TARRAGON CORP - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)


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

For the quarterly period ended SEPTEMBER 30, 2004

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

For the transition period from to

Commission File Number 0-22999

TARRAGON CORPORATION

(Exact name of registrant as specified in its charter)


Nevada		94-2432628

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

1775 Broadway, 23^rd Floor, New York, NY 10019

(Address of principal executive offices) (Zip Code)

(212) 949-5000

(Registrant’s telephone number, including area code)

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

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


Common Stock, $.01 par value		15,349,340
(Class)		(Outstanding at November 1, 2004)

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS
		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
	ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
	ITEM 6. EXHIBITS
SIGNATURES
Indenture Agreement
Rule 13a-14(a) Certification by William S. Friedman, CEO
Rule 13a-14(a) Certification by Erin D. Pickens, Executive Vice President and CFO
Section 1350 Certifications

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements for the period ended September 30, 2004, have not been audited by independent certified public accountants, but, in our opinion, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of consolidated financial position, consolidated results of operations, and consolidated cash flows at the dates and for the periods indicated have been included.

TARRAGON CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)


	September 30,			December 31,
	2004			2003
Assets
Real estate held for investment (net of accumulated depreciation of $132,730 in 2004 and $110,817 in 2003)	$	525,739		$	395,095
Homebuilding inventory		267,029			97,234
Contracts receivable		129,870			—
Investments in and advances to partnerships and joint ventures		34,425			81,764
Cash and cash equivalents		17,867			21,626
Restricted cash		35,067			6,573
Goodwill		2,691			2,691
Other assets, net		45,732			18,834

	$	1,058,420		$	623,817

Liabilities and Stockholders’ Equity
Liabilities
Notes and interest payable (including $756 in 2004 due to affiliates)	$	800,633		$	471,262
8% Senior convertible notes		50,000			—
Other liabilities		55,324			26,886

		905,957			498,148
Commitments and contingencies
Minority interests		21,882			22,341
Stockholders’ equity
Common stock, $.01 par value; authorized shares, 100,000,000; shares outstanding, 15,377,760 in 2004 and 11,583,973 in 2003		126			87
Special stock, $.01 par value; authorized shares, 17,500,000; shares outstanding, none		—			—
Cumulative preferred stock, $.01 par value; authorized shares, 2,500,000; shares outstanding, 753,333 in 2004 and 2003; liquidation preference, $9,040 in 2004 and 2003, or $12 per share		8			8
Paid-in capital		352,498			346,372
Accumulated deficit		<180,022	>		<202,357	>
Treasury stock, at cost; 6,197,445 shares in 2004 and 4,889,821 shares in 2003		<42,029	>		<40,782	>

		130,581			103,328

	$	1,058,420		$	623,817

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

TARRAGON CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2004			2003			2004			2003
Revenue
Rentals	$	24,417		$	21,449		$	73,162		$	61,965
Homebuilding sales		56,913			20,302			135,062			35,135
Management fees and other (including $88 and $295 in the three and nine month periods in 2004 and $112 and $310 in the three and nine month periods in 2003 from affiliates)		318			166			668			402

		81,648			41,917			208,892			97,502

Expenses
Property operations		13,482			12,303			38,651			33,928
Costs of homebuilding sales		43,409			15,103			105,687			28,733
Depreciation		5,517			4,821			16,469			15,021
General and administrative
Corporate		4,490			3,222			12,432			9,748
Property		1,076			878			3,181			2,756

		67,974			36,327			176,420			90,186

Other income and expenses
Equity in income <loss> of partnerships and joint ventures		<97	>		7,169			5,713			6,276
Minority interest in income of consolidated partnerships and joint ventures		<397	>		<1,166	>		<3,886	>		<2,284	>
Interest income (including $76 and $308 in the three and nine month periods in 2004 from affiliates)		165			412			578			664
Interest expense (including $7 and $9 in the three and nine month periods in 2004 to affiliates)		<6,819	>		<5,520	>		<19,369	>		<19,863	>
Gain on sale of real estate		—			—			378			1,223
Gain on disposition of other assets		—			—			2,075			—

Income <loss> from continuing operations before income tax		6,526			6,485			17,961			<6,668	>
Income tax <expense> benefit		<2,632	>		—			2,400			—

Income <loss> from continuing operations		3,894			6,485			20,361			<6,668	>
Discontinued operations
Income <loss> from operations		—			<21	>		<13	>		144
Gain on sale of real estate		—			7,367			2,666			16,590

Net income		3,894			13,831			23,014			10,066
Dividends on cumulative preferred stock		<226	>		<226	>		<678	>		<559	>

Net income allocable to common stockholders	$	3,668		$	13,605		$	22,336		$	9,507

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

TARRAGON CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)


	For the Nine Months
	Ended September 30,
	2004			2003
Cash Flows from Operating Activities
Net income	$	23,014		$	10,066
Adjustments to reconcile net income to net cash used in operating activities:
Gain on sale of real estate		<3,044	>		<17,813	>
Gain on disposition of other assets		<2,075	>		—
Deferred income tax		<2,400	>		—
Minority interests in income of consolidated partnerships and joint ventures		3,886			2,284
Depreciation and amortization		19,206			17,875
Equity in income of partnerships and joint ventures		<5,713	>		<6,276	>
Costs of homebuilding sales		105,687			28,733
Purchase of homebuilding inventory		<11,431	>		<12,450	>
Noncash compensation related to stock options		320			200
Excess of homebuilding sales revenue over sales collected attributable to commissions and closing costs		<1,817	>		<2,529	>
Homebuilding renovation and development costs paid		<78,292	>		<17,232	>
Noncash homebuilding sales recorded under percentage of completion method		<62,668	>		—
Changes in other assets and liabilities, net of effects of noncash investing and financing activities:
Decrease <increase> in interest receivable		80			<159	>
Increase in other assets		<18,699	>		<3,254	>
Increase<decrease> in other liabilities		13,133			<2,563	>
Increase <decrease> in interest payable		<17,754	>		337

Net cash used in operating activities		<38,567	>		<2,781	>

Cash Flows from Investing Activities
Acquisition of real estate		<8,696	>		—
Proceeds from the sale of real estate		1,203			20,168
Net cash paid in conjunction with consolidation of partnerships and joint ventures		<972	>		—
Property capital improvements		<6,146	>		<7,256	>
Real estate development costs		<5,908	>		<10,186	>
Earnest money deposits paid, net		<6,153	>		<727	>
Advances to partnerships and joint ventures for development costs or for the purchase of land for development		<16,754	>		<27,010	>
Net distributions related to property operations of partnerships and joint ventures		968			7,521
Proceeds from disposition of other assets		2,075			—
Distributions to minority partners of consolidated partnerships		<926	>		<913	>
Buyout of minority partners		<9,555	>		—
Other		<955	>		146

Net cash used in investing activities		<50,847	>		<18,257	>

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

TARRAGON CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)


	For the Nine Months
	Ended September 30,
	2004			2003
Cash Flows from Financing Activities
Proceeds from borrowings	$	283,557		$	177,698
Principal payments on notes payable		<206,230	>		<159,197	>
Distributions from financing activities of partnerships and joint ventures		4,369			8,837
Stock repurchases		<1,261	>		<3,245	>
Dividends to stockholders		<679	>		<564	>
Proceeds from the exercise of stock options		5,859			231
Other		40			818

Net cash provided by financing activities		85,655			24,578

Net increase in cash and cash equivalents		<3,759	>		3,540
Cash and cash equivalents, beginning of period		21,626			18,023

Cash and cash equivalents, end of period	$	17,867		$	21,563

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid	$	34,934		$	18,550

Income taxes paid	$	470		$	—

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Changes in assets and liabilities in connection with the purchase of real estate:
Real estate	$	19,951		$	—
Restricted cash		114			—
Other assets		163			—
Notes and interest payable		<11,333	>		—
Other liabilities		<199	>		—

Cash paid	$	8,696		$	—

Assets written off and liabilities released in connection with the sale of real estate:
Real estate	$	2,517		$	22,006
Other assets		137			382
Notes and interest payable		<4,402	>		<19,374	>
Other liabilities		<93	>		<659	>
Gain on sale		3,044			17,813

Cash received	$	1,203		$	20,168

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

TARRAGON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)


	For the Nine Months
	Ended September 30,
	2004			2003
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES (Continued):
Effect on assets and liabilities of the consolidation of four apartment communities, four homebuilding projects, and one commercial property in 2004 and the deconsolidation of one property in 2003:
Real estate	$	116,567		$	<16,377	>
Homebuilding inventory		107,414			—
Contracts receivable		78,066			—
Investments in and advances to partnerships and joint ventures		<65,101	>		2,549
Restricted cash		17,073			—
Other assets		15,195			<260	>
Notes and interest payable		<238,715	>		13,424
Other liabilities		<23,362	>		664
Minority interest		<6,165	>		—

Net cash paid	$	<972	>	$	—

Purchase of mortgage receivable financed with note payable	$	—		$	12,826

Liabilities that financed the purchase of homebuilding inventory	$	63,572		$	60,866

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

TARRAGON CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Operating results for the nine month period ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the Consolidated Financial Statements and Notes included in our Annual Report on Form 10-K for the year ended December 31, 2003. Dollar amounts in tables are in thousands. Certain 2003 balances have been reclassified to conform to the 2004 presentation.

NOTE 2. STOCK OPTION PLANS

In 2002, we adopted the fair value method defined in Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” in accounting for our stock option plans, where previously we applied the Accounting Principles Board’s Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” and related Interpretations. We elected to apply it prospectively for all options granted or modified since the beginning of 2002, as allowed by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” Because some awards under the plans vest over periods ranging from one to five years, the cost related to stock-based employee compensation included in the determination of net income for the three and nine month periods ended September 30, 2004 and 2003, is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123. The following table illustrates the effect on net income and earnings per common share as if the fair value based method had been applied to all outstanding and unvested awards in each period.


	For The Three Months Ended September 30,						For The Nine Months Ended September 30,
	2004			2003			2004			2003
Net income allocable to common stockholders, as reported	$	3,668		$	13,605		$	22,336		$	9,507
Add:
Stock-based employee compensation expense included in reported net income		85			49			320			201
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards		<96	>		<109	>		<342	>		<387	>

Pro forma net income allocable to common stockholders	$	3,657		$	13,545		$	22,314		$	9,321

Earnings per common share
Net income allocable to common stockholders, as reported	$	.24		$	.93		$	1.50		$	.65

Net income allocable to common stockholders, pro forma	$	.24		$	.93		$	1.50		$	.63

Earnings per common share – assuming dilution
Net income allocable to common stockholders, as reported	$	.21		$	.80		$	1.30		$	.65

Net income allocable to common stockholders, pro forma	$	.21		$	.80		$	1.30		$	.63

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 3. VARIABLE INTEREST ENTITIES

In December 2003, the Financial Accounting Standards Board issued Interpretation 46-R (“FIN 46R”), “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin 51, “Consolidated Financial Statements.” FIN 46R changes the criteria by which one company includes another entity in its consolidated financial statements. FIN 46R requires a variable interest entity (“VIE”) to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or entitled to receive a majority of the entity’s residual returns or both. Additionally, if the holders of equity at risk as a group do not have controlling financial interest, the entity may be defined as a VIE. Once an entity is determined to be a VIE, the primary beneficiary must consolidate the VIE into its financial statements. We adopted the provisions of FIN 46R on January 1, 2004.

