scope
of SFAS Nos. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and 124, "Accounting for Certain Investments Held by Not-for-Profit
Organizations." It also applies to investments in equity securities that are
both outside SFAS No. 115's scope and not accounted for under the equity method.
The Task Force reached a consensus that certain quantitative and qualitative
disclosures should be required for securities that are impaired at the balance
sheet date but for which an other-than-temporary impairment has not been
recognized. The new impairment guidance creates a model that calls for many
judgments and

9

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

additional evidence gathering in determining whether or not securities are
other-than-temporarily impaired and lists some of these impairment indicators.
The impairment accounting guidance is effective for periods beginning after June
15, 2004 and the disclosure requirements for annual reporting periods are
effective for periods ending after June 15, 2004. The Company adopted EITF 03-1
effective July 1, 2004 and expects no impact on the Company's financial
condition or its results of operations.

SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION OF VARIABLE INTEREST ENTITIES. On January 15, 2003, the
FASB approved the issuance of Interpretation 46, "Consolidation of Variable
Interest Entities," ("FIN 46"), an interpretation of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements." In December 2003, the FASB
issued FIN 46R, "Consolidation of Variable Interest Entities" ("FIN 46R"), which
amended FIN 46. Under FIN 46R, consolidation requirements are effective
immediately for new Variable Interest Entities ("VIEs") created after January
31, 2003. The consolidation requirements apply to existing VIEs for financial
periods ending after March 15, 2004, except for special purpose entities which
had to be consolidated by December 31, 2003. VIEs are generally a legal
structure used for business enterprises that either do not have equity investors
with voting rights, or have equity investors that do not provide sufficient
financial resources for the entity to support its activities. The objective of
the new guidance is to improve reporting by addressing when a company should
include in its financial statements the assets, liabilities and activities of
other entities such as VIEs. FIN 46R requires VIEs to be consolidated by a
company if the company is subject to a majority of the expected losses of the
VIE's activities or entitled to receive a majority of the entity's expected
residual returns or both.

The adoption of FIN 46R did not have a material impact to the Company's
financial condition or results of operations. Due to the adoption of this
Interpretation and management's assumptions in application of the guidelines
stated in the Interpretation, the Company has consolidated GDW LLC, a subsidiary
of DMDC, as of December 31, 2003 and Elijah Fulcrum Fund Partners, L.P.
("Elijah") as of January 1, 2004. Elijah is a limited partnership whose purpose
is to invest in the SunTx Fulcrum Fund, L.P. SunTx Fulcrum Fund, L.P.'s
objective is to invest in a portfolio of acquisitions that offer the potential
for substantial capital appreciation. While it was determined that one of the
Company's unconsolidated joint ventures, Main Street Partners, L.P., and its
investments in Canyon Ranch Las Vegas, L.L.C., CR License, L.L.C. and CR License
II, L.L.C. ("Canyon Ranch Entities") are VIEs under FIN 46R, the Company is not
the primary beneficiary and is not required to consolidate these entities under
other GAAP. The Company's maximum exposure to loss is limited to its equity
investment of approximately $52.0 million in Main Street Partners, L.P. and $5.1
million in the Canyon Ranch Entities at June 30, 2004.

In connection with the Hughes Center acquisition, the Company entered
into two separate exchange agreements with a third party intermediary. The first
exchange agreement includes two parcels of undeveloped land and the second
exchange agreement includes the 3930 Hughes Parkway Office Property. Both
agreements were for a maximum term of 180 days and allow the Company to pursue
favorable tax treatment on other properties sold by the Company within this
period. During the 180-day periods, which will end on August 28, 2004 and
November 6, 2004, respectively, the third party intermediary is the legal owner
of the properties, although the Company controls the properties, retains all of
the economic benefits and risks associated with these properties and indemnifies
the third party intermediary and, therefore, the Company fully consolidates
these properties. The Company will take legal ownership of the properties no
later than on the expiration of the 180-day period.

Further, in connection with the Hughes Center acquisition, the Company
entered into an exchange agreement with a third party intermediary for six of
the Office Properties and the nine retail parcels. This agreement was for a
maximum term of 180 days and allowed the Company to pursue favorable tax
treatment on other properties sold by the Company within this period. During the
180-day period, which ended on June 28, 2004, the third party intermediary was
the legal owner of the properties, although the Company controlled the
properties, retained all of the economic benefits and risks associated with
these properties and indemnified the third party intermediary and, therefore,
the Company fully consolidated these properties. On June 28, 2004, the Company
took legal ownership of the Office Properties and the nine retail parcels.

STOCK-BASED COMPENSATION. Effective January 1, 2003, the Company
adopted the fair value expense recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," on a prospective basis as permitted
by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," which requires that the fair value of stock options at the date of
grant be amortized ratably into expense over the appropriate vesting period.
During the six months ended June 30, 2004, the Company granted stock options and
recognized compensation expense that was not significant to its results of
operations. With respect to the Company's stock options which were granted prior
to 2003, the Company accounted for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations ("APB
No. 25"). Had compensation cost

10

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

been determined based on the fair value at the grant dates for awards under the
Plans consistent with SFAS No. 123, the Company's net loss and loss per share
would have been reduced to the following pro forma amounts:

MARKETABLE SECURITIES. The Company has classified and recorded its
marketable securities in accordance with SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Realized gains or losses on the sale
of securities are recorded based on specific identification. When a decline in
the fair value of marketable securities is determined to be
other-than-temporary, the cost basis is written down to fair value and the
amount of the write-down is included in earnings for the applicable period.
Investments in securities with no readily determinable market value are reported
at cost, as they are not considered marketable under SFAS No. 115, and total
$5.5 million at June 30, 2004 and December 31, 2003.

The following tables present the cost, fair value and unrealized gains
and losses as of June 30, 2004 and December 31, 2003 and the realized gains and
change in Accumulated Other Comprehensive Income ("OCI") for the six months
ended June 30, 2004 and 2003 for the Company's marketable securities.

- ----------

(1) Held to maturity securities are carried at amortized cost and consist
of $173.9 million of U.S. Treasury and government sponsored agency
securities purchased for the sole purpose of funding debt service
payments on the LaSalle Note II and $13.8 million of bonds included in
"Other assets, net" in the accompanying Consolidated Balance Sheets at
June 30, 2004. See Note 9, "Notes Payable and Borrowings Under Credit
Facility," for additional information on the defeasance of the LaSalle
Note II.

(2) Trading securities consist of primarily marketable securities purchased
in connection with the Company's dividend incentive unit program. These
securities are included in "Other assets, net" in the accompanying
Consolidated Balance Sheets and are marked to market value on a monthly
basis with the change in fair value recognized in earnings.

(3) Available for sale securities consist of marketable securities which
the Company intends to hold for an indefinite period of time. These
securities are included in "Other assets, net" in the accompanying
Consolidated Balance Sheets and are marked to market value on a monthly
basis with the corresponding unrealized gain or loss recorded in OCI.

In July 2004, Fresh Choice, Inc., in which the Company owns $5.5
million Series B Preferred shares reported at cost at June 30, 2004 and December
31, 2003, filed for protection under Chapter 11 of the U.S. Bankruptcy Court in
order to facilitate a reorganization and restructuring. At June 13, 2004, the
accrued liquidation preference on the Series B Preferred shares was $9.1
million. Based on the Company's evaluation of its preferred interest in Fresh
Choice, the Company estimates the value of its shares at a minimum to be equal
to the investment balance of $5.5 million.

11

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

EARNINGS PER SHARE. SFAS No. 128, "Earnings Per Share," ("EPS")
specifies the computation, presentation and disclosure requirements for earnings
per share.

Basic EPS is computed by dividing net income available to common
stockholders by the weighted average number of shares outstanding for the
period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock, where such exercise or conversion would result in a lower EPS
amount. The Company presents both basic and diluted earnings per share.

The following tables present reconciliations for the three and six
months ended June 30, 2004 and 2003 of basic and diluted earnings per share from
"Loss before discontinued operations and cumulative effect of a change in
accounting principle" to "Net loss available to common shareholders." The table
also includes weighted average shares on a basic and diluted basis, which for
the periods presented, are the same.

- ----------

(1) Anti-dilutive shares not included are 114 and 13 for the three months ended
June 30, 2004 and 2003, respectively.

- ----------
(1) Anti-dilutive shares not included are 218 and 7 for the six months ended
June 30, 2004 and 2003, respectively.

12

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SUPPLEMENTAL DISCLOSURE TO STATEMENTS OF CASH FLOWS

3. SEGMENT REPORTING

For purposes of segment reporting as defined in SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," the
Company currently has four major investment segments based on property type: the
Office Segment; the Resort/Hotel Segment; the Residential Development Segment;
and the Temperature-Controlled Logistics Segment. Management utilizes this
segment structure for making operating decisions and assessing performance.

The Company uses funds from operations ("FFO") as the measure of
segment profit or loss. FFO, as used in this document, is based on the
definition adopted by the Board of Governors of the National Association of Real
Estate Investment Trusts ("NAREIT") and means:

o Net Income (Loss) - determined in accordance with GAAP;

o excluding gains (losses) from sales of depreciable operating
property;

o excluding extraordinary items (as defined by GAAP);

o plus depreciation and amortization of real estate assets; and

o after adjustments for unconsolidated partnerships and joint
ventures.

The Company calculates FFO available to common shareholders - diluted
in the same manner, except that Net Income (Loss) is replaced by Net Income
(Loss) Available to Common Shareholders and the Company includes the effect of
Operating Partnership unitholder minority interests.

13

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NAREIT developed FFO as a relative measure of performance of an equity
REIT to recognize that income-producing real estate historically has not
depreciated on the basis determined under GAAP. The Company considers FFO
available to common shareholders - diluted and FFO appropriate measures of
performance for an equity REIT and for its investment segments. However, FFO
available to common shareholders - diluted and FFO should not be considered as
alternatives to net income determined in accordance with GAAP as an indication
of the Company's operating performance.

The Company's measures of FFO available to common shareholders -
diluted and FFO may not be comparable to similarly titled measures of other
REITs if those REITs apply the definition of FFO in a different manner than the
Company.

Selected financial information related to each segment for the three
and six months ended June 30, 2004 and 2003, and total assets, consolidated
property level financing, consolidated other liabilities, and minority interests
for each of the segments at June 30, 2004 and December 31, 2003, are presented
below:

See footnotes to the following table.

14

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

See footnotes to the following table.

See footnotes to the following table.

15

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

See footnotes to the following table.

- ----------

(1) The property revenue includes lease termination fees (net of the
write-off of deferred rent receivables) of approximately $5.9 million
and $0.9 million for the three months ended June 30, 2004 and 2003,
respectively and $7.2 million and $2.9 million for the six months ended
June 30, 2004 and 2003, respectively.

(2) The Company sold its interest in The Woodlands Land Development
Company, L.P. on December 31, 2003.

(3) For purposes of this Note, Corporate and Other includes the total of:
interest and other income, corporate general and administrative
expense, interest expense, amortization of deferred financing costs,
extinguishment of debt, other expenses, and equity in net income of
unconsolidated companies-other.

(4) The Company's net book value for the Residential Development Segment
includes total assets, consolidated property level financing,
consolidated other liabilities and minority interest totaling $496
million at June 30, 2004. The primary components of net book value are
$332 million for CRDI, consisting of Tahoe Mountain Resort properties
of $192 million, Denver development properties of $61 million and
Colorado Mountain development properties of $79 million, $132 million
for Desert Mountain and $32 million for other land development
properties.

(5) Total assets by segment are inclusive of investments in unconsolidated
companies.

(6) Non-income producing land held for investment or development of $82.5
million by segment is as follows: Corporate $79.0 million and
Resort/Hotel $3.5 million.

(7) Includes U.S. Treasury and government sponsored agency securities of
$173.9 million.

(8) Inclusive of Corporate bonds, credit facility, the $75 million Fleet
Term Loan and Funding II defeased debt.

16

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ASSET ACQUISITIONS

OFFICE PROPERTIES

During January and February 2004, in accordance with the original
purchase contract, the Company acquired an additional five Class A Office
Properties and seven retail parcels located within Hughes Center in Las Vegas,
Nevada from the Rouse Company. One of these Office Properties is owned through a
joint venture in which the Company acquired a 67% interest. The remaining four
Office Properties are wholly-owned by the Company. The Company acquired these
five Office Properties and seven retail parcels for approximately $175.3
million, funded by the Company's assumption of approximately $85.4 million in
mortgage loans and by a portion of the proceeds from the sale of the Company's
interests in The Woodlands on December 31, 2003. The Company recorded the loans
assumed at their fair value of approximately $93.2 million, which includes $7.8
million of premium. The five Office Properties are included in the Company's
Office Segment.

On March 31, 2004, the Company acquired Dupont Centre, a 250,000 square
foot Class A office property, located in the John Wayne Airport submarket of
Irvine, California. The Company acquired the Office Property for approximately
$54.3 million, funded by a draw on the Company's credit facility and
subsequently placed a $35.5 million non-recourse first mortgage loan on the
property. This Office Property is wholly-owned and included in the Company's
Office Segment.

On May 10, 2004, the Company completed the purchase of the remaining
Hughes Center Office Property in Las Vegas, Nevada for approximately $18.3
million. The purchase was funded by a draw on the Company's credit facility.
This Office Property is wholly-owned and included in the Company's Office
Segment.

UNDEVELOPED LAND

On March 1, 2004, in accordance with the agreement to acquire the
Hughes Center Properties, the Company completed the purchase of two tracts of
undeveloped land in Hughes Center from the Rouse Company for $10.0 million. The
purchase was funded by a $7.5 million loan from the Rouse Company and a draw on
the Company's credit facility.

5. DISCONTINUED OPERATIONS

In accordance with SFAS No. 144,"Accounting for the Impairment or
Disposal of Long-Lived Assets," the results of operations of the assets sold or
held for sale have been presented as "Income from discontinued operations, net
of minority interests," gain or loss on the assets sold or held for sale have
been presented as "Loss on real estate from discontinued operations, net of
minority interests" and impairments on the assets sold or held for sale have
been presented as "Impairment charges related to real estate assets from
discontinued operations, net of minority interests" in the accompanying
Consolidated Statements of Operations for the three and six months ended June
30, 2004 and 2003. The carrying value of the assets held for sale has been
reflected as "Properties held for disposition, net" in the accompanying
Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003.

ASSETS SOLD

On March 23, 2004, the Company completed the sale of the 1800 West Loop
South Office Property in Houston, Texas. The sale generated proceeds, net of
selling costs, of approximately $28.2 million and a net gain of approximately
$0.2 million, net of minority interests. The Company previously recorded an
impairment charge of approximately $13.9 million, net of minority interests,
during the year ended December 31, 2003. The proceeds from the sale were used
primarily to pay down the Company's credit facility. This property was
wholly-owned.

On March 31, 2004, the Company sold its last remaining behavioral
healthcare property. The sale generated proceeds, net of selling costs, of
approximately $2.0 million and a net loss of approximately $0.3 million, net of
minority interests. This property was wholly-owned.

On April 13, 2004, the Company completed the sale of the Liberty Plaza
Office Property in Dallas, Texas. The sale generated proceeds, net of selling
costs, of approximately $10.8 million and a net loss of approximately $0.2
million, net of minority interests. The Company previously recorded an
impairment charge of approximately $3.6 million, net of minority interests,
during the year ended December 31, 2003. The proceeds from the sale were used
primarily to pay down the Company's credit facility. This property was
wholly-owned.

17

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On June 17, 2004, the Company completed the sale of the Ptarmigan Place
Office Property in Denver, Colorado. The sale generated proceeds, net of selling
costs, of approximately $25.3 million and a net loss of approximately $2.0
million, net of minority interests. The Company previously recorded an
impairment charge of approximately $0.5 million, net of minority interests,
during the quarter ended March 31, 2004. In addition, the Company completed the
sale of approximately 3.0 acres of undeveloped land adjacent to Ptarmigan Place.
The sale generated proceeds, net of selling costs, of approximately $2.9 million
and a net gain of approximately $0.9 million. The proceeds from these sales were
used to pay down a portion of the Company's Bank of America Fund XII Term Loan.
The property and adjacent land were wholly-owned.

On June 29, 2004, the Company completed the sale of the Addison Tower
Office Property in Dallas, Texas. The sale generated proceeds, net of selling
costs, of approximately $8.8 million and a net gain of approximately $0.2
million, net of minority interests. The proceeds from the sale were used
primarily to pay down the Company's credit facility. This property was
wholly-owned.

ASSETS HELD FOR SALE

The following Properties are classified as held for sale as of June 30,
2004.

- ----------

(1) This property was sold in July 2004.

(2) The Company has entered into a contract to sell this property. The sale
is expected to close in the third quarter of 2004.

OFFICE SEGMENT

As of June 30, 2004, the Company determined that 3333 Lee Parkway, in
the Uptown/Turtle Creek submarket in Dallas, Texas was no longer held for sale
due to the Property no longer being actively marketed for sale due to changes in
market conditions. The Property has been reclassified from "Properties held for
disposition, net" to "Land," "Building and improvements, net of accumulated
depreciation," and "Other assets, net" in the accompanying Consolidated Balance
Sheets with a net book value of $14.3 million at June 30, 2004. In addition,
approximately $0.1 million has been reclassified from "Income from discontinued
operations, net of minority interests," to "Office Property revenue," "Office
Property real estate taxes," "Office Property operating expenses" and
"Depreciation and amortization" in the accompanying Consolidated Statements of
Operations for the six months ended June 30, 2004.

SUMMARY OF ASSETS HELD FOR SALE

The following table indicates the major asset classes of the properties
held for sale.

- ----------

(1) Includes three Office Properties, two Resort/Hotel Properties and other
assets.