We have identified eight partnerships and joint ventures, over which we exercise significant influence but do not control, which qualify as VIEs and of which we are the primary beneficiary. These eight entities, which were previously accounted for using the equity method, have been consolidated in accordance with FIN 46R. Their assets and liabilities were recorded at carrying value. The eight entities consist of three limited partnerships and one limited liability company engaged in homebuilding and one partnership and three limited liability companies which own and operate rental apartment communities with 1,226 units. The consolidation of these eight entities increased assets by $365.1 million as of September 30, 2004. Gross revenue for the three and nine month periods ended September 30, 2004, includes rentals of $2.8 million and $9 million, respectively, and respective homebuilding sales of $6.5 million and $46 million produced by these eight consolidated entities. One Las Olas, Ltd. is the most significant of the VIEs with $209.9 million in assets as of September 30, 2004, and gross revenue of $6.5 million and $46 million for the three and nine months ended September 30, 2004, respectively. One Las Olas, Ltd. is a limited partnership currently developing Las Olas River House, a luxury high-rise condominium development in Ft. Lauderdale, FL. Two of these VIEs have mortgages of $53.9 million that are non-recourse to the general assets of Tarragon.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 4. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES

Investments in and advances to partnerships and joint ventures consisted of the following carrying values:


	Tarragon’s
	Interest			September 30,		December 31,
	in Profits			2004		2003
601 Ninth Street Development, L.L.C.		50	%	$	—	$	477
801 Pennsylvania Avenue		50	%		24		15
900 Monroe Street Development, L.L.C.		50	%		407		—
Adams Street Development, L.L.C.		40	%		4,217		1,567
Ansonia Apartments, L.P.		70	%		—		—
Ansonia Liberty, L.L.C.		90	%		—		—
Block 88 Development, L.L.C.		40	%		2,729		610
Block 99/102 Development, L.L.C.		40	%		2,820		233
Block 144 Development, L.L.C.		50	%		279		—
Cypress Grove, L.L.C.		50	%		4,043		—
Danforth Apartment Owners, L.L.C.		99	%		—		80
Delaney Square, L.L.C.		50	%		3,317		—
Fenwick Tarragon Apartments, L.L.C.⁽¹⁾		70	%		—		1,830
Guardian-Jupiter Partners, Ltd.⁽¹⁾		70	%		—		3,315
Lake Sherwood Partners, L.L.C. ⁽¹⁾		70	%		—		—
Larchmont Associates, L.P.		57	%		3,051		2,619
Madison Warehouse Development, L.L.C.		50	%		355		—
Merritt 8 Acquisitions, L.L.C.		80	%		—		907
Merritt Stratford, L.L.C.		50	%		219		497
Metropolitan Sarasota ⁽¹⁾		70	%		—		15,910
One Las Olas, Ltd. ⁽¹⁾		70	%		—		33,993
100 East Las Olas, Ltd., and East Las Olas, Ltd. ⁽¹⁾		70	%		—		6,408
Sacramento Nine		70	%		369		443
Summit/Tarragon Murfreesboro, L.L.C. ⁽¹⁾		70	%		—		416
Tarragon Calistoga, L.L.C.		80	%		632		557
Tarragon Savannah I & II, L.L.C.		99	%		2,268		2,514
Thirteenth Street Development, L.L.C.		50	%		9,440		8,393
Upper Grand Realty, L.L.C.		50	%		255		—
Vineyard at Eagle Harbor, L.L.C.		99	%		—		—
Warwick Grove Company, L.L.C. ⁽¹⁾		50	%		—		980

				$	34,425	$	81,764

(1)

The Company adopted the provisions of FIN46R as of January 1, 2004, and as a result, these investments are consolidated for 2004.

We exercise significant influence over but hold noncontrolling interests in each of the above partnerships or joint ventures or our outside partners have significant participating rights, as defined in the Financial Accounting Standard Board’s Emerging Issues Task Force’s 96-16 Abstract, or important rights, as defined by the American Institute of Public Accountants’ Statement of Position 78-9, “Accounting for Investments in Real Estate Ventures.” Therefore, we account for our investments in these partnerships and joint ventures using the equity method.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 4. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES (Continued)

We have guaranteed an unconsolidated entity’s $5 million land loan that matures in December 2004. We have also guaranteed payment of $3.5 million of a loan with an outstanding balance of $37.5 million of an unconsolidated joint venture. This loan matures in October 2006 and upon maturity may be extended for six months. Additionally, we have guaranteed $55 million of construction loans, with an aggregate balance at September 30, 2004, of $29.9 million, of an unconsolidated joint venture. The construction loans mature in March and April 2006 and may be extended for six months. We have recorded liabilities totaling $1.2 million in connection with two of these guarantees. Estimated fair values of other guarantees provided since January 1, 2003, are not significant.

Below are unaudited summarized financial data for our unconsolidated partnerships and joint ventures for the three and nine month periods ended September 30, 2004 and 2003.

For the Three Months

For the Nine Months

Ended September 30,

2004

2003

2004

2003

Rental revenue

9,433

12,500

28,721

34,708

Property operating expenses

<4,988

<6,947

<14,798

<18,938

Interest expense

<3,226

<4,779

<9,908

<13,285

Depreciation expense

<1,712

<2,417

<5,167

<7,044

Net loss

<493

<1,643

<1,152

<4,559

Elimination of management and other fees paid to Tarragon

362

442

1,084

1,218

Net income <loss> before management fees paid to Tarragon

<131

<1,201

<68

<3,341

Equity in income <loss> of partnerships and joint ventures

<190

<792

<69

<2,365

Loss from investment written off

—

<313

—

<313

Cash distributions in excess of investment

8,274

5,782

8,954

<97

7,169

5,713

6,276

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 5. EARNINGS PER COMMON SHARE

Earnings per common share have been computed based on the weighted average number of shares of common stock outstanding for the three and nine month periods ended September 30, 2004 and 2003. Following is a presentation of net income allocable to common stockholders and earnings per common share – assuming dilution adjusted to exclude the after-tax interest expense related to the convertible notes that were issued in September 2004 and the effect on weighted average shares – assuming dilution if the aforementioned notes were converted to stock, as discussed in NOTE 8. “SALE OF CONVERTIBLE NOTES”. The information presented for 2003 has been restated to give effect to the five-for-four stock split in January 2004.


	For the Three Months				For the Nine Months
	Ended September 30,				Ended September 30,
	2004		2003		2004		2003
Net income allocable to common stockholders, as reported	$	3,668	$	13,605	$	22,336	$	9,507
Add:
Convertible notes tax effected interest expense		120		—		120		—

Net income allocable to common stockholders and assumed conversions	$	3,788	$	13,605	$	22,456	$	9,507

Earnings per common share
Net income allocable to common stockholders, as reported	$	.24	$	.93	$	1.50	$	.65

Net income allocable to common stockholders and assumed conversions - assuming dilution	$	.21	$	.80	$	1.30	$	.65

Weighted average of common shares used in computing earnings per share		15,254,133		14,581,036		14,909,466		14,700,636
Convertible preferred interest of minority partner in consolidated joint venture		445,398		445,398		445,398		—
Convertible securities		444,018		—		149,086		—
Effect of stock options		1,565,293		1,932,502		1,710,601		—

Weighted average of common shares used in computing earnings per share – assuming dilution		17,708,842		16,958,936		17,214,551		14,700,636

The convertible preferred interest of minority partner in consolidated joint venture represents the preferred interest of Mr. Robert Rohdie in a joint venture we consolidate. For the nine month period ended September 30, 2003, his interest was convertible into 445,398 shares. For the nine month period ended September 30, 2003, on a weighted average basis, options to purchase 3,611,914 shares of common stock at a price of $5.70 were outstanding. The effect of the options, the convertible preferred interest, and the convertible notes are not reflected in the computations of weighted average shares of common stock outstanding – assuming dilution and weighted average shares of common stock outstanding – assuming dilution, pro forma because their effect is antidilutive due to a loss from continuing operations allocable to common stockholders during the period. During all periods presented, the exercise prices of all options were less than the market prices of the common stock.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING

Our business is divided into two principal segments – homebuilding and the operation of our investment portfolio. Our Homebuilding Division has become the main focus of our business in terms of financial and human capital. Our activities in the Homebuilding Division encompass condominium conversions of existing apartment communities, the development of town homes, carriage homes, and new, mid-rise or high-rise condominiums for sale to residents, the sale of single-family home sites to homebuilders, and development of new investment properties, primarily apartment communities, which, upon stabilization, become part of our investment portfolio.

Our investment portfolio of stabilized apartment communities and commercial properties is the larger segment in terms of assets. Funds generated by the operation, sale, or refinancing of properties in the investment portfolio support our overhead and finance our homebuilding activities. We transfer rental properties from the Homebuilding Division to the Investment Division once they have achieved stabilized operations, as defined below. We transfer properties from the Investment Division to the Homebuilding Division if we have initiated renovation, reposition, or condominium conversion activities.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING (Continued)

Homebuilding. For-sale assets in this division include luxury mid-rise and high-rise condominiums and townhouses under development and existing apartment communities under conversion to condominiums. They also include single-family home sites for sale to homebuilders. Communities under development and/or being marketed for sale at September 30, 2004, include the following:


		Number of
		Remaining
		Homes or
Community	Location	Home Sites			Description
Consolidated communities
100 East Las Olas	Ft. Lauderdale, FL		90		Mixed-use retail and condominium development
5600 Collins Avenue	Miami Beach, FL		6		Condominium conversion
Alexandria Place	Apopka, FL		26		Single-family home site development
Alexandria Pointe	Deland, FL		102		Single-family home site development
Alta Mar	Ft. Meyers, FL		131	^(a)	Mid-rise luxury condominium development
Arlington Park	Tampa, FL		76		Townhome conversion
Belle Park	Nashville, TN		36		Luxury single-family home development
Las Olas River House	Ft. Lauderdale, FL		287	^(a)	High-rise luxury condominium development
Lincoln Pointe	Aventura, FL		147		Townhome conversion
Pine Crest Village I	Ft. Lauderdale, FL		2		Condominium conversion
Pine Crest Village II	Ft. Lauderdale, FL		116		Condominium conversion
Southridge Pointe	Deland, FL		29		Single-family home site development
Tuscany on the Intracoastal	Boynton Beach, FL		101		Condominium conversion
Venetian Bay Village II	Kissimmee, FL		133		Townhome vacation community
Venetian Bay Village III	Kissimmee, FL		144		Townhome vacation community
Waterstreet at Celebration	Celebration, FL		145		Condominium conversion
Wekiva Crest	Apopka, FL		10		Single-family home site development
Woods of Lake Helen	Lake Helen, FL		95		Single-family home site development
Woods at Southridge	Deland, FL		17		Single-family home site development

			1,693

Unconsolidated communities
1100 Adams	Hoboken, NJ		76		Mid-rise luxury condominium development
Cypress Grove	Pompano Beach, FL		476		Townhome community
The Grande	Orlando, FL		364		Mid-rise condominium conversion
Warwick Grove	Warwick, NY		214		Traditional new development - flats, townhomes, and condominiums
XII Hundred Grand	Hoboken, NJ		159		Mid-rise luxury condominium development
XIII Hundred Grand	Hoboken, NJ		118		Mid-rise luxury condominium development

			1,407

			3,100

(a)

We have recognized revenue for sales of 100 homes for Alta Mar and 203 homes for Las Olas River House under the percentage of completion method as of September 30, 2004.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING (Continued)

Also included in the Homebuilding Division are rental communities under development or in initial lease-up, existing rental communities under renovation or reposition, and land held for development or sale. The Homebuilding Division has 216 apartments in one rental community, two communities with 442 apartments under construction, and land for the development of one additional community with 90 apartments.

We measure the performance of our Homebuilding Division primarily by gross profit from home sales. Intercompany sales, which represent the transfer of properties from the Homebuilding Division to the Investment Division, are also included in the following operating statements for 2003 for the Homebuilding Division. The sale prices for these properties were their estimated fair market values as of the date of transfer, and the cost of sales was their net carrying values as of the same date. Gains on transfers of assets between segments do not represent gains recognizable in accordance with GAAP and, accordingly, are eliminated for purposes of consolidated reporting. Beginning in 2004, properties are transferred between divisions at cost, and we do not report intercompany sales.

Gross profit on homebuilding sales is based on estimates of total project sales value and total project costs. When estimates of sales value or project costs are revised, gross profit is adjusted in the period of change so that cumulative project earnings reflect the revised profit estimate. During the third quarter of 2004, we revised our estimate of sales value for Tuscany on the Intracoastal, resulting in an increase in gross profit of approximately 2% from the previous estimate.

Investment. This division includes properties with stabilized operations. We consider a property stabilized when development or renovation is substantially complete and recurring operating income exceeds operating expenses and debt service. The Investment Division has 45 consolidated stabilized apartments and 17 stabilized apartments owned through unconsolidated partnerships and joint ventures. It also has consolidated commercial properties with 1.3 million square feet and commercial properties owned through unconsolidated partnerships and joint ventures with 103,036 square feet.

We use net operating income to measure the performance of our Investment Division. Net operating income is defined as rental revenue less property operating expenses (excluding depreciation). We believe net operating income is an important supplemental measure of operating performance of our investment properties because it provides a measure of the core operations of the properties. Additionally, we believe that net operating income, as defined, is a widely accepted measure of comparative operating performance in the real estate investment community. We believe that net income <loss> is the most directly comparable GAAP measure to net operating income. The operating statements for the Investment Division present reconciliations of Investment Division net operating income to Investment Division net income <loss>.

We allocate our general and administrative expenses between the segments based on the functions of the corporate departments. We allocate other corporate items, including interest income, management fee and other revenue, and minority interests in income of consolidated partnerships and joint ventures that are not directly associated with one of our divisions in the same proportions as general and administrative expenses are allocated.

Following are operating statements and balance sheets for our two divisions and net operating income for our Investment Division. In our segment operating statements, we do not distinguish between consolidated and unconsolidated properties. We have provided a reconciliation of segment revenues to consolidated revenue following the operating statements, balance sheets, and summary of investment division net operating income.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING (Continued)


	HOMEBUILDING DIVISION
	Operating Statements
	For the Three Months										For the Nine Months
	Ended September 30,										Ended September 30,
	2004					2003					2004					2003
Homebuilding sales	$	56,913		100	%	$	20,302		100	%	$	135,062		100	%	$	35,135		100	%
Intercompany sales		—		—			62,200		100	%		—		—			92,909		100	%

		56,913		100	%		82,502		100	%		135,062		100	%		128,044		100	%

Costs of homebuilding sales		<43,409	>	<76	%>		<15,103	>	<74	%>		<105,687	>	<78	%>		<28,733	>	<82	%>
Costs of intercompany sales		—		—			<53,303	>	<86	%>		—		—			<77,490	>	<83	%>

		<43,409	>	<76	%>		<68,406	>	<83	%>		<105,687	>	<78	%>		<106,223	>	<83	%>

Gross profit on homebuilding sales		13,504		24	%		5,199		26	%		29,375		22	%		6,402		18	%
Gross profit from intercompany sales		—		—			8,897		14	%		—		—			15,419		17	%

		13,504		24	%		14,096		17	%		29,375		22	%		21,821		17	%
Minority interests in homebuilding sales of consolidated partnerships and joint ventures		<375	>	<1	%>		<591	>	<1	%>		<3,002	>	<2	%>		<687	>	<1	%>
Outside partners’ interests in intercompany sales of unconsolidated partnerships and joint ventures		—		—			<2,463	>	<3	%>		—		—			<3,440	>	<3	%>
Additional costs attributable to profits recognized by the Investment Division on intercompany sales^(a)		—		—			<2,313	>	<3	%>		<791	>	<1	%>		<3,738	>	<3	%>

		13,129		23	%		8,729		11	%		25,582		19	%		13,956		11	%
Other income and expenses:
Net loss from property operations		<383	>	<1	%>		<1,553	>	<2	%>		<1,144	>	<1	%>		<4,353	>	<3	%>
General and administrative expenses		<3,917	>	<7	%>		<2,859	>	<3	%>		<10,688	>	<8	%>		<8,386	>	<7	%>
Other corporate items		343		1	%		401		—			1,109		1	%		724		1	%
Gain on disposition of joint venture interest		—		—			—		—			1,698		1	%		—		—
Gain on sale of real estate, net of minority interest		—		—			—		—			350		—			—		—
Prepayment penalty on early retirement of debt in connection with condominium conversion		—		—			—		—			—		—			<3,117	>	<2	%>

Net income <loss>	$	9,172		16	%	$	4,718		6	%	$	16,907		13	%	$	<1,176	>	<1	%>

^(a)

The Homebuilding Division’s basis in Pine Crest is higher than our cost because the Investment Division recognized a gain on the transfer of this property to the Homebuilding Division in 2002. See reconciliation of divisional net income <loss> to consolidated net income <loss> below. Beginning in 2004, properties are transferred between divisions at cost.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING (Continued)


	HOMEBUILDING DIVISION
	Balance Sheets
	September 30,		December 31,
	2004		2003
Assets
Real estate held for investment	$	32,858	$	32,166
Homebuilding inventory ^(a)		273,458		104,454
Contracts receivable		129,870		—
Investments in partnerships and joint ventures		31,882		77,242
Cash		15,762		19,365
Restricted cash		25,748		1,042
Other assets		26,494		5,746

	$	536,072	$	240,015

Liabilities and Equity
Notes and interest payable	$	281,127	$	65,912
Other liabilities		39,700		11,969

		320,827		77,881

Minority interest		11,429		1,824
Equity		203,816		160,310

	$	536,072	$	240,015

^(a) The Homebuilding Division’s basis in Pine Crest is higher than our cost because the Investment Division recognized a gain on the transfer of this property to the Homebuilding Division in 2002. See reconciliation of divisional total assets to consolidated total assets below. Beginning in 2004, properties are transferred between divisions at cost.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING (Continued)

INVESTMENT DIVISION

Operating Statements

For the Three Months

For the Nine Months

Ended September 30,

2004

2003

2004

2003

Rental revenue

33,603

31,947

100,907

91,783

Property operating expenses

<18,019

<17,490

<52,259

<48,171

Net operating income

15,584

14,457

48,648

43,612

Net gain on sale of real estate

—

7,367

2,666

16,524

Distributions from unconsolidated partnerships and joint ventures in excess of investment

8,274

5,772

8,954

Minority interests in income of consolidated partnerships and joint ventures

<19

<463

<774

<1,293

Elimination of management and other fees paid to Tarragon by unconsolidated partnerships and joint ventures

362

410

1,084

1,104

Outside partners’ interests in losses of unconsolidated partnerships and joint ventures

118

348

253

594

General and administrative expenses

<1,649

<1,241

<4,925

<4,118

Other corporate items

139

176

515

343

Interest expense

<10,085

<9,310

<28,935

<27,132

Depreciation expense

<7,922

<7,462

<23,622

<22,354

Net income <loss>

<3,390

12,556

682

16,234


	INVESTMENT DIVISION
	Balance Sheets
	September 30,		December 31,
	2004		2003
Assets
Real estate held for investment ^(a)	$	534,100	$	395,507
Investments in partnerships and joint ventures ^(a)		38,679		50,677
Cash		2,105		2,261
Restricted cash		9,319		5,531
Other assets		16,591		13,088

	$	600,794	$	467,064

Liabilities and Equity
Notes and interest payable	$	519,505	$	405,350
8% Senior convertible notes		50,000		—
Other liabilities		15,624		14,917

		585,129		420,267

Minority interest		14,440		20,517
Equity		1,225		26,280

	$	600,794	$	467,064

^(a)

The Investment Division’s basis in properties transferred from the Homebuilding Division prior to January 1, 2004, is higher than our cost because the Homebuilding Division recognized profits upon these transfers. See reconciliation of divisional total assets to consolidated total assets below. Beginning in 2004, properties are transferred between divisions at cost.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING (Continued)


	For the Three Months Ended										For the Nine Months Ended
	September 30,										September 30,
	2004					2003					2004					2003
Summary of Investment Division net operating income:
Rental revenue
Same store stabilized apartment communities	$	24,837		100	%	$	24,763		100	%	$	74,996		100	%	$	72,929		100	%
Apartment communities stabilized during period		4,535		100	%		1,551		100	%		13,491		100	%		1,551		100	%
Apartment communities targeted for reposition in 2003		—		—			818		100	%		—		—			2,550		100	%
Apartment communities sold during period		—		—			1,021		100	%		382		100	%		3,817		100	%
Apartment community acquired during period		384		100	%		—		—			605		100	%		—		—
Commercial properties		3,847		100	%		3,794		100	%		11,433		100	%		10,936		100	%

		33,603		100	%		31,947		100	%		100,907		100	%		91,783		100	%
Property operating expenses
Same store stabilized apartment communities		<12,942	>	<52	%>		<13,222	>	<53	%>		<38,014	>	<51	%>		<37,505	>	<51	%>
Apartment communities stabilized during period		<2,735	>	<60	%>		<801	>	<52	%>		<7,537	>	<56	%>		<801	>	<52	%>
Apartment communities targeted for reposition in 2003		—		—			<1,044	>	<128	%>		—		—			<2,536	>	<99	%>
Apartment communities sold during period		—		—			<687	>	<67	%>		<277	>	<73	%>		<2,295	>	<60	%>
Apartment community acquired during period		<261	>	<68	%>		—		—			<352	>	<58	%>		—		—
Commercial properties		<2,081	>	<54	%>		<1,736	>	<46	%>		<6,079	>	<53	%>		<5,034	>	<46	%>

		<18,019	>	<54	%>		<17,490	>	<55	%>		<52,259	>	<52	%>		<48,171	>	<52	>
Net operating income
Same store stabilized apartment communities		11,895		48	%		11,541		47	%		36,982		49	%		35,424		49	%
Apartment communities stabilized during period		1,800		40	%		750		48	%		5,954		44	%		750		48	%
Apartment communities targeted for reposition in 2003		—		—			<226	>	<28	%>		—		—			14		1	%
Apartment communities sold during period		—		—			334		33	%		105		27	%		1,522		40	%
Apartment community acquired during period		123		32	%		—		—			253		42	%		—		—
Commercial properties		1,766		46	%		2,058		54	%		5,354		47	%		5,902		54	%

	$	15,584		46	%	$	14,457		45	%	$	48,648		48	%	$	43,612		48	%

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 6. SEGMENT REPORTING (Continued)


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2004			2003			2004			2003
Reconciliation of divisional revenues to consolidated revenue:
Homebuilding division total revenue	$	56,913		$	82,502		$	135,062		$	128,044
Investment division rental revenue		33,603			31,947			100,907			91,783

		90,516			114,449			235,969			219,827
Less homebuilding revenue from intercompany sales		—			<62,200	>		—			<92,909	>
Less investment division rental revenue presented in discontinued operations		—			<1,021	>		<382	>		<3,888	>
Add management fee and other revenue included in other corporate items		318			166			668			402
Add rental revenues from homebuilding properties presented in net loss from property operations		247			3,023			1,357			8,778
Less rental revenues of unconsolidated partnerships and joint ventures		<9,433	>		<12,500	>		<28,720	>		<34,708	>

Consolidated total revenue	$	81,648		$	41,917		$	208,892		$	97,502

Reconciliation of divisional net income <loss> to consolidated net income:
Homebuilding division net income <loss>	$	9,172		$	4,718		$	16,907		$	<1,176	>
Less homebuilding division profit from intercompany sales		—			<6,434	>		—			<11,979	>
Add additional costs attributable to profits recognized by investment division on intercompany sales		—			7			29			20
Add depreciation on higher basis resulting from intercompany sales		—			2,313			791			3,738

Homebuilding division contribution to <reduction of> consolidated net income		9,172			604			17,727			<9,397	>

Investment division net income <loss>		<3,390	>		12,556			682			16,234
Add reduction to investment division gain on sale of real estate for profit previously recognized by homebuilding division		—			—			—			1,289
Add depreciation on higher basis resulting from intercompany sales		744			671			2,205			1,940

Investment division contribution to <reduction of> consolidated net income		<2,646	>		13,227			2,887			19,463
Income tax <expense> benefit		<2,632	>		—			2,400			—

Consolidated net income	$	3,894		$	13,831		$	23,014		$	10,066


	September 30,			December 31,
	2004			2003
Reconciliation of divisional total assets to consolidated total assets:
Homebuilding division total assets	$	536,072		$	240,015
Investment division total assets		600,794			467,064

		1,136,866			707,079
Less higher basis resulting from intercompany sales		<83,784	>		<85,953	>
Add goodwill		2,691			2,691
Add deferred tax asset		2,647			—

Consolidated total assets	$	1,058,420		$	623,817

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 7. INCOME TAXES

At December 31, 2003, Tarragon had Federal net operating loss carryforwards of approximately $71.2 million. During 2004, Tarragon has provided for income taxes at an effective tax rate of 36% which is net of the reversal of a valuation allowance of $9.8 million. The valuation allowance from December 31, 2003, was reversed during the second quarter as it was determined that realization of Tarragon’s deferred tax asset was more likely than not. As of September 30, 2004, Tarragon’s net deferred tax asset is approximately $2.6 million.

NOTE 8. SALE OF CONVERTIBLE NOTES

On September 16, 2004, Tarragon completed the sale of $50 million principal amount of 8% Senior Convertible Notes Due 2009 (the “Notes”) to Lazard, Frères & Co., LLC (“Lazard”) as the Initial Purchaser under a Purchase Agreement dated September 9, 2004 (the “Purchase Agreement”). The Notes were resold by Lazard to persons reasonably believed to be “Qualified Institutional Buyers” (as defined in Rule 144A under the Securities Act of 1933, as amended the “Securities Act”). The amount of Notes sold includes $10 million principal amount of Notes issued pursuant to an over-allotment option granted to the Initial Purchaser that was exercised. The Notes are general, senior, unsecured obligations of Tarragon, bear interest at the rate of 8% per annum, and are convertible into Tarragon Common Stock at an initial conversion rate of 54.4662 shares per $1,000 in principal amount of Notes (equal to a conversion price of $18.36 per share of Tarragon Common Stock), subject to adjustment in certain instances. Tarragon sold the Notes to the Initial Purchaser at a 6% discount which resulted in net proceeds of $47 million.

Prior to September 16, 2007, the Notes are not redeemable, but after that date until maturity, we have the right, but not the obligation upon certain notice, to redeem Notes (in whole or in part) for cash at a redemption price of $1,000 original amount of Note, plus accrued and unpaid interest if the closing price of Tarragon’s Common Stock equals or exceeds 150% of the then applicable conversion price for 20 out of 30 consecutive trading days. The Notes may also be subject to a “put option” by the Holders if a fundamental change occurs, as that term is defined in the Note Indenture. The Notes have been sold pursuant to and in reliance upon Rule 144A and are subject to certain registration rights. Interest is payable semi-annually in March and September, and the outstanding balance of the Notes is payable at maturity.

NOTE 9. DISCONTINUED OPERATIONS

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” operating results for properties for which we implemented plans of disposals after the adoption of this statement have been reported in discontinued operations. Discontinued operations for the three and nine month periods ended September 30, 2004 and 2003, include the operations of one property sold in 2004 and seven properties sold during 2003. Total revenues for these properties for the nine month period ended September, 2004, were $382,000. Total revenues for the three and nine month periods ended September 30, 2003, were $1 million and $3.9 million, respectively. The operations of these properties were previously reported in the Investment Division.