(2) Includes seven Office Properties, two Resort/Hotel Properties, one
behavioral healthcare property and other assets.

18

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following tables present total revenues, operating and other
expenses, depreciation and amortization, unitholder minority interests,
impairments of real estate assets and realized loss on sale of properties for
the six months ended June 30, 2004 and 2003, for properties included in
discontinued operations.

6. OTHER TRANSACTIONS

On June 28, 2004, the Company completed a transaction related to the
Fountain Place Office Property with Crescent FP Investors, L.P., ("FP
Investors"), a limited partnership that is owned 99.9% by LB FP L.L.C., an
affiliate of Lehman Brothers Holding, Inc., (the affiliate is referred to as
"Lehman"), and 0.1% by the Company. In the transaction, the Fountain Place
Office Property was, for tax purposes, sold to FP Investors for $168.2 million,
including the assumption by FP Investors of a new $90.0 million loan from
Lehman Capital. The Company received net proceeds of approximately $78.2
million. This transaction resulted in the completion of a reverse Section 1031
like-kind exchange associated with the Company's prior purchase of a portion
of the Hughes Center office portfolio.

Included in the terms of this transaction is a provision which provides
Lehman the unconditional right to require the Company to purchase Lehman's
interest in FP Investors for an agreed upon fair value of $79.9 million at any
time until November 30, 2004. For GAAP purposes, under SFAS No. 66, "Accounting
for Sales of Real Estate," this unconditional right, or contingency, results in
the transaction requiring accounting associated with a financing transaction. As
a result, no gain has been recorded on the transaction and the Company's
accompanying financial statements continue to include the Office Property,
related debt and operations until expiration of the contingency. The fair value
of the contingency, $79.9 million, is included in the "Accounts payable, accrued
expenses and other liabilities" line item in the Company's Consolidated Balance
Sheet at June 30, 2004.

Also on June 28, 2004, the Company paid off the $220.0 million Deutsche
Bank - CMBS loan with proceeds from the Fountain Place Office Property
transaction and a draw on the Company's revolving credit facility. See Note 9,
"Notes Payable and Borrowings Under Credit Facility," for further information
relating to the $90.0 million loan with Lehman Capital, secured by the Fountain
Place Office Property.

19

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. TEMPERATURE-CONTROLLED LOGISTICS SEGMENT

TEMPERATURE-CONTROLLED LOGISTICS PROPERTIES

AmeriCold Logistics, a limited liability company owned 60% by Vornado
Operating L.P. and 40% by a subsidiary of Crescent Operating, Inc. ("COPI"), as
sole lessee of the Temperature-Controlled Logistics Properties, leases the
Temperature-Controlled Logistics Properties from the Temperature-Controlled
Logistics Corporation under three triple-net master leases, as amended. The
Company has no interest in COPI or AmeriCold Logistics. On March 2, 2004, the
Temperature-Controlled Logistics Corporation and AmeriCold Logistics amended the
leases to further extend the deferred rent period to December 31, 2005, from
December 31, 2004. The parties previously extended the deferred rent period to
December 31, 2004 from December 31, 2003, on March 7, 2003.

Under terms of the leases, AmeriCold Logistics elected to defer $26.9
million of the total $78.9 million of rent payable for the six months ended June
30, 2004. The Company's share of the deferred rent was $10.8 million. The
Company recognizes rental income from the Temperature-Controlled Logistics
Properties when earned and collected and has not recognized the $10.8 million of
deferred rent in equity in net income of the Temperature-Controlled Logistics
Properties for the six months ended June 30, 2004. As of June 30, 2004, the
Temperature-Controlled Logistics Corporation's deferred rent and valuation
allowance from AmeriCold Logistics were $109.3 million and $101.2 million,
respectively, of which the Company's portions were $43.7 million and $40.5
million, respectively.

As a result of the continuing inability of AmeriCold Logistics to pay
the full amount of the rent due under the leases without deferral elections, the
Company anticipates that the Temperature-Controlled Logistics Corporation may
restructure the leases in 2004, although it is under no obligation to do so.

On February 5, 2004, the Temperature-Controlled Logistics Corporation
completed a $254.4 million mortgage financing with Morgan Stanley Mortgage
Capital Inc., secured by 21 of its owned and seven of its leased
temperature-controlled logistics properties. The loan matures in April 2009,
bears interest at LIBOR plus 295 basis points (with a LIBOR floor of 1.5% with
respect to $54.4 million of the loan) and requires principal payments of $5.0
million annually. The net proceeds to the Temperature-Controlled Logistics
Corporation were approximately $225.0 million, after closing costs and the
repayment of approximately $12.9 million in existing mortgages. On February 6,
2004, the Temperature-Controlled Logistics Corporation distributed cash of
approximately $90.0 million to the Company.

For information regarding the planned sale of COPI's interest in
AmeriCold Logistics, see Note 16, "COPI."

VORNADO CRESCENT CARTHAGE AND KC QUARRY, L.L.C.

On January 20, 2004, VCQ purchased $6.1 million of trade receivables
from Americold Logistics at a 2% discount. VCQ used cash from a $6.0 million
contribution from its owners, of which approximately $2.4 million represented
the Company's contribution for the purchase of the trade receivables. The
receivables were collected during the first quarter of 2004. On March 29, 2004,
VCQ purchased an additional $4.1 million of receivables from AmeriCold Logistics
at a 2% discount. VCQ used cash from collection of the trade receivables
previously purchased. The remaining $2.0 million was distributed to its owners,
of which $0.8 million was received by the Company on April 1, 2004. On July 2,
2004, VCQ purchased an additional $6.0 million of receivables from AmeriCold
Logistics at a 2% discount. VCQ used cash from collection of the trade
receivables previously purchased.

20

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. INVESTMENTS IN UNCONSOLIDATED COMPANIES

The following is a summary of the Company's ownership in significant
unconsolidated joint ventures and investments as of June 30, 2004.

(1) The remaining 50% interest in Main Street Partners, L.P. is owned by
Trizec Properties, Inc.

(2) The remaining 60% interest in Crescent Miami Center, L.L.C. is owned by
an affiliate of a fund managed by JP Morgan Fleming Asset Management,
Inc.

(3) The remaining 70% interest in Crescent Five Post Oak Park, L.P. is
owned by an affiliate of General Electric Pension Fund Trust.

(4) The remaining 70% interest in Crescent One BriarLake Plaza, L.P. is
owned by affiliates of JP Morgan Fleming Asset Management, Inc.

(5) The remaining 75% interest in Crescent 5 Houston Center, L.P. is owned
by a pension fund advised by JP Morgan Fleming Asset Management, Inc.

(6) The remaining 80% interest in each of Austin PT BK One Tower Office
Limited Partnership, Houston PT Three Westlake Office Limited
Partnership and Houston PT Four Westlake Office Limited Partnership is
owned by an affiliate of General Electric Pension Fund Trust.

(7) The remaining 44% in Vornado Crescent Carthage and KC Quarry, L.L.C. is
owned by Vornado Realty Trust, L.P.

(8) The remaining 60% interest in Vornado Crescent Portland Partnership is
owned by Vornado Realty Trust, L.P.

(9) The remaining 50% interest in Blue River Land Company, L.L.C. is owned
by parties unrelated to the Company. Blue River Land Company, L.L.C.
was formed to acquire, develop and sell certain real estate property in
Summit County, Colorado.

(10) Of the remaining 50% interest in Canyon Ranch Las Vegas, L.L.C., 35% is
owned by an affiliate of the management company of two of the Company's
Resort/Hotel Properties and 15% is owned by the Company through its
investment in CR License II, L.L.C. Canyon Ranch Las Vegas, L.L.C.
operates a Canyon Ranch spa in a hotel in Las Vegas.

(11) The remaining 58.3% interest in EW Deer Valley, L.L.C. is owned by
parties unrelated to the Company. EW Deer Valley, L.L.C. was formed to
acquire, hold and dispose of its 3.3% ownership interest in Empire
Mountain Village, L.L.C. Empire Mountain Village, L.L.C. was formed to
acquire, develop and sell certain real estate property at Deer Valley
Ski Resort next to Park City, Utah.

(12) The remaining 70% interest in CR License, L.L.C. is owned by an
affiliate of the management company of two of the Company's
Resort/Hotel Properties. CR License, L.L.C. owns the licensing
agreement related to certain Canyon Ranch trade names and trademarks.

(13) The remaining 70% interest in CR License II, L.L.C is owned by an
affiliate of the management company of two of the Company's
Resort/Hotel Properties. CR License II, L.L.C. and its wholly-owned
subsidiaries provide management and development consulting services to
a variety of entities in the hospitality, real estate, and health and
wellness industries.

(14) Of the remaining 76.5% of SunTx Fulcrum Fund, L.P., 37.1% is owned by
SunTx Capital Partners, L.P. and the remaining 39.4% is owned by a
group of individuals unrelated to the Company. SunTx Fulcrum Fund,
L.P.'s objective is to invest in a portfolio of acquisitions that offer
the potential for substantial capital appreciation.

(15) SunTx Capital Partners, L.P. is the general Partner of the SunTx
Fulcrum Fund, L.P. The remaining 85.6% interest in SunTx Capital
Partners, L.P. is owned by parties unrelated to the Company.

(16) G2 was formed for the purpose of investing in commercial mortgage
backed securities and other commercial real estate investments. The
remaining 87.5% interest in G2 is owned by Goff-Moore Strategic
Partners, L.P. ("GMSPLP") and by parties unrelated to the Company. G2
is managed and controlled by an entity that is owned equally by GMSPLP
and GMAC Commercial Mortgage Corporation ("GMACCM"). The ownership
structure of GMSPLP consists of an approximately 86% limited
partnership interest owned directly and indirectly by Richard E.
Rainwater, Chairman of the Board of Trust Managers of the Company, and
an approximately 14% general partnership interest, of which
approximately 6% is owned by Darla Moore, who is married to Mr.
Rainwater, and approximately 6% is owned by John C. Goff, Vice-Chairman
of the Company's Board of Trust Managers and Chief Executive Officer of
the Company. The remaining approximately 2% general partnership
interest is owned by unrelated parties.

21

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SUMMARY FINANCIAL INFORMATION

The Company reports its share of income and losses based on its
ownership interest in its respective equity investments, adjusted for any
preference payments. The unconsolidated entities that are included under the
headings on the following tables are summarized below.

Balance Sheets as of June 30, 2004:

o Office - This includes Main Street Partners, L.P., Houston PT
Three Westlake Office Limited Partnership, Houston PT Four
Westlake Office Limited Partnership, Austin PT BK One Tower
Office Limited Partnership, Crescent 5 Houston Center, L.P.,
Crescent Miami Center, L.L.C., Crescent Five Post Oak Park
L.P. and Crescent One BriarLake Plaza, L.P.;

o Temperature-Controlled Logistics - This includes the
Temperature-Controlled Logistics Partnership and VCQ; and

o Other - This includes Blue River Land Company, L.L.C., EW Deer
Valley, L.L.C., CR License, L.L.C., CR License II, L.L.C.,
Canyon Ranch Las Vegas, L.L.C., SunTx Fulcrum Fund, L.P.,
SunTx Capital Partners, L.P. and G2.

Balance Sheets as of December 31, 2003:

o Office - This includes Main Street Partners, L.P., Houston PT
Three Westlake Office Limited Partnership, Houston PT Four
Westlake Office Limited Partnership, Austin PT BK One Tower
Office Limited Partnership, Crescent 5 Houston Center, L.P.,
Crescent Miami Center, L.L.C., Crescent Five Post Oak Park
L.P. and Crescent One BriarLake Plaza, L.P.;

o Temperature-Controlled Logistics - This includes the
Temperature-Controlled Logistics Partnership and VCQ; and

o Other - This includes Blue River Land Company, L.L.C., EW Deer
Valley, L.L.C., CR License, L.L.C., CR License II, L.L.C.,
Canyon Ranch Las Vegas, L.L.C., SunTx Fulcrum Fund, L.P. and
G2.

Summary Statements of Operations for the six months ended June 30,
2004:

o Office - This includes Main Street Partners, L.P., Houston PT
Three Westlake Office Limited Partnership, Houston PT Four
Westlake Office Limited Partnership, Austin PT BK One Tower
Office Limited Partnership, Crescent 5 Houston Center, L.P.,
Crescent Miami Center, L.L.C., Crescent Five Post Oak Park
L.P. and Crescent One BriarLake Plaza, L.P.;

o Temperature-Controlled Logistics - This includes the
Temperature-Controlled Logistics Partnership and VCQ; and

o Other - This includes Blue River Land Company, L.L.C., EW Deer
Valley, L.L.C., CR License, L.L.C., CR License II, L.L.C.,
Canyon Ranch Las Vegas, L.L.C., SunTx Fulcrum Fund, L.P.,
SunTx Capital Partners, L.P. and G2.

Summary Statements of Operations for the six months ended June 30,
2003:

o Office - This includes Main Street Partners, L.P., Houston PT
Three Westlake Office Limited Partnership, Houston PT Four
Westlake Office Limited Partnership, Austin PT BK One Tower
Office Limited Partnership, Crescent 5 Houston Center, L.P.,
Crescent Miami Center, L.L.C, Crescent Five Post Oak Park L.P.
and Woodlands CPC;

o Temperature-Controlled Logistics - This includes the
Temperature-Controlled Logistics Partnership and VCQ;

o The Woodlands Land Development Company, L.P.; and

o Other - This includes Manalapan Hotel Partners, L.L.C., Blue
River Land Company, L.L.C., CR License, L.L.C., CR License II,
L.L.C., the Woodlands Operating Company and Canyon Ranch Las
Vegas, L.L.C., SunTx Fulcrum Fund, L.P. and G2.

22

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

23

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

- ----------

(1) The Company sold its interest in The Woodlands Land Development
Company, L.P. on December 31, 2003.

(2) Inclusive of the preferred return paid to Vornado Realty Trust (1% per
annum of the total combined assets).

24

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

UNCONSOLIDATED DEBT ANALYSIS

The following table shows, as of June 30, 2004, information about the
Company's share of unconsolidated fixed and variable rate debt and does not take
into account any extension options, hedge arrangements or the entities'
anticipated pay-off dates.

- ----------

(1) URS Real Estate, L.P. and AmeriCold Real Estate, L.P., subsidiaries of
the Temperature-Controlled Logistics Corporation, expect to repay this
note on the Optional Prepayment Date of April 11, 2008. The overall
weighted average maturity would be 3.74 years based on this date.

(2) On February 5, 2004, the Temperature-Controlled Logistics Corporation
completed a mortgage financing with Morgan Stanley Mortgage Capital,
Inc., secured by twenty-one of its owned and seven of its leased
properties. The loan bears interest at LIBOR + 295 basis points (with a
LIBOR floor of 1.5% with respect to $54.4 million of the loan) and
requires principal payments of $5.0 million annually. In connection
with this loan, the Company entered into an interest-rate cap agreement
with a maximum LIBOR of 6.5% on the entire loan.

(3) Senior Note - Note A: $81.4 million at variable interest rate, LIBOR +
189 basis points, $4.8 million at variable interest rate, LIBOR + 250
basis points with a LIBOR floor of 2.50%. Note B: $23.9 million at
variable interest rate, LIBOR + 650 basis points with a LIBOR floor of
2.50%. Mezzanine Note - $19.2 million AT variable interest rate, LIBOR
+ 890 basis points with a LIBOR floor of 3.0%. In connection with this
loan, the Company entered into an interest-rate cap agreement with a
maximum LIBOR of 4.52% on all notes. All notes are amortized based on a
25-year schedule.

(4) The Company and its joint venture partner each obtained separate
Letters of Credit to guarantee the repayment of up to $4.3 million each
of principal of the Main Street Partners, L.P. loan.

(5) The variable rate loan has an interest rate of LIBOR + 300 basis
points. A fully consolidated entity of CRDI, of which CRDI owns 88.3%,
provides an unconditional guarantee of up to 70% of the outstanding
balance of up to a $9.0 million loan to Blue River Land Company, L.L.C.
There was approximately $3.1 million outstanding at June 30, 2004 and
the amount guaranteed was $2.2 million.

25

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. NOTES PAYABLE AND BORROWINGS UNDER CREDIT FACILITY

The following is a summary of the Company's debt financing at June 30,
2004:

SECURED DEBT

26

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2004
(in thousands)
SECURED DEBT (CONTINUED)

Northwestern Life Note due November 2008, bears interest at 4.94% with an
interest-only term, secured by the 301 Congress Avenue Office Property......................................... 26,000

Allstate Note(5) due September 2010, bears interest at 6.65% with principal and
interest payments based on a 25-year amortization schedule, secured by the 3993
Hughes Parkway Office Property................................................................................. 25,864

Metropolitan Life Note VI(5) due October 2009, bears interest at 7.71% with
principal and interest payments based on a 25-year amortization schedule,
secured by the 3960 Hughes Parkway Office Property............................................................. 24,363

Northwestern Life Note II(5) due July 2007, bears interest at 7.40% with monthly
principal and interest payments based on a 25-year amortization schedule,
secured by the 3980 Howard Hughes Parkway Office Property...................................................... 10,451

FHI Finance Loan bears interest at LIBOR plus 450 basis points (at June 30,
2004, the interest rate was 5.63%), with an initial interest-only term until the
Net Operating Income Hurdle Date(7), followed by monthly principal and interest
payments based on a 20-year amortization schedule through maturity in September
2009, secured by the Sonoma Mission Inn & Spa.................................................................. 10,000

Woodmen of the World Note due April 2009, bears interest at 8.20% with an
initial five-year interest-only term (through November 2006), followed by
monthly principal and interest payments based on a 25-year amortization
schedule, secured by the Avallon IV Office Property............................................................ 8,500

Nomura Funding VI Note(8) due July 2020 bears interest at 10.07% with monthly
principal and interest payments based on a 25-year amortization schedule,
secured by the Funding VI Property............................................................................. 7,758

The Rouse Company Note due December 2005 bears interest at prime rate plus 100
basis points (at June 30, 2004, the interest rate was 5.0%) with an
interest-only term, secured by undeveloped land in Hughes Center............................................... 7,500

Wells Fargo note due September 2004, bears interest at LIBOR rate plus 200 basis
points (at June 30, 2004, the interest rate was 3.23%), with an interest-only
term, secured by 3770 Howard Hughes Parkway Office Property.................................................... 4,774

Construction, acquisition and other obligations, bearing fixed and variable
interest rates ranging from 2.9% to 10.50% at June 30, 2004, with maturities
ranging between July 2004 and February 2009, secured by various CRDI and MVDC
projects(9).................................................................................................... 75,707

UNSECURED DEBT

2009 Notes bear interest at a fixed rate of 9.25% with a seven-year
interest-only term, due April 2009 with a call date of April 2006.............................................. 375,000

2007 Notes bear interest at a fixed rate of 7.50% with a ten-year interest-only
term, due September 2007....................................................................................... 250,000

Credit Facility(10) interest only due May 2005, bears interest at LIBOR plus
212.5 basis points (at June 30, 2004, the interest rate was 3.36%)............................................. 232,500
----------

Total Notes Payable............................................................................................ $2,710,649
==========

- ----------

(1) In August 2007, the interest rate will increase, and the Company is
required to remit, in addition to the monthly debt service payment, excess
property cash flow, as defined, to be applied first against principal and
thereafter against accrued excess interest, as defined. It is the Company's
intention to repay the note in full at such time (August 2007) by making a
final payment of approximately $221.7 million.

(2) In October 2006, the interest rate will adjust based on current interest
rates at that time. It is the Company's intention to repay the note in full
at such time (October 2006) by making a final payment of approximately
$177.8 million.

(3) In December 2003 and January 2004, the Company purchased a total of $179.6
million in U.S. Treasuries and government sponsored agency securities
("defeasance investments") to substitute as collateral for this loan. The
cash flow from the defeasance investments (principal and interest) will
match the total debt service payments of this loan.

27

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(4) The Company's obligations under this loan were transferred to FP Investors
L.L.C. as part of the transaction in connection with the Fountain Place
Office Property. See Note 6, "Other Transactions," for further information
regarding this transaction.

(5) The Company assumed these loans in connection with the Hughes Center
acquisitions. The following table lists the premium associated with the
assumption of above market interest rate debt which is included in the
balance outstanding at June 30, 2004 and the effective interest rate of the
debt including the premium.

The $7.7 million was recorded as an increase in the carrying amount of the
underlying debt and is being amortized as a reduction of interest expense
through maturity of the underlying debt.

(6) This facility is a $37.6 million line of credit secured by certain DMDC
land and asset improvements ("revolving credit facility"), notes receivable
("warehouse facility") and additional land ("short-term facility"). The
line restricts the revolving credit facility to a maximum outstanding
amount of $26.0 million and is subject to certain borrowing base
limitations and bears interest at prime (at June 30, 2004, the interest
rate was 4.0%). The warehouse facility bears interest at prime plus 100
basis points (at June 30, 2004, the interest rate was 5.0%) and is limited
to $10.0 million. The short-term facility bears interest from prime plus 50
basis points to prime plus 100 basis points (at June 30, 2004, the interest
rates were 4.5% to 5.0%) and is limited to $1.6 million. The blended rate
at June 30, 2004, for the revolving credit facility, the warehouse facility
and the short-term facility was 4.3%.

(7) The Company's joint venture partner, which owns a 19.9% interest in the
Sonoma Mission Inn & Spa, had funded $10.0 million of renovations at the
Sonoma Mission Inn & Spa through a mezzanine loan. The Net Operating Income
Hurdle Date, as defined in the loan agreement, is the date as of which the
Sonoma Mission Inn & Spa has achieved an aggregate Adjusted Net Operating
Income, as defined in the loan agreement, of $12 million for a period of 12
consecutive calendar months.

(8) In July 2010, the interest rate will adjust based on current interest rates
at that time. It is the Company's intention to repay the note in full at
such time (July 2010) by making a final payment of approximately $6.1
million.

(9) Includes $14.6 million of fixed rate debt ranging from 2.9% to 10.5% and
$61.1 million of variable rate debt ranging from 3.4% to 4.5%.

(10) The $400.0 million Credit Facility with Fleet is an unsecured revolving
line of credit to Funding VIII and guaranteed by the Operating Partnership.
Availability under the line of credit is subject to certain covenants
including limitations on total leverage, fixed charge ratio, debt service
coverage, minimum tangible net worth, and specific mix of office and hotel
assets and average occupancy of Office Properties. At June 30, 2004, the
maximum borrowing capacity under the credit facility was $392.0 million.
The outstanding balance excludes letters of credit issued under the
Company's credit facility of $7.6 million which reduce the Company's
maximum borrowing capacity.

On June 28, 2004, the Company paid off the $220.0 million Deutsche
Bank-CMBS loan with proceeds from the Fountain Place transaction and a draw on
the Company's credit facility. See Note 6, "Other Transactions," for additional
information regarding the Fountain Place transaction. The loan was secured by
the Funding X Properties and Spectrum Center. In July 2004, the Company unwound
the $220.0 million interest rate cap with JP Morgan Chase that corresponded to
this loan.

The following table shows information about the Company's consolidated
fixed and variable rate debt and does not take into account any extension
options, hedging arrangements or the Company's anticipated payoff dates.

- ----------

(1) Balance excludes hedges. The percentages for fixed rate debt and
variable rate debt, including the $400.0 million of hedged variable
rate debt, are 81% and 19%, respectively.

(2) Excludes effect of extension options on Bank of America Fund XII Term
Loan and expected early payment of LaSalle Note I, JP Morgan Mortgage
Note, or the Nomura Funding VI Note.

(3) Including the effect of hedge arrangements, the overall weighted
average interest rate would have been 6.82%.

28

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Listed below are the aggregate principal payments by year required as
of June 30, 2004 under indebtedness of the Company. Scheduled principal
installments and amounts due at maturity are included and are based on
contractual maturities and do not include extension options.

- ----------
(1) Excludes effect of extension options on Bank of America Fund XII Term
Loan and expected early payment of LaSalle Note I, JP Morgan Mortgage
Note, or the Nomura Funding VI Note.

The Company is generally obligated by its debt agreements to comply
with financial covenants, affirmative covenants and negative covenants, or some
combination of these types of covenants. Failure to comply with covenants
generally will result in an event of default under that debt instrument. Any
uncured or unwaived events of default under the Company's loans can trigger an
increase in interest rates, an acceleration of payment on the loan in default,
and for the Company's secured debt, foreclosure on the property securing the
debt. In addition, a default by the Company or any of its subsidiaries with
respect to any indebtedness in excess of $5.0 million generally will result in a
default under the Credit Facility, 2007 Notes, 2009 Notes, the Bank of America
Fund XII Term Loan, the Fleet Fund I Term Loan and the Fleet Term Loan after the
notice and cure periods for the other indebtedness have passed. As of June 30,
2004, no event of default had occurred, and the Company was in compliance with
all covenants related to its outstanding debt. The Company's debt facilities
generally prohibit loan pre-payment for an initial period, allow pre-payment
with a penalty during a following specified period and allow pre-payment without
penalty after the expiration of that period. During the six months ended June
30, 2004, there were no circumstances that required prepayment or increased
collateral related to the Company's existing debt.

DEFEASANCE OF LASALLE NOTE II

In January 2004, the Company released the remaining properties in
Funding II by reducing the Fleet Fund I and II Term Loan by $104.2 million and
purchasing an additional $170.0 million of U.S. Treasury and government
sponsored agency securities with an initial weighted average yield of 1.76%. The
Company placed those securities into a collateral account for the sole purpose
of funding payments of principal and interest on the remainder of the LaSalle
Note II. The cash flow from the securities is structured to match the cash flow
(principal and interest payments) required under the LaSalle Note II. The
retirement of the Fleet loan and the purchase of the defeasance securities were
funded through the $275 million Bank of America Fund XII Term Loan. The
collateral for the Bank of America loan is 10 of the 11 properties previously in
the Funding II collateral pool, which are now held in Funding XII. The Bank of
America loan is structured to allow the Company the flexibility to sell, joint
venture or long-term finance these 10 assets over the next 36 months. The final
Funding II property, Liberty Plaza, was moved to the Operating Partnership and
subsequently sold in April 2004.

In addition to the subsidiaries listed in Note 1, "Organization and
Basis of Presentation," certain other subsidiaries of the Company were formed
primarily for the purpose of obtaining secured and unsecured debt or joint
venture financings. These entities, all of which are consolidated and are
grouped based on the Properties to which they relate, are: Funding I Properties
(CREM Holdings, LLC, Crescent Capital Funding, LLC, Crescent Funding Interest,
LLC, CRE Management I Corp.); Funding III Properties (CRE Management III Corp.);
Funding IV Properties (CRE Management IV Corp.); Funding V Properties (CRE
Management V Corp.); Funding VI Properties (CRE Management VI Corp.); Funding
VIII Properties (CRE Management VIII, LLC); 707 17th Street (Crescent 707 17th
Street, LLC); Funding X Properties (CREF X Holdings Management, LLC, CREF X
Holdings, L.P., CRE Management X, LLC); Funding XII Properties (CREF XII Parent
GP, LLC, CREF XII Parent L.P., CREF XII Holding GP, LLC, CREF Holdings, L.P.,
CRE Management XII, LLC); Spectrum Center (Spectrum Mortgage Associates, L.P.,
CSC Holdings Management, LLC, Crescent SC Holdings, L.P., CSC Management, LLC),
The BAC-Colonnade (CEI Colonnade Holdings, LLC), and Crescent Finance Company.

29

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10. CASH FLOW HEDGES

The Company uses derivative financial instruments to convert a portion
of its variable rate debt to fixed rate debt and to manage its fixed to variable
rate debt ratio. As of June 30, 2004, the Company had three cash flow hedge
agreements which are accounted for in conformity with SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities -
an Amendment of FASB Statement No. 133."

The following table shows information regarding the Company's interest
rate swaps designated as cash flow hedge agreements during the six months ended
June 30, 2004, and additional interest expense and unrealized gains (losses)
recorded in Accumulated Other Comprehensive Income ("OCI").

In addition, two of the Company's unconsolidated companies have cash
flow hedge agreements of which the Company's portion of change in unrealized
gains reflected in OCI was approximately $0.4 million for the six months ended
June 30, 2004.

The Company has designated its cash flow hedge agreements as cash flow
hedges of LIBOR-based monthly interest payments on a designated pool of variable
rate LIBOR indexed debt that re-prices closest to the reset dates of each cash
flow hedge agreement. The cash flow hedges have been and are expected to remain
highly effective. Changes in the fair value of these highly effective hedging
instruments are recorded in OCI. The effective portion that has been deferred in
OCI will be reclassified to earnings as interest expense when the hedged items
impact earnings. If a cash flow hedge falls outside 80%-125% effectiveness for a
quarter, all changes in the fair value of the cash flow hedge for the quarter
will be recognized in earnings during the current period. If it is determined
based on prospective testing that it is no longer likely a hedge will be highly
effective on a prospective basis, the hedge will no longer be designated as a
cash flow hedge in conformity with SFAS No. 133, as amended. The Company had no
ineffectiveness related to its cash flow hedges, resulting in no earnings impact
due to ineffectiveness for the six months ended June 30, 2004.

INTEREST RATE CAP

In March 2004, in connection with the Bank of America Fund XII Term
Loan, the Company entered into a LIBOR interest rate cap struck at 6.00% for a
notional amount of approximately $206.3 million through August 31, 2004, $137.5
million from September 1, 2004 through February 28, 2005, and $68.8 million from
March 1, 2005 through March 1, 2006. Simultaneously, the Company sold a LIBOR
interest rate cap with the same terms. Since these instruments do not reduce the
Company's net interest rate risk exposure, they do not qualify as hedges and
changes to their respective fair values are charged to earnings as the changes
occur. As the significant terms of these arrangements are the same, the effects
of a revaluation of these instruments are expected to offset each other.

30

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. COMMITMENTS AND CONTINGENCIES

GUARANTEE COMMITMENTS

The FASB issued Interpretation 45, "Guarantors' Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"), requiring a guarantor to disclose its
guarantees. The Company's guarantees in place as of June 30, 2004 are listed in
the table below. For the guarantees on indebtedness, no triggering events or
conditions are anticipated to occur that would require payment under the
guarantees and management believes the assets associated with the loans that are
guaranteed are sufficient to cover the maximum potential amount of future
payments and therefore, would not require the Company to provide additional
collateral to support the guarantees. The Company has not recorded a liability
associated with these guarantees as they were entered into prior to the adoption
of FIN 45.

- ----------

(1) The Company provides a $7.6 million letter of credit to support the
payment of interest and principal of the Eagle Ranch Metropolitan
District Revenue Development Bonds.

(2) See Note 8, "Investments in Unconsolidated Companies," for a
description of the terms of this debt.

(3) A fully consolidated entity of CRDI, of which CRDI owns 88.3%, provides
an unconditional guarantee of up to 70% of the outstanding balance of
up to a $9.0 million loan to Blue River Land Company, L.L.C. There was
approximately $3.1 million outstanding at June 30, 2004 and the amount
guaranteed was $2.2 million.

(4) The Company and its joint venture partner each obtained separate
Letters of Credit to guarantee the repayment of up to $4.3 million each
of the Main Street Partners, L.P. loan.

OTHER COMMITMENTS

In 2003, the Company entered into a one year option agreement for the
future sale of approximately 1.5 acres of undeveloped investment land located in
Houston, Texas, for approximately $7.8 million. The Company received $0.01
million of consideration in 2003. The option agreement may be extended up to
four years on a yearly basis at the option of the prospective purchaser for
additional consideration.

See Note 16, "COPI," for a description of the Company's commitments
related to the agreement with COPI, executed on February 14, 2002.

CONTINGENCIES

See Note 6, "Other Transactions," for information on the Company's
$79.9 million contingent obligation included in the "Accounts payable, accrued
expenses and other liabilities" line item in the Company's Consolidated Balance
Sheet at June 30, 2004, related to the Fountain Place Office Property
transaction.

The Company has a contingent obligation of approximately $0.9 million
related to a construction warranty matter. The Company believes it is probable
that a significant amount would be recovered through reimbursements from third
parties.

12. MINORITY INTEREST

Minority interest in the Operating Partnership represents the
proportionate share of the equity in the Operating Partnership of limited
partners other than the Company. The ownership share of limited partners other
than the Company is evidenced by Operating Partnership units. The Operating
Partnership pays a regular quarterly distribution to the holders of Operating
Partnership units.

Each Operating Partnership unit may be exchanged for either two common
shares of the Company or, at the election of the Company, cash equal to the fair
market value of two common shares at the time of the exchange. When a unitholder
exchanges a unit, the Company's percentage interest in the Operating Partnership
increases. During the six months ended June 30, 2004, there were 9,036 units
exchanged for 18,072 common shares of the Company.

31

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Minority interest in real estate partnerships represents joint venture
or preferred equity partners' proportionate share of the equity in certain real
estate partnerships. The Company holds a controlling interest in the real estate
partnerships and consolidates the real estate partnerships into the financial
statements of the Company. Income in the real estate partnerships is allocated
to minority interest based on weighted average percentage ownership during the
year.

The following table summarizes the minority interest as of June 30,
2004 and December 31, 2003:

The following table summarizes the minority interests' share of net
loss (income) for the six months ended June 30, 2004 and 2003:

13. SHAREHOLDERS' EQUITY

DISTRIBUTIONS

The following table summarizes the distributions paid or declared to
common shareholders, unitholders and preferred shareholders during the six
months ended June 30, 2004 (dollars in thousands, except per share amounts).

(1) Represents one-half the amount of the distribution per unit because each
unit is exchangeable for two common shares.

32

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SERIES A PREFERRED OFFERING

On January 15, 2004, the Company completed an offering (the "January
2004 Series A Preferred Offering") of an additional 3,400,000 Series A
Convertible Cumulative Preferred Shares (the "Series A Preferred Shares") at a
$21.98 per share price and with a liquidation preference of $25.00 per share for
aggregate total offering proceeds of approximately $74.7 million. The Series A
Preferred Shares are convertible at any time, in whole or in part, at the option
of the holders into common shares of the Company at a conversion price of $40.86
per common share (equivalent to a conversion rate of 0.6119 common shares per
Series A Preferred Share), subject to adjustment in certain circumstances. The
Series A Preferred Shares have no stated maturity and are not subject to sinking
fund or mandatory redemption. At any time, the Series A Preferred Shares may be
redeemed, at the Company's option, by paying $25.00 per share plus any
accumulated accrued and unpaid distributions. Dividends on the additional Series
A Preferred Shares are cumulative from November 16, 2003, and are payable
quarterly in arrears on the fifteenth of February, May, August and November,
commencing February 16, 2004. The annual fixed dividend on the Series A
Preferred Shares is $1.6875 per share.

Net proceeds to the Company from the January 2004 Series A Preferred
Offering were approximately $71.0 million after underwriting discounts, offering
costs and dividends accrued on the shares up to the issuance date. The Company
used the net proceeds to pay down the Company's credit facility.

14. INCOME TAXES

TAXABLE CONSOLIDATED ENTITIES

Deferred income taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities of taxable consolidated
entities for financial reporting purposes and the amounts used for income tax
purposes. For the six months ended June 30, 2004, the taxable consolidated
entities were comprised of the taxable REIT subsidiaries of the Company.