TARRAGON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)

NOTE 10. COMMITMENTS AND CONTINGENCIES

Tarragon is not aware of any liability relating to federal, state, and local environmental laws, ordinances, and regulations that would have a material adverse effect on our business, financial position, or results of operations. However, in April 2003, in connection with the condominium conversion of Pine Crest Village at Victoria Park, a contractor for Tarragon may have inadvertently disturbed asbestos-containing materials. Such actions are currently under investigation by the Environmental Protection Agency and may result in civil and/or criminal proceedings under applicable law. The extent of any resulting liability is unknown at this time. We have incurred legal and other professional fees and costs of relocating residents in connection with this matter totaling $418,000 to date. Remediation has been completed at a total cost of $800,000.

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

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

The following discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in “Risks Associated with Forward Looking Statements.” Actual results may differ from those contained in any such forward-looking statements. You should read the following discussion in conjunction with our consolidated financial statements and the notes to those financial statements included elsewhere in this document. In the following discussion, dollar amounts in tables are in thousands except for per unit or per share amounts.

Business Overview

General

We are a real estate owner, developer, and builder of homes with over 30 years of experience in the real estate industry. We operate through two business segments:

• the Investment Division, which owns, acquires, and operates residential and commercial rental properties, including almost 5,000 garden apartment homes in communities we developed; and

• the Homebuilding Division, which develops, renovates, builds, and markets homes in high-density, urban in-fill locations and in master-planned communities and develops and sells lots in single-family subdivisions.

Investment Division. The Investment Division continues to be our larger segment in terms of assets. Funds generated by the operation, sale, or refinancing of properties in the investment portfolio support our overhead, service our outstanding indebtedness, and finance our development activities. We measure the performance of the Investment Division primarily by net operating income (rental revenue less property operating expenses) of both consolidated and unconsolidated stabilized rental apartment communities and commercial properties.

Homebuilding Division. Over the past seven years, we have substantially increased our investment in homebuilding and development. We have devoted significant resources to our Homebuilding Division in terms of financial investment and human capital. For the nine months ended September 30, 2004, approximately 70% of our corporate and property general and administrative expenses was attributable to the homebuilding division. Because of the long lead time for large projects in urban areas, we are just starting to recognize revenues from some of our earliest projects, which began in 2000. We measure the performance of the Homebuilding Division primarily by gross profit from home sales of its for-sale communities.

Revenue. Our revenue is principally derived from:

• Rental revenues associated with leases of apartments to residents and office and retail space to commercial tenants; and

• Homebuilding sales, which represent sales of condominium homes, townhomes, and residential lots reported on either the completed contract or percentage-of-completion method of revenue recognition, as appropriate;

Expenses. Our expenses principally consist of:

• Property operating expenses, which are costs associated with operating, leasing, and maintaining rental apartment communities and office and retail properties, including payroll and benefit expenses of site-level employees;

• Costs of homebuilding sales, which include construction costs, costs of construction supervision, marketing, commissions and other selling costs, interest, developer fees, and architectural and engineering fees;

• Depreciation of rental apartment communities and office and retail properties; and

• General and administrative expenses, a significant portion of which consists of compensation and benefits and other personnel-related costs.

Other income and expenses. Other income and expenses include:

• Interest expense related to mortgages and other debt;

• Equity in income or losses of partnerships and joint ventures, which represents our pro rata share of the net income or net loss of unconsolidated partnerships and joint ventures and may include income from distributions received from those entities in excess of our share of their income when we have recovered our investment in them. The source of such distributions is generally proceeds from sales of properties or financings;

• Gain on sales of real estate, which generally consists of gain from sales of assets in our Investment Division; and

• Minority interests in consolidated partnerships and joint ventures, which consists of our partners’ pro rata share of gross profit from homebuilding sales or net income or net loss resulting from rental operations and the return on a preferred interest in Tarragon Development Company, LLC, which owns interests in nine rental apartment communities.

Outlook

Our Investment Division has recently experienced increased rental revenues and net operating income for two reasons. First, we have devoted more resources to leasing efforts in order to maintain occupancy levels in highly competitive rental markets. The availability of low cost mortgage financing, while a benefit to our sales efforts in the Homebuilding Division, creates more competition among rental communities for residents desiring rental housing. The more intensive leasing efforts have resulted not only in maintaining occupancy levels but also in increased rental revenue and higher net operating income for our same store properties. Second, our investment portfolio has grown as a result of the transfer from the Homebuilding Division to the Investment Division of newly constructed or repositioned properties upon their stabilization.

We continue to evaluate investment opportunities for additions to our investment portfolio. In May 2004, we acquired a 158-unit rental apartment community in New Haven, Connecticut. This brings the size of our Connecticut portfolio, which has historically been one of the stronger-performing markets, to 2,707 apartments. The Homebuilding Division has also acquired land in Meriden, Connecticut, for development of a 180-unit rental apartment community, which, upon completion and stabilization, will be transferred to the investment portfolio. The Homebuilding Division also has three other rental communities in various stages of development that are planned additions to the investment portfolio:

• 90 affordable apartments in Hoboken, New Jersey, neighboring our for-sale communities of XII Hundred Grand, XIII Hundred Grand, and 1100 Adams;

• 262 apartments in Murfreesboro, Tennessee, where we previously built 278 rental apartments for our investment portfolio; and

• 328 apartments in Ocala, Florida, the state in which approximately two-thirds of the 5,000 rental apartment homes we have built are located.

Our Homebuilding Division has experienced rapid growth in the last few years. Many of our communities are targeted at highly defined market segments in keeping with the more varied lifestyles often associated with the urban areas where our homebuilding is concentrated. We believe the urban in-fill segment of the homebuilding business will continue to present growth opportunities due to several factors:

• Scarcity of suburban land for development and increased restrictions and controls on growth in many areas channeling a larger share of new construction into urban areas;

• Demographic trends of increased immigration, smaller households, and later marriages tend to favor demand in urban as opposed to suburban areas; and

• The recent investment performance of residential real estate and the availability and low cost of mortgage financing resulting in more demand for home ownership instead of renting.

Recent Developments

Acquisitions. On September 30, 2004, a joint venture in which we hold a 50% managing interest acquired the Lincoln at Delaney, a 364-unit, mid-rise luxury apartment property located in downtown Orlando, Florida, for $42.2 million. We intend to convert a portion of the property to condominiums. We financed the purchase with a capital contribution to the joint venture in the amount of $3.3 million and a $38 million acquisition and conversion loan.

In November 2004, a proposed joint venture in which we hold a 50% managing interest is scheduled to close on the acquisition of Park Avenue at Metrowest, a recently completed, 743-unit garden apartment complex with ancillary retail facilities located in Orlando, Florida, for $88 million. We intend to make a capital contribution of approximately $5.5 million to the joint venture, and are currently negotiating the terms of an $80 million acquisition and condominium conversion loan for this project.

In October 2004, we acquired approximately three acres of land in Edgewater, New Jersey for $13 million, for a 168-unit high-rise condominium development to be known as One Hudson Park. We financed this purchase with working capital. We have accepted a commitment for a $63 million construction loan for this project and have begun site and foundation work.

We have agreed to purchase Gables North Village, an existing 315-unit apartment property in Celebration, Florida, for conversion to condominiums, for $47 million. Our due diligence period has expired and we expect to close in January 2005. We intend to finance 85 to 90% of our acquisition and conversion costs with mortgage debt.

In November 2004, we agreed to purchase land in Great Neck, New York for $13 million, for the construction of 40 luxury condominiums. We are currently finalizing the purchase agreement, and seeking acquisition and construction financing.

In November 2004, we also agreed to purchase The Yacht Club on the Intracoastal, an existing 380 unit apartment property with a 44-slip marina located in Hypoluxo, Florida for conversion to condominiums for $67.2 million. Our due diligence period has expired and we anticipate closing on this acquisition in January 2005. We intend to finance 85% of our acquisition and conversion costs with mortgage debt.

Dispositions. On October 14, 2004, we sold the Cross Creek Apartments, a 144-unit Investment Division property located in Lexington, Kentucky, for $3.75 million. We also have contracts to sell our remaining two Investment Division assets in the Lexington market, to the same purchaser. Kirklevington Apartments, a 126-unit apartment property, is under contract for $3.8 million, and Forest Oaks Apartments, a 154-unit apartment property, is under contract for $4 million.

We also have contracts to sell the Woodcreek Garden Apartments, a 416-unit Investment Division property located in Lancaster, California, for $39 million, and the Antelope Pines Apartments, a 314-unit Investment Division property also located in Lancaster, California, for $28.1 million. The due diligence period on these contracts will expire on November 19, 2004, and we expect to close on one of these sales in 2004 and the other in the first quarter of 2005.

In December 2004, we expect to close on a $3.7 million contract to sell Prospect Park, a commercial property located in Sacramento, California. We are also under contract to sell a parcel of commercial land in Fort Worth, Texas for $2.2 million. The contract on Jackson Square Shopping Center, located in Jackson, Mississippi, has been terminated by the purchaser.

Joint Venture Investments. In November 2004, we reached an agreement in principle to purchase a portion of our partners’ interests in various joint venture projects in The Upper Grand neighborhood of Hoboken, New Jersey for an aggregate purchase price of $15 million. Pursuant to this agreement, we will pay $10 million before the end of November 2004, with the balance due in February 2005, in exchange for assignments of all of our partners’ interests in the Block 88 and Adams Street developments, 50% of our partners’ interests in the Block 99 development, and 25% of our partners’ interests in all other Hoboken joint ventures. We intend to finance this acquisition with working capital.

In November 2004, we formed a joint venture for the development of a high-rise luxury condominium development in Houston, Texas. We are the general partner of the joint venture, with an initial 70% interest in Phase I, which will be a single high-rise tower with 180 apartment units. Our interest in the joint venture is subject to reduction to 50% in the event we develop Phase II of the project, which will contain an additional 150-180 units in a second tower. We made an initial $1 million investment in this joint venture in November 2004, and have committed to making a total equity investment in both Phases of $20 million. If presales do not reach $90 million by January 1, 2005, we have the right to require our partners to buy us out of the venture. We are currently seeking land acquisition and construction financing for this project.

Application of FIN 46R. One factor that may affect the comparability of our results is the application of the Financial Accounting Standards Board’s (“FASB”) Interpretation 46-R, “Consolidation of Variable Interest Entities,” or “FIN 46R.” On January 1, 2004, we adopted the provisions of FIN 46R for our partnerships and joint ventures formed before February 1, 2003. As a result of the application of FIN 46R, we have consolidated eight of our joint ventures which were previously unconsolidated, including the partnership that holds the Las Olas River House development. The consolidation of these eight entities increased our total consolidated assets by $365.1 million and total liabilities by $278.5 million as of September 30, 2004. Gross revenue for the three and nine month periods ended September 30, 2004, included homebuilding sales of $6.5 million and $46 million and rental revenue of $2.8 million and $9 million produced by these eight newly consolidated entities.

Another factor affecting the comparability of our results of operations is that the segment results for our Investment and Homebuilding Divisions do not distinguish between revenues generated by consolidated entities and those generated by unconsolidated entities. Therefore, the revenues reflected in the segment results may not be fully comparable with our consolidated results.

Distributions in Excess of Investment in Unconsolidated Entities. Distributions in excess of investment in our unconsolidated entities are primarily related to distributions by those entities of non-recourse refinancing or property sale proceeds where we have recovered our investment in those entities. If such an unconsolidated entity becomes consolidated, we will no longer recognize the receipt of cash in excess of our share of income from that entity as income.

Accounting for Inter-Segment Property Transfers. Prior to January 1, 2004, when a property was transferred from our Investment Division to our Homebuilding Division (such as in connection with a condominium conversion), we recorded in our segment results an intercompany sale at the estimated fair value of that property at the time of the sale, which could exceed the property’s carrying value at the time. The calculation of the cost of sales related to a subsequent sale of that property (or condominium units) by our Homebuilding Division would then be based on that estimated fair value. The same was true for a transfer of a property from our Homebuilding Division to our Investment Division, with the depreciation expense associated with the transferred property being based on the fair value at the time of transfer rather than the carrying value. Gains on transfers of assets between segments do not represent gains recognizable in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and, accordingly, are eliminated for purposes of consolidated reporting. Beginning with the first quarter of 2004, we began recording each inter-segment

property transfer at the property’s carrying value. Nevertheless, since we still own a number of properties that were transferred prior to January 1, 2004, our segment results will continue to include depreciation expense and cost of homebuilding sales based on these intercompany transfers at the properties’ fair values for some future periods.

Percentage-of-Completion Revenue Recognition. The percentage-of-completion method of revenue recognition applies to mid-rise and high-rise condominium developments, where construction typically takes eighteen months or more, including our Las Olas River House and Alta Mar projects. Because this method of revenue recognition requires us to recognize revenues from sales of units prior to the closing of such sales, the timing of revenues generated by projects using the percentage-of-completion method may not be comparable to the timing of revenues generated by projects using the completed contract method. Furthermore, we will recognize a significant portion of the revenues from unit sales at a percentage-of completion-project prior to our receiving cash in excess of deposits in respect of such unit sales. See “Critical Accounting Policies and Estimates—Revenue Recognition.”

Rental Properties in “Lease-up.” Rental properties that have not yet been stabilized typically have lower rental revenues and net operating income than rental properties that are stabilized. Trends in our results of operations may be masked or distorted in a period in which we have a number of properties in lease-up. However, once a property has been stabilized, the results for that property for a period in which it is stabilized will likely be markedly better than the results for that property during lease-up, which may also mask or distort trends in our results of operations. Where possible, when we make comparisons between periods, we segregate the results of properties that were in lease-up in either or both of the two periods to better illustrate the trends in our results of operations.

Consolidated Results of Operations

Results Overview

For the three and nine month periods ended September 30, 2004, total consolidated revenue was $81.6 million and $208.9 million, compared to revenues reported for the corresponding periods in 2003 of $41.9 million and $97.5 million. These increases are mostly attributable to the increase in homebuilding sales, which, for the three and nine month periods ended September 30, 2004, included sales at our Las Olas River House, Tuscany on the Intracoastal, Alta Mar, and Waterstreet at Celebration projects of $54.4 million and $121.5 million, while sales at our Pine Crest Village I, 5600 Collins Avenue, and Venetian Bay Village I projects were the most significant portion of our sales for the three and nine month periods ended September 30, 2003. Homebuilding sales and gross profit have become more significant components of our results of operations as more of our for-sale projects have begun to close sales or are nearing completion. We expect this trend to continue as more of the projects in our pipeline, including our Hoboken projects, begin to generate revenue. See the tables that summarize homebuilding sales and present our backlog of homes sold, not closed, below under “Homebuilding Division.” The application of FIN 46R had no effect on comparability of homebuilding revenue for 2003 and 2004, since the projects generating homebuilding revenue prior to our adoption of FIN 46R were consolidated.

Rental revenue increased $3 million, or 14%, for the three month period and $11.2 million, or 18%, for the nine month period ended September 30, 2004. As presented below under “Operating Results of Consolidated Rental Properties,” four rental apartment communities consolidated in January 2004 as a result of our adoption of the provisions of FIN 46R contributed increases of $3 million and $9.0 million. Rental apartment communities in lease-up during any of the periods presented contributed increases in rental revenue of $295,000 for the three month period and $1.8 million for the nine month period.

Income from continuing operations was $3.9 million and $20.4 million for the three and nine month periods ended September 30, 2004, compared to income from continuing operations of $6.5 million for the three month period and a loss from continuing operations of $6.7 million for the nine month period in 2003. Gross profit from homebuilding sales resulted in increases in income of $8.3 million and $23 million. For the three month period, equity in income <loss> of partnerships and joint ventures decreased $7.3 million because of income recognized in 2003 for distributions received in excess of our investment in Ansonia Apartments and Ansonia Liberty in connection with financings of their properties.

During the nine months ended September 30, 2004, we recognized gains on sale of real estate totaling $3 million including those presented in discontinued operations in accordance with SFAS No. 144. During the corresponding period of 2003, gains on sale, including those presented in discontinued operations, were $17.8 million. During the nine months ended September 30, 2004, we also sold our interest in Ninth Street Development, which has development rights for land in Hoboken, New Jersey, for $2.2 million and recognized a gain of $1.7 million.

Operating Results of Consolidated Rental Properties. At September 30, 2004, our consolidated apartment communities included 10,517 operating rental apartments, and our consolidated commercial properties had an aggregate 1.3 million square feet. The following tables summarizes aggregate property level revenues and expenses for all of our consolidated rental properties for the three and nine month periods ended September 30, 2004 and 2003:

Three Months Ended September 30,

2004

2003

Change

Rental revenue

24,417

21,449

2,968

Property operating expenses

<13,482

<12,303

<1,179

Interest expense

<6,297

<5,141

<1,156

Depreciation expense

<5,517

<4,821

<696

<879

<816

<63

Nine Months Ended September 30,

2004

2003

Change

Rental revenue

73,162

61,965

11,197

Property operating expenses

<38,651

<33,928

<4,723

Interest expense

<18,285

<18,895

610

Depreciation expense

<16,469

<15,021

<1,448

<243

<5,879

5,636

The results of operations of our consolidated rental properties were affected during the periods presented above by:

• The results of operations of properties in lease-up;

• The effect of properties undergoing conversion to condominiums for sale that were previously operated as rental apartment communities;

• The consolidation of properties held by variable interest entities pursuant to FIN 46R in 2004; and

• The acquisition of one apartment community in 2004.

The following tables illustrate the effects of these items on the various components of the results of operations of our consolidated rental properties for the three and nine month periods ended September 30, 2004 and 2003 :

For the Three Months Ended September 30, 2004 and 2003

Properties

Property

Consolidated

Acquired in

Properties in

Condominium

Other

in 2004 (a)

2004

Lease-up (b)

Conversions

Changes

Total

Rental revenue

2,825

384

295

<612

2,968

Property operating expenses

<1,508

<261

<84

142

532

<1,179

Interest expense

<945

<131

<92

597

<585

^(c)

<1,156

Depreciation expense

<749

<79

—

140

<696

<377

<87

111

127

163

<63

(a)		Includes four apartment communities owned by four joint ventures consolidated on January 1, 2004, in connection with the adoption of the provisions of FIN 46R.

(b)		Includes two recently completed apartment communities that were in lease-up during one or both periods presented.

(c)		This increase in interest expense is the result of mortgage financings of several apartment communities in 2003 and 2004.

For the Nine Months Ended September 30, 2004 and 2003

Properties

Property

Consolidated

Acquired in

Properties in

Condominium

in 2004 (a)

2004

Lease-up (b)

Conversions

Other Changes

Total

Rental revenue

9,024

605

1,797

<667

438

11,197

Property operating expenses

<4,156

<352

<556

106

235

<4,723

Interest expense

<2,677

<196

<398

694

3,187

^(c)

610

Depreciation expense

<2,213

<129

<236

—

1,130

^(d)

<1,448

<22

<72

607

133

4,990

5,636

(a)		Includes four apartment communities owned by four joint ventures consolidated on January 1, 2004, in connection with the adoption of the provisions of FIN 46R.

(b)		Includes two recently completed apartment communities that were in lease-up during one or both periods presented.

(c)		This decrease in interest expense is the result of prepayment penalties totaling $3.1 million and $241,000 of deferred financing expenses written off upon the early payoff of two mortgages secured by Pine Crest Apartments in the first quarter of 2003. The mortgages were paid off in connection with the closing of a $25 million loan to finance the condominium conversion of this property.

(d)		This decrease in depreciation expense is primarily due to $1.1 million recorded in the second quarter of 2003 upon the reclassification of two properties to real estate held for investment for the period during which they were classified as held for sale.

Equity in Income <Loss> of Unconsolidated Partnerships and Joint Ventures. The following tables summarize the components of equity in income <loss> of unconsolidated partnerships and joint ventures for the three and nine month periods ended September 30, 2004 and 2003:

Three Months Ended September 30,

2004

2003

Change

Rental revenue

9,433

12,500

<3,067

Property operating expenses

<4,988

<6,947

1,959

Interest expense

<3,226

<4,779

1,553

Depreciation expense

<1,712

<2,417

705

Elimination of management fees paid to Tarragon

362

442

<80

Outside partners’ interests in <income> loss

<59

409

<468

Loss from investment written off

—

<313

313

Distributions in excess of investment

8,274

<8,181

Equity in income <loss> of partnerships and joint ventures

<97

7,169

<7,266

Nine Months Ended September 30,

2004

2003

Change

Rental revenue

28,721

34,708

<5,987

Property operating expenses

<14,798

<18,938

4,140

Interest expense

<9,908

<13,285

3,377

Depreciation expense

<5,167

<7,044

1,877

Elimination of management fees paid to Tarragon

1,084

1,218

<134

Outside partners’ interests in <income> loss

976

<977

Loss from investment written off

—

<313

313

Distributions in excess of investment

5,782

8,954

<3,172

Equity in income of partnerships and joint ventures

5,713

6,276

<563

Income from distributions in excess of investment decreased by $8.2 million and $3.2 million for the three and nine month periods. In the third quarter of 2003, Ansonia Apartments, L.P., and Ansonia Liberty, L.L.C., made distributions of proceeds from refinancings totaling $8.3 million. In the second quarter of 2004, Ansonia Apartments, L.P., made distributions of proceeds from financings of $4.9 million.

Increases in equity in income <loss> of unconsolidated partnerships and joint ventures of $300,000 and $1.3 million for the three and nine month periods are due to the consolidation of four rental apartment communities held by variable interest entities pursuant to FIN 46R in 2004. These properties were in lease up in 2003 and reported net losses. Rental revenue of these properties was $2.8 million and $6.7 million for the three and nine month periods in 2003. The consolidation of these properties also accounted for much of the decrease in property operating expenses, interest expense, and depreciation expense.

General and Administrative Expenses. Corporate general and administrative expenses increased $1.3 million, or 39%, and $2.7 million, or 28%, for the three and nine month periods ended September 30, 2004, compared to the corresponding periods of 2003 primarily due to homebuilding-related personnel additions and compensation increases. We have assembled a team dedicated to homebuilding to manage our pipeline of projects. Because of the long lead time for large projects in urban areas, we are just starting to recognize revenues from some of our earliest projects.

We have also added personnel in our property management group, which has resulted in increases of $198,000, or 23%, and $425,000, or 15%, for the three and nine months ended September 30, 2004, compared to the corresponding periods of 2003 in property general and administrative expenses. Our property management team oversees the Investment Division properties and the initial lease-up of newly constructed rental apartment communities, provides our developers with real time market data, and provides property management services to rental apartment communities acquired for the purpose of converting them to condominiums.

Sales of Consolidated Properties. We recognized a $2.7 million gain on the sale of a 128-unit rental apartment community in June 2004 and a $378,000 gain on the sale of a parcel of land in March 2004. During the nine months ended September 30, 2003, we sold five rental apartment communities with 561 units, a 25,323-square foot shopping center, and a portion of an office building and recognized gains totaling $17.8 million. The number of properties sold and the gains on those sales vary from period to period based on market conditions and other factors, including the length of time we have held the properties. We plan to continue to opportunistically sell properties we own based upon market conditions.

Homebuilding Division

Results Overview

As stated previously, results for our segments do not distinguish between revenues of consolidated and unconsolidated properties. Therefore, revenue and gross profit <loss> from homebuilding sales presented in the Homebuilding Division Operating Statements include both consolidated and unconsolidated homebuilding projects.

The following table summarizes homebuilding sales (in both units and revenues) and gross profit (both in dollars and as a percentage of sales). Units sold represent units closed except for Alta Mar and Las Olas River House, where we have recorded sales revenue under the percentage-of-completion method. See “Factors Affecting Comparability of Results of Operations – Percentage-of-Completion Revenue Recognition.” We experienced delays in closings at our Florida for-sale communities because of the hurricanes in the third quarter 2004.


	For the Three Months Ended				For the Nine Months Ended
	September 30,				September 30,
	2004		2003		2004		2003
Number of units sold
5600 Collins Avenue		—		2		—		21
Alta Mar ^(a)		100		—		100		—
Las Olas River House ^(b)		1		—		17		—
Pine Crest Village I		—		55		15		80
Tuscany on the Intracoastal		61		—		179		—
Single-family home sites		54		18		105		18
Venetian Bay Village I		—		52		29		69
Venetian Bay Village II		3		—		3		—
Waterstreet at Celebration		87		—		87		—

Aggregate number of units sold		306		127		535		188

Homebuilding sales revenue
5600 Collins Avenue	$	—	$	504	$	—	$	6,277
Alta Mar ^(a)		16,697		—		16,697		—
Las Olas River House ^(b)		6,431		—		45,971		—
Pine Crest Village I		—		10,928		4,090		17,624
Tuscany on the Intracoastal		15,869		—		43,479		—
Single-family home sites		2,082		1,595		4,795		1,595
Venetian Bay Village I		—		7,275		4,196		9,639
Venetian Bay Village II		435		—		435		—
Waterstreet at Celebration		15,399		—		15,399		—

Aggregate sales	$	56,913	$	20,302	$	135,062	$	35,135

Gross profit <loss> on homebuilding sales
5600 Collins Avenue	$	—	$	—	$	—	$	<1,571	>
Alta Mar ^(a)		5,010		—		5,010		—
Las Olas River House ^(b)		1,543		—		10,384		—
Pine Crest Village I		—		4,371		1,457		7,050
Tuscany on the Intracoastal		3,742		—		8,720		—
Single-family home sites		59		49		116		49
Venetian Bay Village I		—		779		538		874
Venetian Bay Village II		70		—		70		—
Waterstreet at Celebration		3,080		—		3,080		—

Gross profit	$	13,504	$	5,199	$	29,375	$	6,402


	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2004			2003			2004			2003
Gross profit <loss> on homebuilding sales
5600 Collins Avenue		—			—			—			<25	%>
Alta Mar ^(a)		30	%		—			30	%		—
Las Olas River House ^(b)		24	%		—			23	%		—
Pine Crest Village I		—			40	%		36	%		40	%
Tuscany on the Intracoastal		24	%		—			20	%		—
Single-family home sites		3	%		3	%		2	%		3	%
Venetian Bay Village I		—			11	%		13	%		9	%
Venetian Bay Village II		16	%		—			16	%		—
Waterstreet at Celebration		20	%		—			20	%		—

Gross profit		24	%		26	%		22	%		18	%

(a) Sales represent revenues recognized under the percentage of completion method. At September 30, 2004, 76% of the homes were under firm contracts totaling $33.4 million, and construction was 50% complete.