The Company intends to maintain its qualification as a REIT under
Section 856 of the U.S. Internal Revenue Code of 1986, as amended (the "Code").
As a REIT, the Company generally will not be subject to federal corporate income
taxes as long as it satisfies certain technical requirements of the Code,
including the requirement to distribute 90% of REIT taxable income to its
shareholders. Accordingly, the Company does not believe that it will be liable
for current income taxes on its REIT taxable income at the federal level or in
most of the states in which it operates. The Company consolidates certain
taxable REIT subsidiaries, which are subject to federal and state income tax.
For the six months ended June 30, 2004 and 2003, the Company's federal income
tax benefit from continuing operations was $6.6 million and $5.5 million,
respectively. The Company's $6.6 million income tax benefit at June 30, 2004
consists primarily of $5.2 million for the Residential Development Segment and
$3.3 million for the Resort/Hotel Segment partially offset by $0.8 million tax
expense for the Office Segment and $1.1 million expense for other taxable REIT
subsidiaries.

The Company's total net tax asset of approximately $27.9 million at
June 30, 2004 includes $17.3 million of net deferred tax assets. SFAS No. 109,
"Accounting for Income Taxes," requires a valuation allowance to reduce the
deferred tax assets reported if, based on the weight of the evidence, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. There was no change in the valuation allowance during the six months
ended June 30, 2004.

15. RELATED PARTY TRANSACTIONS

LOANS TO EMPLOYEES AND TRUST MANAGERS OF THE COMPANY FOR EXERCISE OF STOCK
OPTIONS AND UNIT OPTIONS

As of June 30, 2004, the Company had approximately $38.0 million loan
balances outstanding, inclusive of current interest accrued of approximately
$0.2 million, to certain employees and trust managers of the Company on a
recourse basis pursuant to the Company's stock incentive plans and unit
incentive plans pursuant to an agreement approved by the Board of Trust Managers
and the Executive Compensation Committee of the Company. The proceeds of these
loans were used by the employees and the trust managers to acquire common shares
of the Company pursuant to the exercise of vested stock and unit options.
Pursuant to the loan agreements, these loans bear interest at a rate of 2.52%
per year, payable quarterly, and mature on July 28, 2012 and may be repaid in
full or in part at any time without premium or penalty. Mr. Goff had a loan
representing $26.4 million of the $38.0 million total outstanding loans at June
30, 2004. No conditions exist at June 30, 2004 which would cause any of the
loans to be in default. Effective July 29, 2002, the Company ceased offering to
its employees and trust managers the option to obtain loans pursuant to the
Company's stock and unit incentive plans.

33

CRESCENT REAL ESTATE EQUITIES COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

OTHER

On June 28, 2002, the Company purchased the home of an executive
officer of the Company to facilitate the hiring and relocation of this executive
officer. The purchase price was approximately $2.6 million, consistent with a
third-party appraisal obtained by the Company. Shortly after the purchase of the
home, certain changes in the business environment in Houston resulted in a
weakened housing market. In May 2004, the Company completed the sale of the home
for proceeds, net of selling costs, of approximately $1.8 million. The Company
previously recorded an impairment charge of approximately $0.6 million, net of
taxes, during the year ended December 31, 2003. The purchase was part of the
officer's relocation agreement with the Company.

16. COPI

On February 14, 2002, the Company and COPI entered into an agreement
(the "Agreement") pursuant to which COPI and the Company agreed to jointly seek
approval by the bankruptcy court of a pre-packaged bankruptcy plan for COPI. The
Company agreed to fund certain of COPI's costs, claims and expenses relating to
the bankruptcy and related transactions. From February 14, 2002 through June 30,
2004, the Company loaned to COPI, or paid directly on COPI's behalf,
approximately $13.2 million to fund these costs, claims and expenses, $2.1
million of which was funded in the six months ended June 30, 2004. The Company
also agreed to issue common shares with a dollar value of approximately $2.2
million to the COPI stockholders.

In addition, the Company agreed to use commercially reasonable efforts
to assist COPI in arranging COPI's repayment of its $15.0 million obligation to
Bank of America, together with any accrued interest. COPI obtained the loan from
Bank of America primarily to participate in investments with the Company. As a
condition to making the loan, Bank of America required Richard E. Rainwater, the
Chairman of the Board of Trust Managers of the Company, and John C. Goff,
Vice-Chairman of the Board of Trust Managers and Chief Executive Officer of the
Company, to enter into a support agreement with COPI and Bank of America,
pursuant to which Messrs. Rainwater and Goff agreed to make additional equity
investments in COPI under certain circumstances. The Company and COPI are
assessing other alternatives for the sale of COPI's 40% interest in the tenant
of the Temperature-Controlled Logistics properties, AmeriCold Logistics. At this
time, the Company does not expect to spin-off to its shareholders a new entity
that would purchase COPI's interest in AmeriCold Logistics. COPI has agreed that
it will use the proceeds of the sale of its interest in AmeriCold Logistics to
repay Bank of America in full.

On March 10, 2003, COPI filed a plan under Chapter 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the Northern
District of Texas. On June 22, 2004, the bankruptcy court confirmed the
bankruptcy plan, as amended. Effectiveness of the pre-packaged bankruptcy plan
for COPI is contingent upon a number of conditions, including the sale of COPI's
interest in AmeriCold Logistics, the repayment of COPI's obligation to Bank of
America prior to October 21, 2004 and the issuance by the Company of common
shares to the COPI stockholders.

17. SUBSEQUENT EVENTS

ASSET ACQUISITIONS

On August 6, 2004, the Company acquired Alhambra Plaza, a 318,000
square foot Class A Office Property, located in the Coral Gables submarket of
Miami, Florida. The Company acquired the Office Property for approximately $72.3
million, funded by the Company's assumption of a $45.0 million loan from
Wachovia Bank and a draw on the Company's credit facility. The Office Property
is wholly-owned and will be included in the Company's Office Segment.

ASSET DISPOSITIONS

On July 2, 2004, the Company completed the sale of the 5050 Quorum
Office Property in Dallas, Texas. The sale generated proceeds, net of selling
costs, of approximately $8.9 million and a loss of approximately $0.1 million,
net of minority interests. The Company previously recorded an impairment charge
of approximately $0.8 million, net of minority interests, during the quarter
ended March 31, 2004. The proceeds from the sale were used primarily to pay down
the Company's credit facility. This property was wholly-owned. The Company will
continue to provide management and leasing services for this property.

On July 29, 2004, the Company completed the sale of the 12404 Park
Central Office Property in Dallas, Texas. The sale generated proceeds, net of
selling costs, of approximately $9.3 million. During the three months ended June
30, 2004, the Company recorded an impairment charge of approximately $0.4
million, net of minority interests. The Company previously recorded impairment
charges totaling approximately $3.6 million, net of minority interests, $2.9
million during the year ended December 31, 2003 and $0.7 million during the
quarter ended March 31, 2004. The proceeds from the sale were used primarily to
pay down the Bank of America Fund XII Term Loan. This property was wholly-owned.
The Company will continue to provide management and leasing services for this
property.

34

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

INDEX TO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Forward-Looking Statements.......................................... 36

Overview............................................................ 37

Recent Developments................................................. 40

Results of Operations

Three and six months ended June 30, 2004 and 2003.............. 42

Liquidity and Capital Resources

Cash Flows for the six months ended June 30, 2004.............. 49

Equity and Debt Financing........................................... 53

Unconsolidated Investments.......................................... 57

Significant Accounting Policies..................................... 58

Funds from Operations............................................... 62

35

FORWARD-LOOKING STATEMENTS

You should read this section in conjunction with the consolidated
interim financial statements and the accompanying notes in Item 1,"Financial
Statements," of this document and the more detailed information contained in the
Company's Form 10-K for the year ended December 31, 2003. In management's
opinion, all adjustments (consisting of normal and recurring adjustments)
considered necessary for a fair presentation of the unaudited interim financial
statements are included. Capitalized terms used but not otherwise defined in
this section have the meanings given to them in the notes to the consolidated
financial statements in Item 1, "Financial Statements."

This Form 10-Q contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These statements are generally
characterized by terms such as "believe," "expect," "anticipate" and "may."

Although the Company believes that the expectations reflected in such
forward-looking statements are based upon reasonable assumptions, the Company's
actual results could differ materially from those described in the
forward-looking statements.

The following factors might cause such a difference:

o The Company's ability, at its office properties, to timely lease
unoccupied square footage and timely re-lease occupied square footage
upon expiration on favorable terms, which continue to be adversely
affected by existing real estate conditions (including vacancy rates in
particular markets, decreased rental rates and competition from other
properties) and may be adversely affected by general economic
downturns;

o The continuation of relatively high vacancy rates and reduced rental
rates in the Company's office portfolio as a result of the conditions
within the Company's principal markets;

o Adverse changes in the financial condition of existing tenants, in
particular El Paso Energy and its affiliates which provide 4.6% of the
Company's annualized office revenues;

o Further deterioration in the resort/business-class hotel markets or in
the market for residential land or luxury residences, including
single-family homes, townhomes and condominiums, or in the economy
generally;

o Financing risks, such as the Company's ability to generate revenue
sufficient to service and repay existing or additional debt, increases
in debt service associated with increased debt and with variable-rate
debt, the Company's ability to meet financial and other covenants and
the Company's ability to consummate financings and refinancings on
favorable terms and within any applicable time frames;

o The ability of the Company to dispose of its investment land, and other
non-core assets, on favorable terms and within anticipated time frames;

o The ability of the Company to reinvest available funds at anticipated
returns and consummate anticipated office acquisitions and within
anticipated time frames;

o Further or continued adverse conditions in the temperature-controlled
logistics business (including both industry-specific conditions and a
general downturn in the economy) which may further jeopardize the
ability of the tenant to pay all current and deferred rent due;

o The ability of the Company and COPI to satisfy the remaining
conditions to achieve effectiveness of the COPI bankruptcy plan,
including COPI's sale of the temperature-controlled logistics tenant,
its repayment of the loan from Bank of America prior to October 21,
2004, and the Company's issuance of Company common shares to the COPI
stockholders;

o The concentration of a significant percentage of the Company's assets
in Texas;

o The existence of complex regulations relating to the Company's status
as a REIT, the effect of future changes in REIT requirements as a
result of new legislation and the adverse consequences of the failure
to qualify as a REIT; and

o Other risks detailed from time to time in the Company's filings with
the Securities and Exchange Commission.

Given these uncertainties, readers are cautioned not to place undue
reliance on such statements. The Company is not obligated to update these
forward-looking statements to reflect any future events or circumstances.

36

OVERVIEW

The Company is a REIT with assets and operations divided into four
investment segments: Office, Resort/Hotel, Residential Development and
Temperature-Controlled Logistics. The primary business of the Company is its
Office Segment, which consisted of 75 Office Properties and represented 67% of
gross assets as of June 30, 2004.

Capital flows in the real estate industry have changed significantly
over the last few years. Institutions as well as other investors, principally
U.S. pension funds, have increased their allocation to real estate and it
appears that this will continue for the foreseeable future. This inflow of
capital has created a uniquely attractive environment for the sale of assets as
well as joint ventures. Likewise, the acquisition environment is highly
competitive, making it more difficult to provide returns to common equity that
are comparable to those achieved in acquisitions made during the 1990's.

The Company has adapted its strategy to align itself with institutional
partners, with the goal of transitioning towards being a real estate investment
management company. Rather than competing with the substantial inflow of capital
into the acquisition market, the Company is focusing on acquiring assets jointly
with these institutional investors, moving existing assets into joint-venture
arrangements with these investors, and capitalizing on its award-winning
platform in office management and its leasing expertise to continue to provide
these services, for a fee, for the properties in the ventures. Where possible,
the Company will strive to negotiate performance based incentives that allow for
additional equity to be earned if return targets are exceeded.

Consistent with this strategy, the Company continually evaluates its
existing portfolio for potential joint-venture opportunities. In the near to
mid-term, the Company could more than double its existing level of joint
ventures to over $2 billion by contributing existing assets to ventures. As with
previous ventures, the Company would be a minority partner but would continue to
provide leasing and management services to the ventures. In addition, the
Company is targeting the sale of an additional $200 million in non-core assets
by the end of 2004, including land holdings that are currently not contributing
to the Company's earnings. Also included in these sales, are two business class
hotels which the Company believes it can sell at attractive gains, and at the
same time further simplify its business model. As these ventures and sales are
completed, the Company will assess the potential benefits of utilizing a portion
of the net proceeds to repurchase Company shares consistent with the
requirements of its existing debt.

OFFICE SEGMENT

The following table shows the performance factors used by management to
assess the operating performance of the Office Segment.

- ----------
(1) Economic occupancy reflects the occupancy of all tenants paying rent.
Excluding held for sale properties, economic occupancy is 87.0% and 84.8%
at June 30, 2004 and December 31, 2003, respectively.

(2) Leased occupancy reflects the amount of contractually obligated space,
whether or not commencement has occurred. Excluding held for sale
properties, leased occupancy is 88.1% and 87.3% at June 30, 2004 and
December 31, 2003, respectively.

(3) Same-store NOI (net operating income) represents office property net
income excluding depreciation, amortization, interest expense and
non-recurring items such as lease termination fees for Office Properties
owned for the entirety of the comparable periods.

(4) Includes held for sale properties.

(5) Excludes held for sale properties.

The Company continues to expect that 2004 will be a year of
stabilization in the Office Segment rather than meaningful growth, with
projected average and year end occupancy remaining relatively flat compared to
2003. Tenant improvement and leasing costs in 2004 are expected to be in line
with 2003. Same-store NOI is expected to decline by 3% to 6% in 2004, which is a
lower rate of decline than that experienced in 2003.

37

The Company's tenant base continues to be diversified, with the top
five tenants accounting for approximately 11.2% of total Office Segment rental
revenues for the six months ended June 30, 2004. The loss of one or more of the
Company's major tenants, in particular El Paso Energy and its affiliates which
provide 4.6% of the Company's annualized Office Segment revenues, would have a
temporary adverse effect on the Company's financial condition and results of
operations until the Company is able to re-lease the space previously leased to
these tenants.

RESORT/HOTEL SEGMENT

The following table shows the performance factors used by management to
assess the operating performance of the Resort/Hotel Segment, excluding
held-for-sale properties.

Decreases in occupancy at the Company's upscale business class hotels
are primarily attributable to increased competition in the convention business
causing major cities to compete for conventions that have historically gone to
secondary markets and new convention style hotels adding approximately 1,200
rooms in the Houston market and approximately 800 rooms in the Austin market.
The occupancy decrease at the Company's luxury and destination fitness resorts
is partially driven by decreased occupancy at Sonoma Mission Inn (from 74% in
the second quarter 2003 to 62% in the second quarter 2004) as a result of the
renovation of 97 rooms which were taken out of service in November 2003.
Renovation was completed in the second quarter of 2004 and the 97 rooms were put
back into service. In addition, occupancy decreased 25 percentage points (from
81% in the second quarter 2003 to 56% in the second quarter 2004) at Ventana Inn
as a result of the renovation of 12 suites which were taken out of service in
April 2004. The Company anticipates a minimal change in occupancy and a modest
increase in revenue per available room in 2004 at the Resort/Hotel Properties as
the economy and the travel industry continue to recover offset by the financial
impact of Sonoma Mission Inn and Ventana Inn renovations in 2004.

RESIDENTIAL DEVELOPMENT SEGMENT

The following tables show the performance factors used by management to
assess the operating performance of the Residential Development Segment.
Information is provided for the Desert Mountain Residential Development Property
and the CRDI Residential Development Properties, which represent the Company's
significant investments in this Segment as of June 30, 2004.

Desert Mountain

- ----------

(1) Includes equity golf membership

- ----------

(1) Includes equity golf membership

38

Desert Mountain is in the latter stages of development and has
primarily its premier lots remaining in inventory. An increase in lot sales,
combined with higher average sales prices in 2004 compared to 2003, is expected
to result in improved results in 2004.

CRDI

CRDI, which invests primarily in mountain resort residential real
estate in Colorado and California and residential real estate in downtown
Denver, Colorado, is highly dependent upon the national economy and customer
demand. In 2004, management expects that CRDI will be primarily affected by
product mix available at its Residential Development Properties as product
inventory is developed in 2004 for delivery in 2005.

LIQUIDITY

The Company's primary sources of liquidity are cash flows from
operations, its credit facility, return of capital from the Residential
Development segment, and proceeds from asset sales and joint ventures. The
Company believes cash flows from operations will be sufficient to offset normal
operating expenses, as well as capital requirements (including property
improvements, tenant improvements and leasing commissions) in 2004. The cash
flow from the Residential Development segment is cyclical in nature and
primarily focused in the last quarter of each year. The Company expects to meet
any interim short falls in operating cash flow caused by this cyclicality
through working capital draws under the credit facility. As of June 30, 2004,
the Company had $151.9 million in borrowing capacity remaining under its credit
facility. However, net cash flows from operations are not anticipated to fully
cover the projected dividends on the Company's common stock for the next 18
months. The Company expects to use return of capital from the Residential
Development Segment, estimated at approximately $85 million for 2004, and
business initiatives including investment land sales and other income to cover
the shortfall.

Through the sale of the Woodlands in December 2003, the issuance of
preferred shares and additional financing of Temperature-Controlled Logistics
this year, and planned additional leverage on Hughes Center assets, the Company
has an additional $260 million in liquidity to make new investments throughout
2004, of which $63 million has been invested through June 30, 2004.
Additionally, the Company continues to execute on its capital recycling program
and has sold six office properties generating proceeds, net of selling costs, of
$94.2 million which were used to pay down a portion of the Bank of America Fund
XII Term Loan and to reduce the amount outstanding under the credit facility.