(b) Sales represent revenues recognized under the percentage of completion method. At September 30, 2004, 71% of the homes were under firm contracts totaling $154.6 million, and construction was 93% complete. Through December 31, 2003, this was an unconsolidated project. Beginning January 1, 2004, we began reporting Las Olas River House as a consolidated project in connection with the adoption of the provisions of FIN 46R. Gross profit reported in 2004 is before interest on advances from Tarragon, which is eliminated upon consolidation.

Revenue from home sales was $56.9 million and $135.1 million for the three and nine month periods ended September 30, 2004, compared to $20.3 million and $35.1 million for the three and nine month periods ended September 30, 2003. Most of the 2004 revenue relates to sales at Alta Mar, a mid-rise luxury condominium development, Las Olas River House, a luxury, high-rise development, Tuscany on the Intracoastal, a property purchased for conversion to condominiums in June 2003, and Waterstreet at Celebration, a property purchased for conversion to condominiums in March 2004. This is the first quarter we have recognized revenue on Alta Mar. We are recognizing revenues for Alta Mar and Las Olas River House under the percentage-of-completion method. We recognize revenues for all of our other for-sale projects using the completed contract method. Gross profit net of selling expenses on home sales was 24% and 22% for the three and nine month periods ended September 30, 2004, and 26% and 18% for the corresponding periods in 2003. Net of minority interests in consolidated home sales and outside partners’ interests in home sales of unconsolidated projects, we reported $13.1 million and $26.4 million of gross profit from home sales for the three and nine month periods ended September 30, 2004, and $4.6 million and $5.7 million for the corresponding periods in 2003.

Gross profit on homebuilding sales is based on estimates of total project sales value and total project costs. When estimates of sales value or project costs are revised, gross profit is adjusted in the period of change so that cumulative project earnings reflect the revised profit estimate. During the third quarter 2004 we revised our estimate of sales value for Tuscany on the Intracoastal, resulting in an increase in gross profit of approximately 2% from the previous estimate.

Rental properties in the Homebuilding Division reported overall net losses from operations of $383,000 and $1.1 million for the three and nine month periods ended September 30, 2004, and $1.6 million and $4.4 million for the corresponding period in 2003. These losses are due to operating, interest, and depreciation expenses exceeding revenues during lease-up prior to stabilization. We transfer rental properties from the Homebuilding Division to the Investment Division once they are stabilized.

General and administrative expenses of the Homebuilding Division increased to $3.9 million and $10.7 million for the three and nine month periods ended September 30, 2004, from $2.9 million and $8.4 million for the corresponding periods in 2003. As stated previously, assembling the homebuilding team has driven the growth in overall general and administrative expenses.

As of September 30, 2004, as presented in the following table, our backlog of sales was $356.8 million for our 16 for-sale communities with active sales programs (see table below). Of this amount, we have recognized revenues under the percentage-of-completion revenue recognition method of $143.6 million on sales of 203 homes for Las Olas River House and $16.7 million of revenues on sales of 100 homes for Alta Mar. We expect to begin closing sales at Las Olas River House during the fourth quarter of 2004 and at Alta Mar in the second quarter of 2005. Because these sales have not yet been closed, they are presented as backlog in this table.


						Backlog ⁽¹⁾				Unsold Inventory
				Number of						Number
	Tarragon’s			Remaining		Number of		Aggregate		of Homes		Estimated
	Interest in			Homes or		Homes or		Contract		or Home		Remaining
	Profits			Home Sites		Home Sites		Prices		Sites		Sell-Out
Consolidated communities
5600 Collins Avenue		100	%		6		2	$	1,150		4	$	4,575
Alexandria Place		40	%		26		26		982		—		—
Alexandria Pointe		40	%		102		102		3,880		—		—
Alta Mar		100	%		131		102		34,061		29		10,476
Arlington Park		100	%		76		—		—		76		20,512
Las Olas River House		70	%		287		202		155,444		85		109,635
Pine Crest Village I		100	%		2		1		280		1		380
Pine Crest Village II		100	%		116		112		26,796		4		1,270
Southridge Pointe		40	%		29		29		1,771		—		—
Tuscany on the Intracoastal		100	%		101		23		5,908		78		22,823
Venetian Bay Village II		56	%		133		132		19,727		1		142
Venetian Bay Village III		56	%		144		144		22,741		—		—
Waterstreet at Celebration		100	%		145		101		18,510		44		10,495
Wekiva Crest		40	%		10		10		570		—		—
Woods of Lake Helen		40	%		95		95		3,651		—		—
Woods at Southridge		40	%		17		17		1,034		—		—
Unconsolidated communities
XII Hundred Grand		50	%		159		36		15,416		123		53,827
XIII Hundred Grand		50	%		118		117		44,893		1		387

					1,697		1,251		356,814		446	$	234,522

(1)

Homes or home sites sold, but not yet closed.

Investment Division

Results Overview

As stated previously, results for our segments do not distinguish between revenues of consolidated and unconsolidated properties. Therefore, rental revenue and net operating income in the following discussion include both consolidated and unconsolidated rental communities. You should read the following discussion along with the Investment Division operating statements and summary of Investment Division net operating income presented in NOTE 6. “SEGMENT REPORTING” in the Notes to Consolidated Financial Statements. Net operating income is a supplemental non-GAAP financial measure. A reconciliation of Investment Division net operating income to Investment Division net income <loss> is presented in the Investment Division operating statements in NOTE 6. “SEGMENT REPORTING” in the Notes to Consolidated Financial Statements.

The Investment Division reported net operating income of $15.6 million and $48.6 million for the three and nine month periods ended September 30, 2004, and $14.5 million and $43.6 million for the three and nine month periods ended September 30, 2003. Net operating income as a percentage of rental revenue was 46.4% and 48.2% for the three and nine month periods ended September 30, 2004, and 45.3% and 47.5% for the three and nine month periods ended September 30, 2003.

The following table presents net operating income for our 53 same store Investment Division apartment communities with 11,473 units and the seven apartment communities stabilized and moved to the Investment Division since the beginning of 2003. Prior to their stabilization, the operating results of these seven properties were included in the Homebuilding Division.


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2004			2003			2004			2003
Same store stabilized apartment communities:
Rental revenue	$	24,837		$	24,763		$	74,996		$	72,929
Property operating expenses		<12,942	>		<13,222	>		<38,014	>		<37,505	>

Net operating income	$	11,895		$	11,541		$	36,982		$	35,424

Net operating income as a percentage of rental revenue		47.9	%		46.6	%		49.3	%		48.6	%
Average monthly rental revenue per unit	$	722		$	720		$	726		$	706

Apartment communities stabilized during period:
Rental revenue	$	4,535		$	1,551		$	13,491		$	1,551
Property operating expenses		<2,735	>		<801	>		<7,537	>		<801	>

Net operating income	$	1,800		$	750		$	5,954		$	750

Net operating income for our 53 same store stabilized apartment communities increased $354,000, or 3.1%, in the third quarter of 2004 compared to the third quarter of 2003 and increased $1.6 million, or 4.4%, in the nine months ended September 30, 2004, compared to the corresponding period in 2003. These increases were mostly due to increases (.3% and 2.8%, respectively) in rental revenues. The ratio of net operating income to rental revenue for these properties increased 1.3% in the third quarter of 2004 compared to the third quarter of 2003 and increased .7% for the nine month period ended September 30, 2004, compared to the corresponding period in 2003. Property operating expenses decreased 2.1% for the three month period but increased 1.4% for the nine month period, in which we incurred higher personnel, landscaping, and other costs in connection with leasing efforts in highly competitive rental markets.

Twenty-three of our Investment Division rental apartment communities are located in Florida. The recent hurricanes caused relatively minor damage, primarily water instrusion or roof damage and damage to landscaping. We estimate the total cost of repairs to damage and removal and replacement of trees and other landscaping to be $800,000, of which approximately $300,000 has been paid to date. Property maintenance staffs, working in conjunction with contractors, are currently restoring the properties to their pre-storm condition.

The Investment Division reported a $2.7 million gain on the sale of one apartment community in June 2004 and recognized gains totaling $16.5 million in the first nine months of 2003. In 2003, we sold three apartment communities, one shopping center, and a portion of an office building. The Investment Division’s gains on sale of real estate were reduced by $1.3 million in 2003 for intercompany profit recognized previously by the Homebuilding Division upon the transfer of an office building to the Investment Division upon its stabilization.

Interest expense for the Investment Division increased by $775,000, or 8.3%, and $1.8 million, or 6.7%, for the three and nine month periods ended September 30, 2004, compared to the corresponding periods in 2003. Increases of $707,000 and $2.7 million were related to stabilized apartment communities transferred into the Investment Division. For the 53 same store stabilized apartment communities, interest expense increased $388,000, or 1.7%, for the nine month period due to additional debt from financings of these properties in 2003 and 2004. Also for the nine month period, one commercial property reported a decrease of $765,000 due to costs incurred in paying off a mortgage in connection with a refinancing in 2003. Decreases of $160,000 and $590,000 for the three and nine months, respectively, came from the sale of Investment Division apartment communities during 2003 and 2004.

Investment Division depreciation expense was $7.9 million and $23.6 million for the three and nine month periods ended September 30, 2004, compared to $7.5 million and $22.4 million for the three and nine month periods ended September 30, 2003. The 53 same store stabilized apartment communities reported decreases in depreciation expense of $206,000 and $1.2 million, primarily the result of resuming depreciation of two properties upon their reclassification from Real Estate Held for Sale to Real Estate Held for Investment in April 2003, including an adjustment to record depreciation for the period during which they were classified as Held for Sale. Increases of $866,000 and $3.1 million were related to stabilized apartment communities transferred into the Investment Division. Decreases of $196,000 and $692,000 for the three and nine months, respectively, resulted from the sale of properties during 2003 and 2004.

General and administrative expenses of the Investment Division increased to $1.7 million and $4.9 million for the three and nine month periods ended September 30, 2004, from $1.2 million and $4.1 million for the corresponding periods in 2003 mostly due to an increase in property general and administrative expenses. General and administrative expenses as a percentage of divisional revenues were 4.9% for the three and nine month periods ended September 30, 2004, and 3.9% and 4.5% for the three and nine month periods ended September 30, 2003.

Liquidity and Capital Resources

Liquidity

Our principal sources of cash are home sales, rental operations of Investment Division properties, borrowings, and proceeds from the sale of Investment Division properties. As our Homebuilding Division continues to grow, home sales, along with project-related construction loans, will become our primary source of cash. We believe these sources will continue to meet our cash requirements, including debt service, property maintenance and improvements, acquisitions of land for development, development costs for rental apartment and for-sale communities under construction or renovation, projected purchases of existing properties, dividends on preferred stock, and repurchases of common stock under the announced buy back program. Although we expect these sources of cash to be sufficient to fund planned uses of cash, we can make no assurance that the expected home sales and Investment Division property sales and borrowings will be completed as planned.

Mortgages and Other Debt

Senior Convertible Notes. On September 16, 2004, we issued $50 million of 8% Senior Convertible Notes. The Notes are general, senior, unsecured obligations of Tarragon, bear interest at the rate of 8% per annum, mature in September 2009, and are convertible into Tarragon Common Stock at an initial conversion rate of 54.4662 shares per $1,000 in principal amount of Notes (equal to a conversion price of $18.36 per share of Tarragon Common Stock), subject to adjustment in certain instances. Interest is payable semi-annually in March and September, and the outstanding balance of the Notes is payable at maturity. See further discussion in NOTE 8. “SALE OF CONVERTIBLE NOTES” in the Notes to Consolidated Financial Statements.

Unsecured Credit Facilities. We have a $20 million unsecured line of credit with affiliates of William S. Friedman, our Chief Executive Officer and Chairman of our Board of Directors. Advances under the line of credit bear interest at the lower of 100 basis points over the thirty-day LIBOR or the lowest rate offered in writing to us for an unsecured loan by an institutional lender. Payments of interest only are due on demand but no more frequently than monthly. All outstanding principal and interest are due at maturity in January 2006. As of October 31, 2004, all of these funds were available to us.