39

RECENT DEVELOPMENTS

ASSET ACQUISITIONS

OFFICE PROPERTIES

During January and February 2004, in accordance with the original
purchase contract, the Company acquired an additional five Class A Office
Properties and seven retail parcels located within Hughes Center in Las Vegas,
Nevada from the Rouse Company. One of these Office Properties is owned through a
joint venture in which the Company acquired a 67% interest. The remaining four
Office Properties are wholly-owned by the Company. The Company acquired these
five Office Properties and seven retail parcels for approximately $175.3
million, funded by the Company's assumption of approximately $85.4 million in
mortgage loans and by a portion of the proceeds from the sale of the Company's
interests in The Woodlands on December 31, 2003. The Company recorded the loans
assumed at their fair value of approximately $93.2 million, which includes $7.8
million of premium. The five Office Properties are included in the Company's
Office Segment.

On March 31, 2004, the Company acquired Dupont Centre, a 250,000 square
foot Class A office property, located in the John Wayne Airport submarket of
Irvine, California. The Company acquired the Office Property for approximately
$54.3 million, funded by a draw on the Company's credit facility and
subsequently placed a $35.5 million non-recourse first mortgage loan on the
property. This Office Property is wholly-owned and included in the Company's
Office Segment.

On May 10, 2004, the Company completed the purchase of the remaining
Hughes Center Office Property in Las Vegas, Nevada for approximately $18.3
million. The purchase was funded by a draw on the Company's credit facility.
This Office Property is wholly-owned and included in the Company's Office
Segment.

On August 6, 2004, the Company acquired Alhambra Plaza, a 318,000
square foot Class A Office Property, located in the Coral Gables submarket of
Miami, Florida. The Company acquired the Office Property for approximately $72.3
million, funded by the Company's assumption of $45.0 million loan from Wachovia
Bank and a draw on the Company's credit facility. The Office Property is
wholly-owned and will be included in the Company's Office Segment.

UNDEVELOPED LAND

On March 1, 2004, in accordance with the agreement to acquire the
Hughes Center Properties, the Company completed the purchase of two tracts of
undeveloped land in Hughes Center from the Rouse Company for $10.0 million. The
purchase was funded by a $7.5 million loan from the Rouse Company and a draw on
the Company's credit facility.

ASSET DISPOSITIONS

On March 23, 2004, the Company completed the sale of the 1800 West Loop
South Office Property in Houston, Texas. The sale generated proceeds, net of
selling costs, of approximately $28.2 million and a net gain of approximately
$0.2 million, net of minority interests. The Company previously recorded an
impairment charge of approximately $13.9 million, net of minority interests,
during the year ended December 31, 2003. The proceeds from the sale were used
primarily to pay down the Company's credit facility. This property was
wholly-owned.

On March 31, 2004, the Company sold its last remaining behavioral
healthcare property. The sale generated proceeds, net of selling costs, of
approximately $2.0 million and a net loss of approximately $0.3 million, net of
minority interests. This property was wholly-owned.

On April 13, 2004, the Company completed the sale of the Liberty Plaza
Office Property in Dallas, Texas. The sale generated proceeds, net of selling
costs, of approximately $10.8 million and a net loss of approximately $0.2
million, net of minority interests. The Company previously recorded an
impairment charge of approximately $3.6 million, net of minority interests,
during the year ended December 31, 2003. The proceeds from the sale were used
primarily to pay down the Company's credit facility. This property was
wholly-owned.

On June 17, 2004, the Company completed the sale of the Ptarmigan Place
Office Property in Denver, Colorado. The sale generated proceeds, net of selling
costs, of approximately $25.3 million and a net loss of approximately $2.0
million, net of minority interests. The Company previously recorded an
impairment charge of approximately $0.5 million, net of minority interests,
during the quarter ended March 31, 2004. In addition, the Company completed the
sale of approximately 3.0 acres of undeveloped land adjacent to Ptarmigan Place.
The sale generated proceeds, net of selling costs, of approximately $2.9 million
and a net gain of approximately $0.9 million. The proceeds from these sales were
used to pay

40

down a portion of the Company's Bank of America Fund XII Term Loan. The property
and adjacent land were wholly-owned.

On June 29, 2004, the Company completed the sale of the Addison Tower
Office Property in Dallas, Texas. The sale generated proceeds, net of selling
costs, of approximately $8.8 million and a net gain of approximately $0.2
million, net of minority interests. The proceeds from the sale were used
primarily to pay down the Company's credit facility. This property was
wholly-owned.

On July 2, 2004, the Company completed the sale of the 5050 Quorum
Office Property in Dallas, Texas. The sale generated proceeds, net of selling
costs, of approximately $8.9 million and a loss of approximately $0.1 million,
net of minority interests. The Company previously recorded an impairment charge
of approximately $0.8 million, net of minority interests, during the quarter
ended March 31, 2004. The proceeds from the sale were used primarily to pay down
the Company's credit facility. This property was wholly-owned. The Company will
continue to provide management and leasing services for this property.

On July 29, 2004, the Company completed the sale of the 12404 Park
Central Office Property in Dallas, Texas. The sale generated proceeds, net of
selling costs, of approximately $9.3 million. During the three months ended June
30, 2004, the Company recorded an impairment charge of approximately $0.4
million, net of minority interests. The Company previously recorded impairment
charges totaling approximately $3.6 million, net of minority interests, $2.9
million during the year ended December 31, 2003 and $0.7 million during the
quarter ended March 31, 2004. The proceeds from the sale were used primarily to
pay down the Bank of America Fund XII Term Loan. This property was wholly-owned.
The Company will continue to provide management and leasing services for this
property.

OTHER TRANSACTIONS

On June 28, 2004, the Company completed a transaction related to the
Fountain Place Office Property with Crescent FP Investors, L.P., ("FP
Investors"), a limited partnership that is owned 99.9% by LB FP L.L.C., an
affiliate of Lehman Brothers Holding, Inc., (the affiliate is referred to as
"Lehman"), and 0.1% by the Company. In the transaction, the Fountain Place
Office Property was, for tax purposes, sold to FP Investors for $168.2 million,
including the assumption by FP Investors of a new $90.0 million loan from
Lehman Capital. The Company received net proceeds of approximately $78.2
million. This transaction resulted in the completion of a reverse Section 1031
like-kind exchange associated with the Company's prior purchase of a portion
of the Hughes Center office portfolio.

Included in the terms of this transaction is a provision which provides
Lehman the unconditional right to require the Company to purchase Lehman's
interest in FP Investors for an agreed upon fair value of $79.9 million at any
time until November 30, 2004. For GAAP purposes, under SFAS No. 66, "Accounting
for Sales of Real Estate," this unconditional right, or contingency, results in
the transaction requiring accounting associated with a financing transaction. As
a result, no gain has been recorded on the transaction and the Company's
accompanying financial statements continue to include the Office Property,
related debt and operations until expiration of the contingency. The fair value
of the contingency, $79.9 million, is included in the "Accounts payable, accrued
expenses and other liabilities" line item in the Company's Consolidated Balance
Sheet at June 30, 2004.

Also on June 28, 2004, the Company paid off the $220.0 million Deutsche
Bank - CMBS loan with proceeds from the Fountain Place Office Property
transaction and a draw on the Company's revolving credit facility. See Note 9,
"Notes Payable and Borrowings Under Credit Facility," included in Item 1,
"Financial Statements," for further information relating to the $90.0 million
loan with Lehman Capital, secured by the Fountain Place Office Property.

41

RESULTS OF OPERATIONS

The following table shows the Company's variance in dollars between the
three and six months ended June 30, 2004 and 2003.

42

COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2004 TO THE THREE MONTHS ENDED
JUNE 30, 2003

PROPERTY REVENUES

Total property revenues increased $7.6 million, or 3.5%, to $227.6
million for the three months ended June 30, 2004, as compared to $220.0 million
for the three months ended June 30, 2003. The primary components of the increase
in total property revenues are discussed below.

o Office Property revenues increased $13.0 million, or 10.9%, to $131.8
million, primarily due to:

o an increase of $12.0 million from the acquisitions of The
Colonnade in August 2003, the Hughes Center Properties in
December 2003 through May 2004, and Dupont Centre in March
2004;

o an increase of $5.0 million in net lease termination fees;
and

o an increase of $0.6 million primarily resulting from third
party management services and related direct expense
reimbursements; partially offset by

o a decrease of $4.7 million from the 54 consolidated Office
Properties (excluding 2003 and 2004 acquisitions and
properties held for sale) that the Company owned or had an
interest in, primarily due to a decrease in full service
weighted average rental rates, a decrease in recoveries due
to expense reductions, and a decline in net parking revenue,
partially offset by a 0.4 point increase in same-store
average occupancy (from 85.7% to 86.1%).

o Resort/Hotel Property revenues increased $1.0 million, or 2.5%, to
$40.3 million, primarily due to:

o an increase of $1.2 million at the Luxury and Destination
Fitness Resorts, primarily Canyon Ranch Tucson and Canyon
Ranch Lenox, related to a 3% increase in revenue per
available room (from $290 to $299) as a result of a 10%
increase in average daily rate (from $444 to $489).

o Residential Development Property revenues decreased $6.4 million, or
10.3%, to $55.6 million, primarily due to:

o a decrease of $17.3 million in CRDI revenues related to
product mix in lots and units available for sale in 2004
versus 2003, primarily at the One Vendue project in
Charleston, South Carolina which had sales in 2003, but none
in 2004 as the project sold out in 2003; partially offset by

o an increase of $8.9 million in real estate sales primarily
due to increased lot sales at DMDC of 12 lots (from 11 to
23) and increased lot sales at MVDC of 10 lots (from 3 to 13
lots); and

o an increase of $1.8 million in club revenue at DMDC and CRDI
primarily due to increased membership levels at DMDC and the
full impact in 2004 of the sale of Tahoe Club memberships at
the Tahoe Mountain Resorts Property, which began selling
memberships in mid-2003.

PROPERTY EXPENSES

Total property expenses increased $0.5 million, or 0.3%, to $148.0
million for the three months ended June 30, 2004, as compared to $147.5 million
for the three months ended June 30, 2003. The primary components of the
variances in property expenses are discussed below.

o Office Property expenses increased $1.8 million, or 3.1%, to $60.4
million, primarily due to:

o an increase of $4.1 million from the acquisition of The
Colonnade in August 2003, the Hughes Center Properties in
December 2003 through May 2004 and Dupont Centre in March
2004; and

o an increase of $0.4 million related to the cost of providing
third party management services to joint venture properties,
which is offset by increased third party fee income and
direct expense reimbursements; partially offset by

o a decrease of $2.6 million from the 54 consolidated Office
Properties (excluding 2003 and 2004 acquisitions and
properties held for sale) that the Company owned or had an
interest in, primarily due to:

o $1.9 million decrease in property taxes and
insurance;

o $1.5 million decrease in utilities expense;
partially offset by

o $0.4 million increase in administrative
expenses.

43

o Resort/Hotel Property expenses increased $2.5 million, or 7.5%, to
$35.8 million, due to:

o an increase of $1.9 million in operating expenses, general
and administrative costs, and advertising at the Destination
Fitness Resorts primarily related to increases in employee
health insurance costs and an increase in occupancy of 5
percentage points at Canyon Ranch Tucson; and

o an increase of $0.6 million in operating expenses at the
resorts.

o Residential Development Property expenses decreased $3.8 million, or
6.8%, to $51.8 million, primarily due to:

o a decrease of $15.6 million primarily due to a reduction in
cost of sales related to product mix in lots and units
available for sale in 2004 versus 2003 at CRDI, primarily at
the One Vendue project in Charleston, South Carolina which
had sales in 2003, but none in 2004 as the project sold out
in 2003; partially offset by

o an increase of $6.8 million in DMDC and MVDC cost of sales
due to increased lot sales compared to 2003;

o an increase of $2.4 million in marketing expenses at certain
CRDI projects; and

o an increase of $2.0 million in club operating expenses due
to an increase in membership and restaurant addition at CRDI
and the golf course additions at DMDC.

OTHER INCOME/EXPENSE

Total other expenses increased $20.2 million, or 26.0%, to $97.8
million for the three months ended June 30, 2004, compared to $77.6 million for
the three months ended June 30, 2003. The primary components of the increase in
total other expenses are discussed below.

OTHER INCOME

Other income decreased $6.3 million, or 87.7%, to $1.0 million for the
three months ended June 30, 2004, as compared to $7.3 million for the three
months ended June 30, 2003. The primary components of the decrease in other
income are discussed below.

o Interest and other income increased $1.8 million primarily due to $0.7
million of interest on U.S. Treasury and government sponsored agency
securities purchased in December 2003 and January 2004 related to debt
defeasance, $0.5 million of dividends received on other marketable
securities and a $0.3 million increase in interest on certain notes
resulting from note amendments in December 2003.

o Equity in net income of unconsolidated companies decreased $7.4
million, or 164.4%, to a $2.9 million loss, primarily due to:

o a decrease of $3.0 million in equity in net income ($1.9
million attributable to Residential Development Properties
and $1.1 million to Office Properties) primarily due to net
income recorded in 2003 for the Company's interests in the
entities through which the Company held its interests in The
Woodlands, which were sold in December 2003;

o a decrease of $2.3 million in Temperature-Controlled
Logistics Properties equity in net income primarily due to a
decrease in rental revenues net of deferred rent and an
increase in interest expense primarily attributable to the
$254.4 million financing with Morgan Stanley Mortgage
Capital, Inc. in February 2004; and

o a decrease of $1.4 million in Resort/Hotel Properties equity
in net income primarily due to net income recorded in 2003
for the Company's interest in the Ritz-Carlton Hotel
Property, which was sold in November 2003, and included a
$1.1 million payment which the Company received from the
operator of the Resort/Hotel Property pursuant to the terms
of the operating agreement because the property did not
achieve the specified net operating income level.

44

OTHER EXPENSES

Other expenses increased $13.9 million, or 16.4%, to $98.8 million for
the three months ended June 30, 2004, as compared to $84.9 million for the three
months ended June 30, 2003. The primary components of the increase in other
expenses are discussed below.

o Depreciation expense increased $9.5 million, or 28.9%, to $42.4
million, primarily due to:

o $7.6 million increase in Office Property depreciation
expense, attributable to:

o $3.2 million from the acquisitions of The
Colonnade in August 2003 and the Hughes Center
Properties in December 2003 through May 2004,
and Dupont Centre in March 2004; and

o $4.4 million due to an increase in leasehold
improvements, lease commissions, building
improvements, and accelerated depreciation of
leasehold improvements and lease commissions
upon lease terminations;

o $1.5 million increase in Residential Development Property
depreciation expense; and

o $0.6 million increase in Resort/Hotel Property depreciation
expense.

o Interest expense increased $2.4 million, or 5.6%, to $45.4
million due to an increase of approximately $273.0 million
in the weighted average debt balance, partially offset by a
0.76 percentage point decrease in the weighted average
interest rate (from 7.18% to 6.42%) primarily due to the
refinancing and new financings of fixed rate debt at lower
interest rates and the termination of $400.0 million in cash
flow hedges, which were replaced with $400.0 million of cash
flow hedges resulting in a 3.1 percentage point reduction in
strike prices (from 6.6% to 3.5%).

o Corporate general and administrative expense increased $1.1
million, or 19.3%, to $6.8 million primarily due to salary merit
increases, cost increases of employee benefits and restricted
stock compensation recorded in 2004.

o Extinguishment of debt increased $1.0 million due to the write
off of deferred financing costs associated with the reduction of
the Bank of America Fund XII Term Loan funded by proceeds from
the sale of the Ptarmigan Place Office Property and adjacent land
and the payoff of the $220.0 million Deutsche Bank-CMBS Loan in
June 2004 funded with proceeds from the Fountain Place Office
Property transaction and a draw on the credit facility.

o Amortization of deferred financing costs increased $0.5 million,
or 19.2%, to $3.1 million primarily due to the addition of
deferred financing costs related to debt restructuring and
refinancing associated with the $275.0 million secured loan with
Bank of America and Deutsche Bank in January 2004.

DISCONTINUED OPERATIONS

Income from discontinued operations on assets sold and held for sale
decreased $2.5 million, or 69.4%, to $1.1 million, primarily due to:

o a decrease of $2.2 million, net of minority interests, due to an
aggregate $2.1 million loss on three Office Properties sold in 2004
compared to a $0.1 million gain on one Office Property in 2003;

o a decrease of $0.9 million, net of minority interests, due to the
reduction of net income associated with properties held for sale in
2004 compared to 2003;

o a decrease of $0.4 million, net of minority interests, due to the
impairment of one Office Property in 2004; partially offset by

o an increase of $0.8 million, net of minority interests, due to
impairments recorded in 2003 on behavioral healthcare properties.

45

COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2004 TO THE SIX MONTHS ENDED JUNE
30, 2003

PROPERTY REVENUES

Total property revenues increased $12.0 million, or 2.8%, to $447.9
million for the six months ended June 30, 2004, as compared to $435.9 million
for the six months ended June 30, 2003. The primary components of the increase
in total property revenues are discussed below.

o Office Property revenues increased $14.7 million, or 6.1%, to $254.4
million, primarily due to:

o an increase of $20.8 million from the acquisitions of The
Colonnade in August 2003, the Hughes Center Properties in
December 2003 through May 2004, and Dupont Centre in March
2004;

o an increase of $4.2 million in net lease termination fees;

o an increase of $1.6 million primarily resulting from third
party management services and related direct expense
reimbursements; partially offset by

o a decrease of $11.2 million from the 54 consolidated Office
Properties (excluding 2003 and 2004 acquisitions and
properties held for sale) that the Company owned or had an
interest in, primarily due to a decrease in full service
weighted average rental rates, a decrease in recoveries due
to expense reductions, and a decline in net parking
revenues; and

o a decrease of $0.8 million due to nonrecurring revenue
earned in 2003.

o Residential Development Property revenues decreased $2.4 million, or
2.3%, to $103.3 million, primarily due to:

o a decrease of $22.6 million in CRDI revenues related to
product mix in lots and units available for sale in 2004
versus 2003, primarily at the One Vendue project in
Charleston, South Carolina which had sales in 2003, but none
in 2004 as the project sold out in 2003, partially offset by
the Old Greenwood project in Tahoe, California which had
sales in 2004, but none in the six months ended June 30,
2003 as product was not available for sale until December
2003; partially offset by

o an increase of $17.1 million primarily due to increased
sales of 15 lots (from 24 to 39) at DMDC and increased sales
of 12 lots (from 4 to 16 lots) at MVDC; and

o an increase of $3.5 million in club revenue at DMDC and CRDI
primarily due to increased membership levels at DMDC
and the full impact in 2004 of the sale of Tahoe Club
memberships at the Tahoe Mountain Resorts Property, which
began selling memberships in mid-2003.

PROPERTY EXPENSES

Total property expenses increased $0.7 million, or 0.2%, to $287.4
million for the six months ended June 30, 2004, as compared to $286.7 million
for the six months ended June 30, 2003. The primary components of the variances
in property expenses are discussed below.

o Office Property expenses increased $2.8 million, or 2.4%, to $119.2
million, primarily due to:

o an increase of $6.7 million from the acquisition of The
Colonnade in August 2003, the Hughes Center Properties in
December 2003 through May 2004 and Dupont Centre in March
2004; and

o an increase of $0.7 million related to the cost of providing
third party management services to joint venture properties,
which is offset by increased third party fee income and
direct expense reimbursements; partially offset by

o a decrease of $4.0 million from the 54 consolidated Office
Properties (excluding 2003 and 2004 acquisitions and
properties held for sale) that the Company owned or had an
interest in, primarily due to:

o $3.5 million decrease in property taxes,
insurance and legal fees;

o $2.2 million decrease in building repairs and
maintenance; partially offset by

o $0.6 million increase in administrative
expenses; and

o $0.5 million increase in nonrecoverable leasing
costs.

o Resort/Hotel Property expenses increased $2.6 million, or $3.5%,
to $75.9 million, primarily due to:

o an increase of $3.6 million in operating expenses,
general and administrative costs, and advertising at
the Destination Fitness Resorts primarily related to
increases in employee health insurance costs and an
increase in occupancy of 2 percentage points at Canyon
Ranch Tucson; offset by

o a decrease of $0.7 million in resort property operating
and management fee expense related to a 6 percentage
point decrease in occupancy (from 60% to 54%).

46

o Residential Development Property expenses decreased $4.7 million, or
4.8%, to $92.3 million, primarily due to:

o a decrease of $22.0 million primarily due to a reduction in
cost of sales related to product mix in lots and units
available for sale in 2004 versus 2003 at CRDI primarily at
the One Vendue project in Charleston, South Carolina which
had sales in 2003, but none in 2004 as the project sold out
in 2003, partially offset by the Old Greenwood project in
Tahoe, California which had sales in 2004, but none in the
six months ended June 30, 2003 as product was not available
for sale until December 2003; partially offset by

o an increase of $10.1 million in DMDC and MVDC cost of sales
due to increased lot sales compared to 2003;

o an increase of $4.1 million in marketing expenses at certain
CRDI projects; and

o an increase of $3.5 million in club operating expenses due
to an increase in membership and restaurant addition at CRDI
and the golf course additions at DMDC.

OTHER INCOME/EXPENSE

Total other expenses increased $31.1 million, or 19.3%, to $192.1
million for the six months ended June 30, 2004, compared to $161.0 million for
the six months ended June 30, 2003. The primary components of the increase in
total other expenses are discussed below.

OTHER INCOME

Other income decreased $9.0 million, or 71.4%, to $3.6 million for the
six months ended June 30, 2004, as compared to $12.6 million for the six months
ended June 30, 2003. The primary components of the decrease in other income are
discussed below.

o Interest and other income increased $3.1 million primarily due to $1.4
million of interest on U.S. Treasury and government sponsored agency
securities purchased in December 2003 and January 2004 related to debt
defeasance, $0.7 million of dividends received on other marketable
securities and a $0.5 million increase in interest on certain notes
resulting from note amendments in December 2003.

o Equity in net income of unconsolidated companies decreased $11.3
million, or 137.8%, to a $3.1 million loss, primarily due to:

o a decrease of $4.7 million in Temperature-Controlled
Logistics Properties equity in net income primarily due to a
decrease in rental revenues net of deferred rent and an
increase in interest expense primarily attributable to the
$254.4 million financing with Morgan Stanley Mortgage
Capital, Inc. in February 2004;

o a decrease of $4.4 million equity in net income ($2.8
million attributable to Residential Development Properties
and $1.6 million to Office Properties) primarily due to net
income recorded in 2003 for the Company's interests in the
entities through which the Company held its interests in The
Woodlands, which were sold in December 2003; and

o a decrease of $2.4 million in Resort/Hotel Properties equity
in net income primarily due to net income recorded in 2003
for the Company's interest in the Ritz-Carlton Hotel
Property which was sold in November 2003 and included a $1.1
million payment which the Company received from the operator
of the Resort/Hotel Property pursuant to the terms of the
operating agreement because the Property did not achieve the
specified net operating income level.

OTHER EXPENSES

Other expenses increased $22.2 million, or 12.8%, to $195.7 million for
the six months ended June 30, 2004, as compared to $173.5 million for the six
months ended June 30, 2003. The primary components of the increase in other
expenses are discussed below.

o Interest expense increased $4.2 million, or 4.9%, to $90.4 million due
to an increase of approximately $337.0 million in the weighted average
debt balance, partially offset by a 0.75 percentage point decrease in
the weighted average interest rate (from 7.31% to 6.56%) primarily due
to the refinancing and new financings of fixed rate debt at lower
interest rates and the termination of $400.0 million in cash flow
hedges, which were replaced with $400.0 million of cash flow hedges
resulting in a 3.1 percentage point reduction in strike prices (from
6.6% to 3.5%).

o Extinguishment of debt increased $2.9 million due to the write off of
deferred financing costs associated with reduction of the Fleet Fund I
and II Term Loan in January 2004, reduction of the Bank of America Fund
XII Term

47

Loan funded by proceeds from the sale of Ptarmigan Place Office
Property and adjacent land and the payoff of the $220.0 million
Deutsche Bank-CMBS Loan in June 2004 funded with proceeds from the
Fountain Place Office Property transaction and a draw on the credit
facility.

o Corporate general and administrative expense increased $2.1 million, or
18.1%, to $13.7 million primarily due to salary merit increases, cost
increases of employee benefits and restricted stock compensation
recorded in 2004.

o Depreciation expense increased $13.1 million, or 19.1%, to $81.6
million, primarily due to:

o $10.1 million increase in Office Property depreciation expense,
attributable to:

o $5.9 million from the acquisitions of The Colonnade in
August 2003 and the Hughes Center Properties in
December 2003 though May 2004 and Dupont Centre in
March 2004; and

o $4.2 million due to an increase in leasehold
improvements, lease commissions, building
improvements, and accelerated depreciation of
leasehold improvements and lease commissions upon
lease terminations;

o $2.0 million increase in Residential Development Property
depreciation expense; and

o $1.2 million increase in Resort/Hotel Property depreciation
expense.

o Amortization of deferred financing costs increased $1.8 million, or
36.0%, to $6.8 million primarily due to the addition of deferred
financing costs related to debt restructuring and refinancing
associated with the $275.0 million secured loan with Bank of America
and Deutsche Bank in January 2004.

o Impairment charges decreased $1.2 million primarily due to the $1.2
million impairment of the North Dallas Athletic Club in the first
quarter 2003.

DISCONTINUED OPERATIONS

Income from discontinued operations on assets sold and held for sale
increased $7.4 million, or 113.8%, to an income of $0.9 million, primarily due
to:

o an increase of $12.8 million, net of minority interests, due to the
impairment of the 1800 West Loop South Office Property in 2003;

o an increase of $1.5 million, net of minority interests, due to
impairments recorded in 2003 on the behavioral healthcare properties;
partially offset by

o a decrease of $2.6 million, net of minority interests, due to the
reduction of net income associated with properties held for sale in
2004 compared to 2003;

o a decrease of $2.4 million, net of minority interests, due to the
impairments of three Office Properties in 2004; and

o a decrease of $1.8 million, net of minority interests, due to the loss
on four Office Properties and one behavioral healthcare property sold
in 2004.

48

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOWS

OPERATING ACTIVITIES

The Company's cash provided by operating activities of $25.7 million is
attributable to Property operations.

INVESTING ACTIVITIES

The Company's cash used in investing activities of $135.0 million is
primarily attributable to:

o $169.8 million purchase of U.S. Treasuries and government
sponsored agency securities in connection with the defeasance
of LaSalle Note II;

o $164.4 million for the acquisition of investment properties,
primarily due to the acquisition of Hughes Center and Dupont
Centre Office Properties;

o $46.7 million for revenue and non-revenue enhancing tenant
improvement and leasing costs for Office Properties;

o $22.1 million for property improvements for rental
properties, primarily attributable to non-recoverable
building improvements for the Office Properties, renovations
at Sonoma Mission Inn and Ventana Inn, and replacement of
furniture, fixtures and equipment for the Resort/Hotel
Properties;

o $17.3 million for development of amenities at the Residential
Development Properties;

o $2.4 million of additional investment in
Temperature-Controlled Logistics Properties;

o $1.9 million for development of investment properties; and

o $0.9 million of additional investment in unconsolidated
Residential Development Properties.

The cash used in investing activities is partially offset by:

o $113.3 million decrease in restricted cash, due primarily to
decreased escrow deposits for the purchase of the Hughes
Center Office Properties in January and February 2004;

o $90.8 million from return of investment in
Temperature-Controlled Logistics Properties due primarily to
the $254.4 million of additional financing at the
Temperature-Controlled Logistics Corporation;

o $78.8 million of proceeds from property sales, primarily due
to the sale of the 1800 West Loop South, Liberty Plaza,
Ptarmigan Place and Addison Tower Office Properties;

o $5.5 million of proceeds from defeasance investment
maturities;

o $0.7 million from return of investment in unconsolidated
Office Properties; and

o $0.6 million from return of investment in unconsolidated
Resort/Hotel Properties.

FINANCING ACTIVITIES

The Company's cash provided by financing activities of $88.3 million is
primarily attributable to:

o $407.5 million of proceeds from other borrowings, primarily
as a result of the new Bank of America Fund XII Term Loan
secured by the Fund XII Properties, the new Lehman Capital
Note secured by the Fountain Place Office Property, and the
new Metropolitan Life Note VII secured by the Dupont Centre
Office Property;

o $319.0 million of proceeds from borrowings under the
Company's credit facility;

o $79.9 million of proceeds from the Fountain Place Office
Property transaction;

49

o $71.0 million of net proceeds from issuance of Series A
Preferred Shares;

o $47.2 million of proceeds from borrowings for construction
costs for infrastructure development at the Residential
Development Properties;

o $1.1 million of capital contributions from joint venture
partners; and

o $0.4 million of net proceeds from the exercise of share
options.

The cash provided by financing activities is partially offset by:

o $372.8 million of payments under other borrowings, due
primarily to the pay off of the Deutsche Bank-CMBS Loan, the
pay down of the Fleet Fund I Term Loan and the pay down of
the Bank of America Fund XII Term Loan;

o $325.5 million of payments under the Company's credit
facility;

o $87.8 million of distributions to common shareholders and
unitholders;

o $24.5 million of Residential Development Property note
payments;

o $16.0 million of distributions to preferred shareholders;

o $6.1 million of debt financing costs primarily associated
with the $275 million Bank of America and Deutsche Bank Term
Loan and the Lehman Capital Note;

o $3.9 million of capital distributions to joint venture
partners; and

o $1.1 million of amortization of debt premiums.

LIQUIDITY REQUIREMENTS

DEBT FINANCING SUMMARY

The following tables show summary information about the Company's debt,
including its share of unconsolidated debt, as of June 30, 2004. Additional
information about the significant terms of the Company's debt financing
arrangements and its unconsolidated debt is contained in Note 9, "Notes Payable
and Borrowings under Credit Facility" and Note 8, "Investments in Unconsolidated
Companies," of Item 1, "Financial Statements."

Listed below are the aggregate principal payments by year required as
of June 30, 2004. Scheduled principal installments and amounts due at maturity
are included.

- ----------

(1) Excludes effect of extension options on Bank of America Fund XII Term Loan
and expected early payment of LaSalle Note I, JP Morgan Mortgage Note, or
the Nomura Funding VI Note.

50

OFF-BALANCE SHEET ARRANGEMENTS - GUARANTEE COMMITMENTS

The FASB issued Interpretation 45, "Guarantors' Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," requiring a guarantor to disclose its guarantees. The
Company's guarantees in place as of June 30, 2004 are listed in the table below.
For the guarantees on indebtedness, no triggering events or conditions are
anticipated to occur that would require payment under the guarantees and
management believes the assets associated with the loans that are guaranteed are
sufficient to cover the maximum potential amount of future payments and
therefore, would not require the Company to provide additional collateral to
support the guarantees. The Company has not recorded a liability associated with
these guarantees as they were entered into prior to the adoption of FIN 45.

(1) The Company provides a $7.6 million letter of credit to support the
payment of interest and principal of the Eagle Ranch Metropolitan
District Revenue Development Bonds.

(2) See Note 8, "Investments in Unconsolidated Companies," for a
description of the terms of this debt.

(3) A fully consolidated entity of CRDI, of which CRDI owns 88.3%, provides
a guarantee of 70% of the outstanding balance of up to a $9.0 million
loan to Blue River Land Company, L.L.C. There was approximately $3.1
million outstanding at June 30, 2004 and the amount guaranteed was $2.2
million.

(4) The Company and its joint venture partner each provide separate Letters
of Credit to guarantee repayment of up to $4.3 million each of the Main
Street Partners, L.P. loan.

OTHER COMMITMENTS AND CONTINGENCIES

See "Recent Developments" in this Item 2, for information on the
Company's $79.9 million contingent obligation related to the Fountain Place
Office Property transaction.

The Company has a contingent obligation of approximately $0.9 million
related to a construction warranty matter. The Company believes it is probable
that a significant amount would be recoverable through reimbursements from third
parties.

51

CAPITAL EXPENDITURES

As of June 30, 2004, the Company had unfunded capital expenditures of
approximately $34.5 million relating to capital investments that are not in the
ordinary course of operations of the Company's business segments. The table
below specifies the Company's requirements for capital expenditures and its
amounts funded as of June 30, 2004, and amounts remaining to be funded (future
fundings classified between short-term and long-term capital requirements):

- ----------

(1) All amounts are approximate.

(2) Reflects the Company's estimate of the breakdown between short-term and
long-term capital expenditures.

(3) The capital expenditures reflect the Company's ownership percentage of
30% for Five Post Oak Park Office Property.

(4) Located within the Houston Center Office Property complex.

(5) As of June 30, 2004, the Company had invested $40.0 million in Tahoe
Mountain Club, which includes the acquisition of land and development
of a golf course and retail amenities. During 2004, the Company is
developing a swim and fitness facility, clubhouse, and completing the
golf course.

(6) The Company has a $2.4 million construction loan with the purchaser of
the land, which will be secured by 9 developed lots and a $0.4 million
letter of credit.

(7) The Sonoma Mission Inn rooms remodel was completed and all rooms were
returned to service in July 2004.

(8) This commitment is related to the Company's investment in a private
equity fund and its general partner. The commitment is based on cash
contributions and distributions and does not consider equity gains or
losses.

(9) The Company and COPI are assessing other alternatives for the sale of
COPI's 40% interest in the tenant of the Temperature-Controlled
Logistics properties, AmeriCold Logistics. At this time, the Company
does not expect to spin-off to its shareholders a new entity that would
purchase COPI's interest in AmeriCold Logistics.

In April 2004, the Company entered into agreements with Ritz-Carlton
Hotel Company, L.L.C. to develop the first Ritz-Carlton hotel and condominium
project in Dallas, Texas with development to commence upon reaching an
acceptable level of pre-sales for the residences. The development plans include
a Ritz-Carlton with approximately 216 hotel rooms and 70 residences.
Construction on the development is anticipated to begin in the first quarter of
2005.

LIQUIDITY OUTLOOK

The Company expects to fund its short-term capital requirements of
approximately $30.7 million through a combination of net cash flow from
operations and borrowings under the Company's credit facility or additional debt
facilities. As of June 30, 2004, the Company had maturing debt obligations of
$547.0 million through June 30, 2005, consisting primarily of its credit
facility, Fleet Fund I Term Loan and the Lehman Capital Note. The Company plans
to refinance the credit facility and the Fleet Fund I Term Loan in 2004. The
Lehman Capital Note is also expected to be refinanced. The remaining maturities
consist primarily of normal principal amortization and will be meet with cash
flow from operations. In addition, $38.1 million of debt relating to the
Residential Developments is maturing within the next 12 months and will be
retired with the sales of the corresponding land or units or will be refinanced.

The Company expects to meet its other short-term liquidity
requirements, consisting of normal recurring operating expenses, principal and
interest payment requirements, non-revenue enhancing capital expenditures and
revenue enhancing capital expenditures (such as property improvements, tenant
improvements and leasing costs), distributions to shareholders and unitholders,
and unfunded expenses related to the COPI bankruptcy, primarily through cash
flow provided by operating

52

activities. The Company expects to fund the remainder of these short-term
liquidity requirements with borrowings under the Company's credit facility,
return of capital from Residential Development Properties, proceeds from the
sale of non-core investments, other business initiatives or the joint venture of
Properties, and borrowings under additional debt facilities.