We have a $5 million unsecured line of credit with Wachovia Bank. Payment terms are interest only monthly at 200 basis points over the thirty-day LIBOR, with the outstanding balance due at maturity of July 2005. As of October 31, 2004, we have fully drawn the $5 million.

Secured Credit Facilities. We have a $20.2 million revolving line of credit with SouthTrust Bank, an Alabama banking corporation. This loan bears interest at a floating rate equal to the 30-day LIBOR plus 175 basis points. Interest only is payable monthly, with the outstanding principal amount due at maturity in June 2005. It is secured by five properties (one of which was added in July 2004) and shares of our common stock owned by Mr. Friedman and his affiliates. We have agreed to indemnify Mr. Friedman and his affiliates from any loss, cost, or liability associated with their pledge of stock to secure this line of credit. As of October 31, 2004, we had $12.8 million available under this line of credit.

We currently have mortgage loans totaling $197.3 million (of which $25 million represents a revolving commitment), secured by a pool of eleven properties, under a secured credit facility with General Electric Capital Corporation (“GECC”) that matures in May 2006. The mortgage loans under this facility are cross-collateralized and cross-defaulted with each other. Under the GECC mortgage facility, we are required to maintain, at all times, a consolidated net worth of not less than $50 million, measured at the end of each quarter, and minimum aggregate unrestricted cash and marketable securities of not less than $10 million in order to be able to incur other debt.

We currently have outstanding mortgage loans on a sub-portfolio of seven properties with an aggregate balance of $103.8 million that bear interest at 173 basis points over the thirty-day LIBOR, payable monthly. If our ratio of net operating income of all of the properties in the entire portfolio to the total debt outstanding in the facility (the “Cash on Cash Ratio”) falls below 8% or our ratio of net operating income of the entire portfolio to the total debt service required under the facility (“Debt Service Coverage Ratio”) falls below 1.2x, the interest rate for these loans will be increased to 198 basis points over the thirty-day LIBOR.

We also have mortgage loans with respect to four additional properties with an aggregate balance of $93.5 million that currently bear interest at 190 basis points over the thirty-day LIBOR and require monthly payments of principal and interest computed on a 27 1/2 -year amortization schedule. If our Cash on Cash Ratio for this sub-portfolio reaches 9%, for at least two consecutive quarters the interest rate on these loans will be reduced to 173 basis points over the thirty-day LIBOR; if our Cash on Cash Ratio for this sub-portfolio reaches 9.75% for at least two consecutive quarters, principal amortization will cease.

If the Cash on Cash Ratio for our overall portfolio falls below 8% in any month, payment on the loans on the sub-portfolio of seven properties will change to principal plus interest computed on a 30-year amortization schedule. In addition, we will be required to pay the lender 100% of our net cash flow (after payment of property operating expenses, debt service and impounds) from all of the properties in the portfolio in reduction of the principal balance of the loans, until the portfolio Cash on Cash Ratio is again 8% or greater for two consecutive months.

This credit facility has two one-year extension options. The first extension option requires a Cash on Cash Ratio of 10% or greater and a Debt Service Coverage Ratio of 1.25x or greater. The second extension option requires a Cash on Cash Ratio of 10.5% or greater and a Debt Service Coverage Ratio of 1.3x or greater.

Non-recourse Mortgage Debt. As of September 30, 2004, in addition to the GECC mortgage facility, we had an aggregate of $229 million of outstanding non-recourse indebtedness secured by 34 Investment Division assets. The agreements governing this mortgage debt generally do not contain restrictive covenants and are not guaranteed by us or any of our subsidiaries or joint ventures. Of these mortgage loans, $194 million bear interest at various fixed rates, and $35 million bear interest at various floating rates. As of September 30, 2004, they bore interest at a weighted average rate of 5.9%.

Recourse Mortgage Debt. The following table summarizes the material terms of our recourse mortgage debt (dollars in thousands):


			Interest
	Balance at		Rate as of					Tarragon’s
	September 30,		September 30,					Interest in
Project name	2004		2004			Maturity Date		Profits
200 Fountain Apartments	$	11,318		4.14	%	Nov 2005			100	%
Aventerra Apartments		7,871		3.84	%	Dec 2005			100	%
Emerson Center		7,322		4.09	%	Feb 2005			100	%
Northwest O’Hare		2,960		4.34	%	Apr 2006			100	%
Orlando Central Park		5,562		6.00	%	Oct 2004	(1)		100	%
Paramus Shopping Center		2,075		4.34	%	Oct 2007			100	%
Pine Crest Village		322		4.24	%	Feb 2006			100	%
Venetian Bay Village		6,000		4.59	%	Jun 2005			56	%

	$	43,430

(1)

In October 2004, this loan was modified, and the maturity was extended to January 2005.

Construction Loans. In connection with our various homebuilding projects, we obtain construction loans to finance the cost of construction. Generally, one of our subsidiaries or a joint venture will incur the construction loan, and we will guarantee the repayment of the construction loan and/or grant a completion guarantee with respect to the project. In general, we repay outstanding amounts under construction loans on for-sale communities with proceeds from home sales. We refinance construction loans on rental communities with permanent or semi-permanent mortgage financing upon the completion and stabiliation of the properties. The following table summarizes the material terms of our construction loans, all of which we have guaranteed (dollars in thousands):


					Interest
			Balance at		Rate as of				Tarragon’s
	Commitment		September 30,		September 30,				Interest in
Project name	Amount		2004		2004			Maturity Date	Profits
Alta Mar	$	20,500	$	7,544		3.84	%	Nov 2006		100	%
Belle Park		13,000		3,625		4.04	%	Sep 2007		100	%
Cason Estates		14,339		—		3.64	%	May 2006		100	%
Las Olas River House		109,000		102,248		4.64	%	Apr 2005		70	%
Venetian Bay Village		9,000		8,614		4.34	%	Dec 2005		56	%
Villa Tuscany		22,500		22,500		3.89	%	Jun 2006		70	%
Vintage at Fenwick Plantation		14,425		14,425		3.84	%	Nov 2004		70	%
Vintage at Lake Lotta		13,511		13,511		3.74	%	Nov 2005		100	%
Warwick Grove		8,300		5,971		4.04	%	Jul 2006		50	%

	$	224,575	$	178,438

Condominium Conversion Loans. We generally obtain loans to finance the cost of acquiring and/or renovating rental properties to condominium homes. Generally, one of our subsidiaries or a joint venture will incur the loan, and we will guarantee the repayment of the loan. The following table summarizes the material terms of our construction loans and the related guarantees (dollars in thousands):


					Interest
			Balance at		Rate as of				Tarragon’s
	Commitment		September 30,		September 30,			Maturity	Interest in
Project name	Amount		2004		2004			Date	Profits			Guarantee
5600 Collins	$	1,000	$	97		4.75	%	May 2005		100	%	Tarragon/Payment
Pine Crest Village		12,105		1,986		3.84	%	Feb 2006		100	%	None⁽¹⁾
Pine Crest Village		9,300		9,300		4.24	%	Feb 2006		100	%	None⁽¹⁾
Lincoln Pointe		40,000		38,008		4.84	%	May 2006		70	%	Tarragon/Payment
Waterstreet at Celebration		13,350		13,350		4.79	%	Mar 2006		100	%	None⁽²⁾

	$	75,755	$	62,741

(1)		These loans are recourse to the borrower, our subsidiary.

(2)		This loan is cross-defaulted and cross-collateralized with the mortgages totaling $197.3 million under the secured credit facility with General Electric Capital Corporation discussed above.

Mezzanine Loans. In connection with our homebuilding projects, we occasionally obtain mezzanine loans to finance part of the cost of construction. Generally, one of our subsidiaries or a joint venture will incur the construction loan, and we will either guarantee the repayment of the construction loan or grant a completion guarantee with respect to the project. We have one mezzanine loan on our Las Olas River House project with a September 30, 2004, balance of $36 million. This loan bears interest at a variable rate, which was 5.34% at September 30, 2004, and matures in March 2005. We have guaranteed payment of this loan.

Acquisition and Development Loans. In connection with our homebuilding projects, we obtain acquisition and development loans to finance the purchase of land and the development of the infrastructure with the intent to subdivide and sell lots to other homebuilders. Generally, one of our subsidiaries or a joint venture will incur the loan, and we will guarantee the repayment of the loan. The following table summarizes the material terms of our acquisition and development loans, all of which we have guaranteed, and the related guarantees (dollars in thousands):


					Interest
			Balance at		Rate as of				Tarragon’s
	Commitment		September		September 30,				Interest in
Project name	Amount		30, 2004		2004			Maturity Date	Profits
Alexandria Place	$	2,823	$	291		6.50	%	Jun 2005		40	%
Alexandria Pointe		2,562		1,032		4.84	%	Jun 2007		40	%
Metropolitan Sarasota		19,400		17,544		4.59	%	Aug 2005		70	%
Southridge Pointe		1,158		769		4.84	%	Jun 2006		40	%
Woods of Lake Helen		2,319		2,029		6.00	%	Nov 2005		40	%
Woods at Southridge		750		542		4.84	%	Dec 2005		40	%

	$	29,012	$	22,207

Land Loans. When we acquire land for future development or sale, we sometimes finance the acquisitions with land loans. Generally, one of our subsidiaries or a joint venture will incur the loan, and we will guarantee the repayment of the loan. The following table summarizes the material terms of our land loans, all of which we have guaranteed, and the related guarantees (dollars in thousands):


			Interest
	Balance at		Rate as of				Tarragon’s
	September 30,		September 30,				Interest in
Project name	2004		2004			Maturity Date	Profits
100 East Las Olas	$	4,125		6.00	%	Mar 2005		70	%
Fort Worth Land		1,950		8.50	%	Oct 2004 (1)		90	%

	$	6,075

(1)

The lender has agreed to extend the maturity of the loan to October 2009. Amended documents are anticipated to be executed by end of November 2004.

Other Non-Recourse Debt. We have a loan of $8.4 million due to Aetna secured by interests in our joint ventures with it. The loan matures in November 2010. Aetna receives a sliding percentage ranging from all to 10% of operating cash flow or capital proceeds from the three properties owned by the joint ventures based on the cumulative return received.

Sources and Uses of Cash

The following table presents major sources and uses of cash for the nine month periods ended September 30, 2004 and 2003.


	For Nine Months Ended September 30,
	2004			2003
Sources of cash:
Net cash flow from property operations	$	15,697		$	15,367
Net proceeds from the sale of real estate
Investment Division		693			20,168
Homebuilding Division		510			—
Net proceeds <payments> related to financings and other borrowings
Investment Division		14,376			28,041
Homebuilding Division		11,300			—
Convertible debt		46,762			—
Lines of credit		<3,561	>		<6,970	>
Net proceeds from home sales		6,465			8,160
Other:
Proceeds from disposition of other assets		2,075			—
Proceeds from the exercise of stock options		5,859			231
Other		—			1,202

Total sources of cash		100,176			66,199

Uses of cash:
Purchase of homebuilding inventory or land for development		<22,119	>		<13,177	>
Development and renovation costs (net of borrowings)		<25,313	>		<62	>
Advances to partnerships and joint ventures for homebuilding activities		<16,754	>		<27,010	>

Cash used in homebuilding activities		<64,186	>		<40,249	>

Purchase of Investment Division apartment community		<4,161	>		—
Property capital improvements		<6,146	>		<7,256	>
Other:
Stock repurchases		<1,261	>		<3,209	>
General and administrative expenses paid		<15,684	>		<10,471	>
Dividends to stockholders		<678	>		<561	>
Distributions to minority partner of consolidated partnership		<926	>		<913	>
Buyout of minority partners		<11,081	>
Other		188			—

Total uses of cash		<103,935	>		<62,659	>

Net sources <uses> of cash	$	<3,759	>	$	3,540

Cash Flows. For the nine months ended September 30, 2004, our net cash used in operating activities was $38.6 million compared to $2.8 million in the nine months ended September 30, 2003. This increase is principally related to homebuilding activities. Homebuilding renovation and development costs paid increased $61.1 million, while cash received from homebuilding sales increased $38 million. Additionally, we paid interest of $10 million in connection with the refinancing of the mezzanine loan for Las Olas River House during the second quarter of 2004.

For the first nine months of 2004, our net cash used in investing activities was $50.8 million compared to $18.3 million in the first nine months of 2003. During 2004, we acquired one rental apartment community for $15.4 million, the cash portion of which was $4.2 million. We also purchased land for development for $4.5 million. Additionally, in the third quarter of 2004, we acquired the interests of minority partners in one office building and two apartment communities for $11.1 million. In 2003, we sold seven investment properties for net proceeds of $20.2 million, while net proceeds from the sale of real estate during 2004 was $1.2 million from the sale of one investment property and one parcel of land. Advances to partnerships and joint ventures for development costs decreased $10.2 million in 2004 compared to 2003 partly due to the consolidation of our Las Olas River House project in January 2004 in connection with the adoption of FIN 46R.