The Company's long-term liquidity requirements as of June 30, 2004
consist primarily of $2.2 billion of debt maturing after June 30, 2005.
The Company also has $3.8 million of long-term capital expenditure requirements.
The Company anticipates meeting these long-term maturity obligations primarily
through refinancing maturing debt with long-term secured and unsecured debt and
through other debt and equity financing alternatives as well as cash proceeds
received from the sale or joint venture of Properties.

Debt and equity financing alternatives currently available to the
Company to satisfy its liquidity requirements and commitments for material
capital expenditures include:

o Additional proceeds from the Company's Credit Facility under which the
Company had up to $151.9 million of borrowing capacity available as of
June 30, 2004;

o Additional proceeds from the refinancing of existing secured and
unsecured debt;

o Additional debt secured by existing underleveraged properties;

o Issuance of additional unsecured debt; and

o Equity offerings including preferred and/or convertible securities or
joint ventures of existing properties.

The following factors could limit the Company's ability to utilize
these financing alternatives:

o The reduction in the operating results of the Properties supporting
the Company's Credit Facility to a level that would reduce the
availability of funds under the Credit Facility;

o A reduction in the operating results of the Properties could limit the
Company's ability to refinance existing secured and unsecured debt, or
extend maturity dates or could result in an uncured or unwaived event
of default;

o The Company may be unable to obtain debt or equity financing on
favorable terms, or at all, as a result of the financial condition of
the Company or market conditions at the time the Company seeks
additional financing;

o Restrictions under the Company's debt instruments or outstanding
equity may prohibit it from incurring debt or issuing equity on terms
available under then-prevailing market conditions or at all; and

o The Company may be unable to service additional or replacement debt
due to increases in interest rates or a decline in the Company's
operating performance.

The Company's portion of unconsolidated debt maturing through June 30,
2005 is $74.4 million. The Company's portion of unconsolidated debt maturing
after June 30, 2005 is $410.0 million. Unconsolidated debt is the liability of
the unconsolidated entity, is typically secured by that entity's property, and
is non-recourse to the Company except where a guarantee exists.

EQUITY AND DEBT FINANCING

SERIES A PREFERRED OFFERING

On January 15, 2004, the Company completed an offering (the "January
2004 Series A Preferred Offering") of an additional 3,400,000 Series A
Convertible Cumulative Preferred Shares (the "Series A Preferred Shares") at a
$21.98 per share price and with a liquidation preference of $25.00 per share for
aggregate total offering proceeds of approximately $74.7 million. The Series A
Preferred Shares are convertible at any time, in whole or in part, at the option
of the holders, into common shares of the Company at a conversion price of
$40.86 per common share (equivalent to a conversion rate of 0.6119 common shares
per Series A Preferred Share), subject to adjustment in certain circumstances.
The Series A Preferred Shares have no stated maturity and are not subject to
sinking fund or mandatory redemption. At any time, the Series A Preferred Shares
may be redeemed, at the Company's option, by paying $25.00 per share plus any
accumulated accrued and unpaid distributions. Dividends on the additional Series
A Preferred Shares are cumulative from November 16, 2003, and are payable
quarterly in arrears on the fifteenth of February, May, August and November,
commencing February 16, 2004. The annual fixed dividend on the Series A
Preferred Shares is $1.6875 per share.

Net proceeds to the Company from the January 2004 Series A Preferred
Offering were approximately $71.0 million after underwriting discounts, offering
costs and dividends accrued on the shares up to the issuance date. The Company
used the net proceeds to pay down the Company's credit facility.

53

DEBT FINANCING ARRANGEMENTS

The significant terms of the Company's primary debt financing
arrangements existing as of June 30, 2004, are shown below:

- ----------
(1) For more information regarding the terms of the Company's debt
financing arrangements, including properties securing the Company's
secured debt and the method of calculation of the interest rate for the
Company's variable rate debt, see Note 9, "Notes Payable and Borrowings
under the Credit Facility," included in Item 1, "Financial Statements."

(2) In December 2003, the Company defeased approximately $8.7 million of
this loan to release one of the Funding II Properties securing the loan
by purchasing $9.6 million in U.S. Treasuries and government sponsored
agency securities to substitute as collateral. On January 15, 2004, the
Company defeased approximately $150.7 million to release the remainder
of the Funding II properties by purchasing $170.0 million in U.S.
Treasuries and government sponsored agency securities. The earnings and
principal maturity from these investments will pay the principal and
interest associated with the LaSalle Note II.

(3) Includes a portion of total premiums of $7.7 million reflecting market
value of debt acquired with purchase of Hughes Center portfolio.

(4) This loan has one one-year extension option.

(5) The outstanding balance excludes letters of credit issued under the
credit facility of $7.6 million.

(6) The overall weighted average interest rate does not include the effect
of the Company's cash flow hedge agreements. Including the effect of
these agreements, the overall weighted average interest rate would have
been 6.82%.

54

The Company is generally obligated by its debt agreements to comply
with financial covenants, affirmative covenants and negative covenants, or some
combination of these types of covenants. The financial covenants to which the
Company is subject include, among others, leverage ratios, debt service coverage
ratios and limitations on total indebtedness. The affirmative covenants to which
the Company is subject under its debt agreements include, among others,
provisions requiring the Company to comply with all laws relating to operation
of any Properties securing the debt, maintain those Properties in good repair
and working order, maintain adequate insurance and provide timely financial
information. The negative covenants under the Company's debt agreements
generally restrict the Company's ability to transfer or pledge assets or incur
additional debt at a subsidiary level, limit the Company's ability to engage in
transactions with affiliates and place conditions on the Company's or a
subsidiary's ability to make distributions.

Failure to comply with covenants generally will result in an event of
default under that debt instrument. Any uncured or unwaived events of default
under the Company's loans can trigger an increase in interest rates, an
acceleration of payment on the loan in default, and for the Company's secured
debt, foreclosure on the property securing the debt, and could cause the credit
facility to become unavailable to the Company. In addition, an event of default
by the Company or any of its subsidiaries with respect to any indebtedness in
excess of $5.0 million generally will result in an event of default under the
Credit Facility, 2007 Notes, 2009 Notes, Bank of America Fund XII Term Loan, the
Fleet Fund I Term Loan and the Fleet Term Loan after the notice and cure periods
for the other indebtedness have passed. As a result, any uncured or unwaived
event of default could have an adverse effect on the Company's business,
financial condition, or liquidity.

The Company's debt facilities generally prohibit loan prepayment for an
initial period, allow prepayment with a penalty during a following specified
period and allow prepayment without penalty after the expiration of that period.
During the six months ended June 30, 2004, there were no circumstances that
required prepayment penalties or increased collateral related to the Company's
existing debt.

On June 28, 2004, the Company paid off the $220.0 million Deutsche
Bank-CMBS loan with proceeds from the Fountain Place transaction and a draw on
the Company's credit facility. See "Recent Developments," in this Item 2, for
additional information regarding the Fountain Place transaction. The loan was
secured by the Funding X Properties and Spectrum Center. In July 2004, the
Company unwound the $220.0 million interest rate cap with JP Morgan Chase that
corresponded to this loan.

DEFEASANCE OF LASALLE NOTE II

In January 2004, the Company released the remaining properties in
Funding II by reducing the Fleet Fund I and II Term Loan by $104.2 million and
purchasing an additional $170.0 million of U.S. Treasury and government
sponsored agency securities with an initial weighted average yield of 1.76%. The
Company placed those securities into a collateral account for the sole purpose
of funding payments of principal and interest on the remainder of the LaSalle
Note II. The cash flow from the securities is structured to match the cash flow
(principal and interest payments) required under the LaSalle Note II. The
retirement of the Fleet loan and the purchase of the defeasance securities were
funded through the $275 million Bank of America Fund XII Term Loan. The
collateral for the Bank of America loan is 10 of the 11 properties previously in
the Funding II collateral pool, which are now held in Funding XII. The Bank of
America loan is structured to allow the Company the flexibility to sell, joint
venture or long-term finance these 10 assets over the next 36 months. The final
Funding II property, Liberty Plaza, was moved to the Operating Partnership and
subsequently sold in April 2004.

UNCONSOLIDATED DEBT ARRANGEMENTS

As of June 30, 2004, the total debt of the unconsolidated joint
ventures and equity investments in which the Company has ownership interests was
$1.3 billion, of which the Company's share was $484.4 million. The Company had
guaranteed $6.4 million of this debt as of June 30, 2004. Additional information
relating to the Company's unconsolidated debt financing arrangements is
contained in Note 8, "Investments in Unconsolidated Companies," of Item 1,
"Financial Statements."

55

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Company uses derivative financial instruments to convert a portion
of its variable rate debt to fixed rate debt and to manage its fixed to variable
rate debt ratio. As of June 30, 2004, the Company had three cash flow hedge
agreements which are accounted for in conformity with SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities -
an Amendment of FASB Statement No. 133."

The following table shows information regarding the Company's interest
rate swaps designated as cash flow hedge agreements during the six months ended
June 30, 2004, and additional interest expense and unrealized gains (losses)
recorded in Accumulated Other Comprehensive Income ("OCI").

In addition, two of the Company's unconsolidated companies have cash
flow hedge agreements of which the Company's portion of change in unrealized
gains reflected in OCI was approximately $0.4 million for the six months ended
June 30, 2004.

INTEREST RATE CAP

In March 2004, in connection with the Bank of America Fund XII Term
Loan, the Company entered into a LIBOR interest rate cap struck at 6.00% for a
notional amount of approximately $206.3 million through August 31, 2004, $137.5
million from September 1, 2004 through February 28, 2005, and $68.8 million from
March 1, 2005 through March 1, 2006. Simultaneously, the Company sold a LIBOR
interest rate cap with the same terms. Since these instruments do not reduce the
Company's net interest rate risk exposure, they do not qualify as hedges and
changes to their respective fair values are charged to earnings as the changes
occur. As the significant terms of these arrangements are the same, the effects
of a revaluation of these instruments are expected to offset each other.

56

UNCONSOLIDATED INVESTMENTS

INVESTMENTS IN UNCONSOLIDATED COMPANIES

The following is a summary of the Company's ownership in significant
unconsolidated joint ventures and investments as of June 30, 2004.

- ----------

(1) The remaining 50% interest in Main Street Partners, L.P. is owned by Trizec
Properties, Inc.

(2) The remaining 60% interest in Crescent Miami Center, L.L.C. is owned by an
affiliate of a fund managed by JP Morgan Fleming Asset Management, Inc.

(3) The remaining 70% interest in Crescent Five Post Oak Park, L.P. is owned by
an affiliate of General Electric Pension Fund Trust.

(4) The remaining 70% interest in Crescent One BriarLake Plaza, L.P. is owned
by affiliates of JP Morgan Fleming Asset Management, Inc.

(5) The remaining 75% interest in Crescent 5 Houston Center, L.P. is owned by a
pension fund advised by JP Morgan Fleming Asset Management, Inc.

(6) The remaining 80% interest in each of Austin PT BK One Tower Office Limited
Partnership, Houston PT Three Westlake Office Limited Partnership and
Houston PT Four Westlake Office Limited Partnership is owned by an
affiliate of General Electric Pension Fund Trust.

(7) The remaining 44% in Vornado Crescent Carthage and KC Quarry, L.L.C. is
owned by Vornado Realty Trust, L.P.

(8) The remaining 60% interest in Vornado Crescent Portland Partnership is
owned by Vornado Realty Trust, L.P.

(9) The remaining 50% interest in Blue River Land Company, L.L.C. is owned by
parties unrelated to the Company. Blue River Land Company, L.L.C. was
formed to acquire, develop and sell certain real estate property in Summit
County, Colorado.

(10) Of the remaining 50% interest in Canyon Ranch Las Vegas, L.L.C., 35% is
owned by an affiliate of the management company of two of the Company's
Resort/Hotel Properties and 15% is owned by the Company through its
investments in CR License II, L.L.C. Canyon Ranch Las Vegas, L.L.C.
operates a Canyon Ranch spa in a hotel in Las Vegas.

(11) The remaining 58.3% interest in EW Deer Valley, L.L.C. is owned by parties
unrelated to the Company. EW Deer Valley, L.L.C. was formed to acquire,
hold and dispose of its 3.3% ownership interest in Empire Mountain Village,
L.L.C. Empire Mountain Village, L.L.C. was formed to acquire, develop and
sell certain real estate property at Deer Valley Ski Resort next to Park
City, Utah.

(12) The remaining 70% interest in CR License, L.L.C. is owned by an affiliate
of the management company of two of the Company's Resort/Hotel Properties.
CR License, L.L.C. owns the licensing agreement related to certain Canyon
Ranch trade names and trademarks.

(13) The remaining 70% interest in CR License II, L.L.C. is owned by an
affiliate of the management company of two of the Company's Resort/Hotel
Properties. CR License II, L.L.C. and its wholly-owned subsidiaries provide
management and development consulting services to a variety of entities in
the hospitality, real estate, and health and wellness industries.

(14) Of the remaining 76.5% of SunTx Fulcrum Fund, 37.1% is owned by SunTx
Capital Partners, L.P. and the remaining 39.4% is owned by a group of
individuals unrelated to the Company. SunTx Fulcrum Fund, L.P.'s objective
is to invest in a portfolio of acquisitions that offer the potential for
substantial capital appreciation.

(15) SunTx Capital Partners, L.P. is the general Partner of the SunTx Fulcrum
Fund, L.P. The remaining 85.6% interest in SunTx Capital Partners, L.P. is
owned by parties unrelated to the Company.

(16) G2 was formed for the purpose of investing in commercial mortgage backed
securities and other commercial real estate investments. The remaining
87.5% interest in G2 is owned by Goff-Moore Strategic Partners, L.P.
("GMSPLP") and by parties unrelated to the Company. G2 is managed and
controlled by an entity that is owned equally by GMSPLP and GMAC Commercial
Mortgage Corporation ("GMACCM"). The ownership structure of GMSPLP consists
of an approximately 86% limited partnership interest owned directly and
indirectly by Richard E. Rainwater, Chairman of the Board of Trust Managers
of the Company, and an approximately 14% general partnership interest, of
which approximately 6% is owned by Darla Moore, who is married to Mr.
Rainwater, and approximately 6% is owned by John C. Goff, Vice-Chairman of
the Company's Board of Trust Managers and Chief Executive Officer of the
Company. The remaining approximately 2% general partnership interest is
owned by unrelated parties.

57

TEMPERATURE-CONTROLLED LOGISTICS SEGMENT

AmeriCold Logistics, a limited liability company owned 60% by Vornado
Operating L.P. and 40% by a subsidiary of Crescent Operating, Inc. ("COPI"), as
sole lessee of the Temperature-Controlled Logistics Properties, leases the
Temperature-Controlled Logistics Properties from the Temperature-Controlled
Logistics Corporation under three triple-net master leases, as amended. The
Company has no interest in COPI or AmeriCold Logistics. On March 2, 2004, the
Temperature-Controlled Logistics Corporation and AmeriCold Logistics amended the
leases to further extend the deferred rent period to December 31, 2005, from
December 31, 2004. The parties previously extended the deferred rent period to
December 31, 2004 from December 31, 2003, on March 7, 2003.

Under terms of the leases, AmeriCold Logistics elected to defer $26.9
million of the total $78.9 million of rent payable for the six months ended June
30, 2004. The Company's share of the deferred rent was $10.8 million. The
Company recognizes rental income from the Temperature-Controlled Logistics
Properties when earned and collected and has not recognized the $10.8 million of
deferred rent in equity in net income of the Temperature-Controlled Logistics
Properties for the six months ended June 30, 2004. As of June 30, 2004, the
Temperature-Controlled Logistics Corporation's deferred rent and valuation
allowance from AmeriCold Logistics were $109.3 million and $101.2 million,
respectively, of which the Company's portions were $43.7 million and $40.5
million, respectively.

As a result of the continuing inability of AmeriCold Logistics to pay
the full amount of the rent due under the leases without deferral elections, the
Company anticipates that the Temperature-Controlled Logistics Corporation may
restructure the leases in 2004, although it is under no obligation to do so.

On February 5, 2004, the Temperature-Controlled Logistics Corporation
completed a $254.4 million mortgage financing with Morgan Stanley Mortgage
Capital Inc., secured by 21 of its owned and seven of its leased
temperature-controlled logistics properties. The loan matures in April 2009,
bears interest at LIBOR plus 295 basis points (with a LIBOR floor of 1.5% with
respect to $54.4 million of the loan) and requires principal payments of $5.0
million annually. The net proceeds to the Temperature-Controlled Logistics
Corporation were approximately $225.0 million, after closing costs and the
repayment of approximately $12.9 million in existing mortgages. On February 6,
2004, the Temperature-Controlled Logistics Corporation distributed cash of
approximately $90.0 million to the Company.

SIGNIFICANT ACCOUNTING POLICIES

CRITICAL ACCOUNTING POLICIES

The Company's discussion and analysis of financial condition and
results of operations is based on its consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires the
Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, and contingencies as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. The Company evaluates its assumptions and estimates on an
ongoing basis. The Company bases its estimates on historical experience and on
various other assumptions that it believes to be reasonable under the
circumstances. These estimates form the basis for making judgments about the
carrying values of assets and liabilities where that information is available
from other sources. Certain estimates are particularly sensitive due to their
significance to the financial statements. Actual results may differ
significantly from management's estimates.

The Company believes that the most significant accounting policies that
involve the use estimates and assumptions as to future uncertainties and,
therefore, may result in actual amounts that differ from estimates are the
following:

o Impairments,
o Acquisition of operating properties,
o Relative sales method and percentage of completion (Residential
Development entities),
o Gain recognition on sale of real estate assets,
o Consolidation of variable interest entities, and
o Allowance for doubtful accounts.

IMPAIRMENTS. Real estate and leasehold improvements are classified as
long-lived assets held for sale or long-lived assets to be held and used. In
accordance with SFAS No. 144, the Company records assets held for sale at the
lower of carrying value or sales price less costs to sell. For assets classified
as held and used, these assets are tested for recoverability when events or
changes in circumstances indicate that the estimated carrying amount may not be
recoverable. An impairment loss is recognized when expected undiscounted future
cash flows from a Property is less than the carrying value of the Property. The
Company's estimates of cash flows of the Properties requires the Company to make
assumptions related to future rental rates, occupancies, operating expenses, the
ability of the Company's tenants to perform pursuant to their lease obligations
and proceeds to be generated from the eventual sale of the Company's Properties.
Any changes in estimated

58

future cash flows due to changes in the Company's plans or views of market and
economic conditions could result in recognition of additional impairment losses.

If events or circumstances indicate that the fair value of an
investment accounted for using the equity method has declined below its carrying
value and the Company considers the decline to be "other than temporary," the
investment is written down to fair value and an impairment loss is recognized.
The evaluation of impairment for an investment would be based on a number of
factors, including financial condition and operating results for the investment,
inability to remain in compliance with provisions of any related debt
agreements, and recognition of impairments by other investors. Impairment
recognition would negatively impact the recorded value of our investment and
reduce net income.

ACQUISITION OF OPERATING PROPERTIES. The Company allocates the purchase
price of acquired properties to tangible and identified intangible assets
acquired based on their fair values in accordance with SFAS No. 141, "Business
Combinations."

In making estimates of fair value for purposes of allocating purchase
price, management utilizes sources, including, but not limited to, independent
value consulting services, independent appraisals that may be obtained in
connection with financing the respective property, and other market data.
Management also considers information obtained about each property as a result
of its pre-acquisition due diligence, marketing and leasing activities in
estimating the fair value of the tangible and intangible assets acquired.

The aggregate value of the tangible assets acquired is measured based
on the sum of (i) the value of the property and (ii) the present value of the
amortized in-place tenant improvement allowances over the remaining term of each
lease. Management's estimates of the value of the property are made using models
similar to those used by independent appraisers. Factors considered by
management in its analysis include an estimate of carrying costs such as real
estate taxes, insurance, and other operating expenses and estimates of lost
rentals during the expected lease-up period assuming current market conditions.
The value of the property is then allocated among building, land, site
improvements, and equipment. The value of tenant improvements is separately
estimated due to the different depreciable lives.

The aggregate value of intangible assets acquired is measured based on
the difference between (i) the purchase price and (ii) the value of the tangible
assets acquired as defined above. This value is then allocated among
above-market and below-market in-place lease values, costs to execute similar
leases (including leasing commissions, legal expenses and other related
expenses), in-place lease values and customer relationship values.

Above-market and below-market in-place lease values for acquired
properties are calculated based on the present value (using a market interest
rate which reflects the risks associated with the leases acquired) of the
difference between (i) the contractual amounts to be paid pursuant to the
in-place leases and (ii) management's estimate of fair market lease rates for
the corresponding in-place leases, measured over a period equal to the remaining
non-cancelable term of the lease for above-market leases and the initial term
plus the term of the below-market fixed rate renewal option, if any, for
below-market leases. The Company performs this analysis on a lease by lease
basis. The capitalized above-market lease values are amortized as a reduction to
rental income over the remaining non-cancelable terms of the respective leases.
The capitalized below-market lease values are amortized as an increase to rental
income over the initial term plus the term of the below-market fixed rate
renewal option, if any, of the respective leases.

Management estimates costs to execute leases similar to those acquired
at the property at acquisition based on current market conditions. These costs
are recorded based on the present value of the amortized in-place leasing costs
on a lease by lease basis over the remaining term of each lease.

The in-place lease values and customer relationship values are based on
management's evaluation of the specific characteristics of each customer's lease
and the Company's overall relationship with that respective customer.
Characteristics considered by management in allocating these values include the
nature and extent of the Company's existing business relationships with the
customer, growth prospects for developing new business with the customer, the
customer's credit quality, and the expectation of lease renewals, among other
factors. The in-place lease value and customer relationship value are both
amortized to expense over the initial term of the respective leases and
projected renewal periods, but in no event does the amortization period for the
intangible assets exceed the remaining depreciable life of the building.

Should a tenant terminate its lease, the unamortized portion of the
in-place lease value and the customer relationship value and above-market and
below-market in-place lease values would be charged to expense.

RELATIVE SALES METHOD AND PERCENTAGE OF COMPLETION. The Company uses
the accrual method to recognize earnings from the sale of Residential
Development Properties when a third-party buyer had made an adequate cash down
payment and has attained the attributes of ownership. If a sale does not qualify
for the accrual method of recognition,

59

deferral methods are used as appropriate including the percentage-of-completion
method. In certain cases, when the Company receives an inadequate cash down
payment and takes a promissory note for the balance of the sales price, revenue
recognition is deferred until such time as sufficient cash is received to meet
minimum down payment requirements. The cost of residential property sold is
defined based on the type of product being purchased. The cost of sales for
residential lots is generally determined as a specific percentage of the sales
revenues recognized for each Residential Development project. The percentages
are based on total estimated development costs and sales revenue for each
Residential Development project. These estimates are revised annually and are
based on the then-current development strategy and operating assumptions
utilizing internally developed projections for product type, revenue and related
development costs. The cost of sale for residential units (such as townhomes and
condominiums) is determined using the relative sales value method. If the
residential unit has been sold prior to the completion of infrastructure cost,
and those uncompleted costs are not significant in relation to total costs, the
full accrual method is utilized. Under this method, 100% of the revenue is
recognized, and a commitment liability is established to reflect the allocated
estimated future costs to complete the residential unit. If the Company's
estimates of costs or the percentage of completion is incorrect, it could result
in either an increase or decrease in cost of sales expense or revenue recognized
and therefore, an increase or decrease in net income.

GAIN RECOGNITION ON SALE OF REAL ESTATE ASSETS. The Company performs
evaluations of each real estate sale to determine if full gain recognition is
appropriate in accordance with SFAS No. 66, "Accounting for Sales of Real
Estate." The application of SFAS No. 66 can be complex and requires the Company
to make assumptions including an assessment of whether the risks and rewards of
ownership have been transferred, the extent of the purchaser's investment in the
property being sold, whether the Company's receivables, if any, related to the
sale are collectible and are subject to subordination, and the degree of the
Company's continuing involvement with the real estate asset after the sale. If
full gain recognition is not appropriate, the Company accounts for the sale
under an appropriate deferral method.

CONSOLIDATION OF VARIABLE INTEREST ENTITIES. On January 15, 2003, the
FASB approved the issuance of Interpretation 46, "Consolidation of Variable
Interest Entities," ("FIN 46"), an interpretation of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements." In December 2003, the FASB
issued FIN 46R, "Consolidation of Variable Interest Entities" ("FIN 46R"), which
amended FIN 46. Under FIN 46R, consolidation requirements are effective
immediately for new Variable Interest Entities ("VIEs") created after January
31, 2003. The consolidation requirements apply to existing VIEs for financial
periods ending after March 15, 2004, except for special purpose entities which
had to be consolidated by December 31, 2003. VIEs are generally a legal
structure used for business enterprises that either do not have equity investors
with voting rights, or have equity investors that do not provide sufficient
financial resources for the entity to support its activities. The objective of
the new guidance is to improve reporting by addressing when a company should
include in its financial statements the assets, liabilities and activities of
other entities such as VIEs. FIN 46R requires VIEs to be consolidated by a
company if the company is subject to a majority of the expected losses of the
VIE's activities or entitled to receive a majority of the entity's expected
residual returns or both.

The adoption of FIN 46R did not have a material impact to the Company's
financial condition or results of operations. Due to the adoption of this
Interpretation and management's assumptions in application of the guidelines
stated in the Interpretation, the Company has consolidated GDW LLC, a subsidiary
of DMDC, as of December 31, 2003 and Elijah Fulcrum Fund Partners, L.P.
("Elijah") as of January 1, 2004. Elijah is a limited partnership whose purpose
is to invest in the SunTx Fulcrum Fund, L.P. SunTx Fulcrum Fund, L.P.'s
objective is to invest in a portfolio of acquisitions that offer the potential
for substantial capital appreciation. While it was determined that one of the
Company's unconsolidated joint ventures, Main Street Partners, L.P., and its
investments in Canyon Ranch Las Vegas, L.L.C., CR License, L.L.C. and CR License
II, L.L.C. ("Canyon Ranch Entities") are VIEs under FIN 46R, the Company is not
the primary beneficiary and is not required to consolidate these entities under
other GAAP. The Company's maximum exposure to loss is limited to its equity
investment of approximately $52.0 million in Main Street Partners, L.P. and $5.1
million in the Canyon Ranch Entities at June 30, 2004.

In connection with the Hughes Center acquisition, the Company entered
into two separate exchange agreements with a third party intermediary. The first
exchange agreement includes two parcels of undeveloped land and the second
exchange agreement includes the 3930 Hughes Parkway Office Property. Both
agreements were for a maximum term of 180 days and allow the Company to pursue
favorable tax treatment on other properties sold by the Company within this
period. During the 180-day periods, which will end on August 28, 2004 and
November 6, 2004, respectively, the third party intermediary is the legal owner
of the properties, although the Company controls the properties, retains all of
the economic benefits and risks associated with these properties and indemnifies
the third party intermediary and, therefore, the Company fully consolidates
these properties. The Company will take legal ownership of the properties no
later than on the expiration of the 180-day period.

Further, in connection with the Hughes Center acquisition, the Company
entered into an exchange agreement with a third party intermediary for six of
the Office Properties and the nine retail parcels. This agreement was for a
maximum term

60

of 180 days and allowed the Company to pursue favorable tax treatment on other
properties sold by the Company within this period. During the 180-day period,
which ended on June 28, 2004, the third party intermediary was the legal owner
of the properties, although the Company controlled the properties, retained all
of the economic benefits and risks associated with these properties and
indemnified the third party intermediary and, therefore, the Company fully
consolidated these properties. On June 28, 2004, the Company took legal
ownership of the Office Properties.

ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company's accounts receivable
balance is reduced by an allowance for amounts that may become uncollectible in
the future. The Company's receivable balance is composed primarily of rents and
operating cost recoveries due from its tenants. The Company also maintains an
allowance for deferred rent receivables which arise from the straight-lining of
rents. The allowance for doubtful accounts is reviewed at least quarterly for
adequacy by reviewing such factors as the credit quality of the Company's
tenants, any delinquency in payment, historical trends and current economic
conditions. If the assumptions regarding the collectibility of accounts
receivable prove incorrect, the Company could experience write-offs in excess of
its allowance for doubtful accounts, which would result in a decrease in net
income.

ADOPTION OF NEW ACCOUNTING STANDARD

EITF 03-1. At the March 17-18, 2004 meeting, consensus was reached by
the FASB Emerging Issues Task Force on EITF 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments." The
Consensus applies to investments in debt and equity securities within the scope
of SFAS Nos. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and 124, "Accounting for Certain Investments Held by Not-for-Profit
Organizations." It also applies to investments in equity securities that are
both outside SFAS No. 115's scope and not accounted for under the equity method.
The Task Force reached a consensus that certain quantitative and qualitative
disclosures should be required for securities that are impaired at the balance
sheet date but for which an other-than-temporary impairment has not been
recognized. The new impairment guidance creates a model that calls for many
judgments and additional evidence gathering in determining whether or not
securities are other-than-temporarily impaired and lists some of these
impairment indicators. The impairment accounting guidance is effective for
periods beginning after June 15, 2004 and the disclosure requirements for annual
reporting periods are effective for periods ending after June 15, 2004. The
Company adopted EITF 03-1 effective July 1, 2004 and expects no impact on the
Company's financial condition or its results of operations.

61

FUNDS FROM OPERATIONS

FFO, as used in this document, means:

o Net Income (Loss) - determined in accordance with GAAP;
o excluding gains (or losses) from sales of depreciable operating
property;
o excluding extraordinary items (as defined by GAAP);
o plus depreciation and amortization of real estate assets; and
o after adjustments for unconsolidated partnerships and joint
ventures.

The Company calculates FFO available to common shareholders - diluted
in the same manner, except that Net Income (Loss) is replaced by Net Income
(Loss) Available to Common Shareholders and the Company includes the effect of
operating partnership unitholder minority interests.

The National Association of Real Estate Investment Trusts ("NAREIT")
developed FFO as a relative measure of performance and liquidity of an equity
REIT to recognize that income-producing real estate historically has not
depreciated on the basis determined under GAAP. The Company considers FFO
available to common shareholders - diluted and FFO appropriate measures of
performance for an equity REIT and for its investment segments. However, FFO
available to common shareholders - diluted and FFO should not be considered
an alternative to net income determined in accordance with GAAP as an indication
of the Company's operating performance.

The aggregate cash distributions paid to common shareholders and
unitholders for the six months ended June 30, 2004 and 2003 were $87.8 million
and $87.7 million, respectively. The Company reported FFO available to common
shareholders before impairments charges related to real estate assets - diluted
of $58.6 million and $77.9 million, for the six months ended June 30, 2004 and
2003, respectively. The Company reported FFO available to common shareholders
after impairments charges related to real estate assets - diluted of $55.7
million and $59.8 million, for the six months ended June 30, 2004 and 2003,
respectively.

An increase or decrease in FFO available to common shareholders -
diluted does not necessarily result in an increase or decrease in aggregate
distributions because the Company's Board of Trust Managers is not required to
increase distributions on a quarterly basis unless necessary for the Company to
maintain REIT status. However, the Company must distribute 90% of its REIT
taxable income (as defined in the Code). Therefore, a significant increase in
FFO available to common shareholders - diluted will generally require an
increase in distributions to shareholders and unitholders although not
necessarily on a proportionate basis.

Accordingly, the Company believes that to facilitate a clear
understanding of the consolidated historical operating results of the Company,
FFO available to common shareholders - diluted should be considered in
conjunction with the Company's net income and cash flows reported in the
consolidated financial statements and notes to the financial statements.
However, the Company's measure of FFO available to common shareholders - diluted
may not be comparable to similarly titled measures of other REITs because these
REITs may apply the definition of FFO in a different manner than the Company.

62

CONSOLIDATED STATEMENTS OF FUNDS FROM OPERATIONS
(in thousands)

- ----------
(1) To calculate basic funds from operations exclude unitholder minority
interest.

(2) Includes interest and other income, income/loss from other
unconsolidated companies, other expenses, depreciation and amortization
of non-real estate assets and amortization of deferred financing costs.

(3) See calculations for the amounts presented in the reconciliation
following this table.

63

The following schedule reconciles the Company's basic weighted average
shares to the diluted weighted average shares/units presented above:

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

No material changes in the Company's market risk occurred from December
31, 2003 through June 30, 2004. Information regarding the Company's market risk
at December 31, 2003 is contained in Item 7A, "Quantitative and Qualitative
Disclosures About Market Risk," in the Company's Annual Report on Form 10-K for
the year ended December 31, 2003.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
reports under the Securities Exchange Act of 1934, as amended (the "Exchange
Act") is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, and that
such information is accumulated and communicated to the Company's management,
including its Chief Executive Officer and its Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure based
closely on the definition of "disclosure controls and procedures" in Rule
13a-15(e) promulgated under the Exchange Act. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.

As of June 30, 2004, the Company carried out an evaluation, under the
supervision and with the participation of the Company's management, including
its Chief Executive Officer and its Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on the foregoing, the Company's Chief Executive Officer
and its Chief Financial Officer concluded that the Company's disclosure controls
and procedures were effective at the reasonable assurance level.

During the three months ended June 30, 2004, there was no change in the
Company's internal control over financial reporting that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.

64

PART II

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

During the three months ended June 30, 2004, the Company issued an
aggregate of 18,072 common shares to holders of Operating Partnership units in
exchange for 9,036 units. The issuances of common shares were exempt from
registration as private placements under Section 4(2) of the Securities Act of
1933, as amended (the "Securities Act"). The Company has registered the resale
of such common shares under the Securities Act.

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

The annual meeting of shareholders of the Company was held on June 28,
2004.

Two proposals were submitted to a vote of shareholders as follows:

(1) The shareholders approved the election of the following
individuals as trust managers of the Company:

The terms of office of the following trust managers continued
after the meeting:

Richard E. Rainwater
John C. Goff
Anthony M. Frank
William F. Quinn
Paul E. Rowsey, III
Robert W. Stallings

(2) The shareholders approved, with 89,592,150 affirmative votes,
2,441,002 negative votes and 104,619 abstentions, the proposal
to ratify the appointment of Ernst & Young LLP as the
Company's independent auditors for the fiscal year ending
December 31, 2004.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

The exhibits required by this item are set forth on the Exhibit Index
attached hereto.

(b) Reports on Form 8-K

None.

65

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.

CRESCENT REAL ESTATE EQUITIES COMPANY
(Registrant)

By /s/ John C. Goff
-----------------------------------------------
John C. Goff
Date: August 6, 2004 Vice-Chairman of the Board and
Chief Executive Officer

By /s/ Jerry R. Crenshaw, Jr.
-----------------------------------------------
Jerry R. Crenshaw, Jr.
Executive Vice President and Chief
Financial Officer
Date: August 6, 2004 (Principal Financial and Accounting Officer)

66

INDEX TO EXHIBITS