In the first nine months of 2004, our net cash provided by financing activities increased to $85.7 million, from $24.6 million in the first nine months of 2003. This increase was primarily due to the issuance of $50 million of Senior Convertible Notes during September 2004. Proceeds from the debt issuance were used to repay approximately $34.6 million of mortgage debt. In 2004, we also borrowed approximately $144 million in construction loans to fund our homebuilding division projects as compared to $38 million in 2003. In 2004, refinancing loans provided $47.8 million as compared to $115.9 million in 2003. Additionally, the exercise of stock options during the first nine months of 2004 provided cash proceeds of $5.9 million, an increase of $5.6 million over the same period in 2003.

Contractual Commitments. The following table summarizes information regarding our contractual commitments as of September 30, 2004:


	Three Months
	Ending
	December 31,		2005		2007
	2004		and 2006		and 2008		Thereafter		Total
Scheduled debt maturities	$	10,455	$	553,761	$	38,578	$	244,327	$	847,121
Operating leases		314		2,270		2,035		26,173		30,792

		10,769		556,031		40,613		270,500		877,913

Guaranteed debt of unconsolidated partnerships and joint ventures		5,075		67,360		—		—		72,435

	$	15,844	$	623,391	$	40,613	$	270,500	$	950,348

Off-Balance Sheet Arrangements. We have guaranteed an unconsolidated entity’s $5 million land loan that matures in December 2004. We have also guaranteed payment of $3.5 million of a loan with a September 30, 2004, balance of $37.5 million of an unconsolidated joint venture. This loan matures in October 2006 and may be extended for six months. Additionally, we have guaranteed two construction loans totaling $55 million, with an aggregate balance at September 30, 2004, of $29.9 million, of an unconsolidated joint venture. The construction loans mature in March and April 2006 and may be extended for six months.

Critical Accounting Policies and Estimates

Accounting estimates are an integral part of the preparation of our consolidated financial statements and our financial reporting process and are based on our current judgments. Certain accounting estimates are particularly sensitive because of their significance to our consolidated financial statements and because of the possibility that future events affecting them may differ from our current judgments. The most significant accounting policies affecting our consolidated financial statements are as follows.

Asset Impairment. GAAP requires a property held for sale to be measured at the lower of its carrying amount or fair value less costs to sell. In instances where a property’s estimated fair value less costs to sell is less than its carrying value at the time of evaluation, we recognize a loss and write down the property’s carrying value to its estimated fair value less costs to sell. We recognize a gain for subsequent increases in fair value less costs to sell, but not in excess of the cumulative loss previously recognized. Our review of properties held for sale generally includes selective site inspections, comparing the property’s current rents to market rents, reviewing the property’s expenses and maintenance requirements, discussions with the property manager, and a review of the surrounding area. We may make adjustments to estimated fair values based on future reviews.

We also evaluate our properties held for investment for impairment whenever events or changes in circumstances indicate that a property’s carrying value may not be recoverable. This evaluation generally consists of reviewing the property’s cash flow and current and projected market conditions, as well as changes in general and local economic conditions. If we conclude that a property has been impaired, we recognize an impairment loss and write down the property’s carrying value to estimated fair value.

Investments in Joint Ventures Accounted for Using the Equity Method. In December 2003, the FASB issued FIN 46R. FIN 46R clarifies the application of Accounting Research Bulletin 51, “Consolidated Financial Statements,” for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support or in which equity investors do not have the characteristics of a controlling financial interest, or “variable interest entities.” Variable interest entities within the scope of FIN 46R are required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. We adopted the provisions of FIN 46R on January 1, 2004 and have consolidated eight variable interest entities that were previously unconsolidated.

We use the equity method to account for investments in partnerships and joint ventures over which we exercise significant influence but do not control or which are not variable interest entities of which we are the primary beneficiary. Under the equity method, our initial investments are increased by our proportionate share of the partnerships’ operating income and additional advances and decreased by our proportionate share of the partnerships’ operating losses and distributions received. Our interest in intercompany transactions is eliminated.

We determine our proportionate share of the profits or losses of the partnerships and joint ventures consistent with the allocation of cash distributions in accordance with the provisions of the American Institute of Certified Public Accountants’ Statement of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures.”

We have investments in a number of partnerships or joint ventures in which we hold non-controlling interests or our outside partners have significant participating rights, as defined by the FASB’s Emerging Issues Task Force in its 96-16 Abstract, or important rights, as defined by SOP 78-9 and which we have determined not to be variable interest entities, as defined by FIN 46R. The net effect of not consolidating these joint ventures has been to exclude their assets, liabilities, and gross revenues and expenses from our consolidated financial statements. There has been no effect on reported net income or loss except in instances where we have received distributions from a joint venture in excess of our investment in the joint venture, with the excess recorded as income. In these situations, we have recovered our investment in the joint venture, its indebtedness is non-recourse to us, and we have no obligation to fund any of its cash flow deficits.

Revenue Recognition. We have generally recognized revenue from homebuilding sales at the time of closing under the completed contract method. The related profit is recognized when collectibility of the sale price is reasonably assured and the earnings process is substantially complete. When a sale does not meet the requirements for income recognition, profit is deferred until such requirements are met. For mid-rise and high-rise condominium developments, where construction typically takes eighteen months or more, the percentage-of-completion method is employed. Under this method, once construction is beyond a preliminary stage, buyers are committed to the extent of being unable to require refunds except for non-delivery of the home, a substantial percentage of homes are under firm contracts, the sale prices are deemed collectible, and remaining costs and revenues can be reasonably estimated, revenue is recorded as a portion of the value of non-cancelable sale contracts. Revenue recognized is calculated based upon the percentage of construction costs incurred in relation to total estimated construction costs. Any amounts due under sale contracts, to the extent recognized as revenue, are recorded as contracts receivable.

Rental revenue is recognized on the straight-line method. Lease terms for our apartment communities are generally for one year or less. Lease terms for our commercial properties are generally from three to five years, although they may be shorter or longer. Rental concessions are deferred and amortized on the straight-line method over the lease terms as a reduction to rental revenue. We accrue percentage rentals only after the tenant’s sales have reached the threshold provided for in the lease.

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

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

Deferred Tax Assets. Our deferred tax assets represent expenses and losses that will offset future income tax liability. If we are unable to generate income tax liability resulting from future net income, the value of this tax asset would be impaired. We consider such factors as current trends and profit margins in determining projected net income, and projected net income is used to assess realizable value of the deferred tax asset.

Environmental Matters

Under federal, state, and local environmental laws, ordinances, and regulations, Tarragon may be liable for removal or remediation costs, as well as other costs (such as fines or injuries to persons and property) where our employees may have arranged for removal, disposal, or treatment of hazardous or toxic substances. In addition, environmental laws impose liability for release of asbestos-containing materials into the air, and third parties can seek recovery from Tarragon for personal injury associated with those materials. We are not aware of any liability relating to these matters that would have a material adverse effect on our business, financial position, or results of operations. However, there is a matter involving the alleged release of asbestos-containing materials at one of our condominium conversion projects, as described in Part II, Item 1. “LEGAL PROCEEDINGS.” As of this date, we are unable to determine the outcome of this matter and whether it will have a material impact on our financial statements. We have incurred legal and other professional fees and costs of relocating residents in connection with this matter totaling $418,000 to date. Remediation has been completed at a total cost of $800,000.

Risks Associated with Forward-Looking Statements Included in this Form 10-Q

In addition to historical information, this Form 10-Q contains forward-looking statements. Forward-looking statements are expressions of our current beliefs and expectations, based on information currently available to us, estimates, and projections about our industry, and certain assumptions made by our management. These statements are not historical facts. We use words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions to identify our forward-looking statements, which include, among other things, our anticipated financings and sales of properties and Homebuilding inventory.

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

and expectations as of the date of this Form 10-Q. We undertake no obligation to publicly update or revise any forward-looking statement in light of new information, future events, or otherwise. Please read this discussion along with the Consolidated Financial Statements and Notes included elsewhere in this report. Dollar amounts in tables are in thousands except for per unit or per share amounts.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Tarragon is exposed to market risk from changes in interest rates that may adversely affect our financial position, results of operations, and cash flows. In seeking to minimize the risks from interest rate fluctuations, we manage such exposure through our regular operating and financing activities. We do not trade or speculate in financial instruments. There have been no material changes to Tarragon’s market risk since December 31, 2003.

ITEM 4. CONTROLS AND PROCEDURES

Based on their most recent evaluation, which was completed as of the end of the period covered by this Form 10-Q, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective at September 30, 2004, to ensure that information required to be disclosed in reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no changes in the Company’s internal controls over financial reporting during the quarter ended September 30, 2004, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Share Repurchase Program. Tarragon’s Board of Directors authorized the repurchase of up to 1 million shares of its common stock under a share repurchase program implemented in September 2001. In March 2004, the Board of Directors authorized the repurchase of up to an additional 500,000 shares. The share repurchase program has no expiration date. Through September 30, 2004, we had repurchased 730,867 shares of our common stock pursuant to this repurchase program. The following table presents shares repurchased during the three months ended September 30, 2004.


					Total Number of		Maximum Number
					Shares Repurchased		of Shares that May
	Total Number of		Weighted		as Part of Publicly		Yet Be
	Shares		Average Price		Announced		Repurchased
Period	Repurchased		Paid per Share		Program		Under the Program
July 1 thru July 31, 2004		7,068	$	14.11		7,068
August 1 thru August 31, 2004		8,536		14.07		8,536
September 1 thru September 30, 2004		47,980		12.86		47,980

Total		63,584	$	13.16		63,584		769,133

Sale of Unregistered Securities. On September 16, 2004, Tarragon completed the sale of $50 million principal amount of 8% Senior Convertible Notes Due 2009 (the “Notes”) to Lazard, Frères & Co., LLC (“Lazard”) as the Initial Purchaser under a Purchase Agreement dated September 9, 2004 (the “Purchase Agreement”). The Notes were resold by Lazard to persons reasonably believed to be “Qualified Institutional Buyers” (as defined in Rule 144A under the Securities Act of 1933, as amended the “Securities Act”). The amount of Notes sold includes $10 million principal amount of Notes issued pursuant to an over-allotment option granted to the Initial Purchaser that was exercised. The Notes are general, senior, unsecured obligations of Tarragon, bear interest at the rate of 8% per annum and are convertible into Tarragon Common Stock at an initial conversion rate of 54.4662 shares per $1,000 in principal amount of Notes (equal to a conversion price of $18.36 per share of Tarragon Common Stock), subject to adjustment in certain instances. Tarragon sold the Notes to the Initial Purchaser at a 6% discount which resulted in net proceeds to Tarragon of $47 million.

If the full principal amount of Notes of $50 million were converted, shares of Tarragon Common Stock issued and outstanding would increase by 2,723,310, or approximately 18% of the shares of Common Stock of Tarragon issued and outstanding as of September 30, 2004.

Prior to September 16, 2007, the Notes are not redeemable, but after that date until maturity, Tarragon has the right, but not the obligation upon certain notice, to redeem Notes (in whole or in part) for cash at a redemption price of $1,000 original amount of Note, plus accrued and unpaid interest if the closing price of Tarragon’s Common Stock equals or exceeds 150% of the then applicable conversion price for 20 out of 30 consecutive trading days. The Notes may also be subject to a “put option” by the Holders if a fundamental change occurs, as that term is defined in the Note Indenture. The Notes have been sold pursuant to and in reliance upon Rule 144A and are subject to certain registration rights.

ITEM 6. EXHIBITS


3.1		Articles of Incorporation of Tarragon Realty Investors, Inc. (incorporated by reference to Exhibit 3.2 to Form 8-K dated July 10, 1997).

3.2		Certificate of Designation of Preferences and Relative Participating or Optional or Other Special Rights and Qualification, Limitations or Restrictions thereof of 10% Cumulative Preferred Stock of Tarragon Realty Investors, Inc., as filed with and approved by the Secretary of State of Nevada on May 1, 2000 (incorporated by reference to Exhibit 4.4 to Registration Statement No. 333-31424 on Form S-4).

3.3		Certificate of Amendment to the Articles of Incorporation of Tarragon Corporation as filed with and approved by the Secretary of State of Nevada on June 22, 2004 (incorporated by reference to Exhibit 3.10 to Form 8-K dated June 14, 2004).

4.1		Indenture Agreement dated September 16, 2004, between Tarragon Corporation and U.S. Bank National Association, as Trustee

31.1*		Rule 13a-14(a) certification by William S. Friedman, Chief Executive Officer.

31.2*		Rule 13a-14(a) certification by Erin D. Pickens, Executive Vice President and Chief Financial Officer.

32		Section 1350 certifications by William S. Friedman, President and Chief Executive Officer, and Erin D. Pickens, Executive Vice President and Chief Financial Officer.

* filed herewith


	TARRAGON CORPORATION

Date: November 9, 2004	By:	/s/William S. Friedman

		William S. Friedman
		Chief Executive Officer, Director, and
		Chairman of the Board of Directors

Date: November 9, 2004	By:	/s/Erin D. Pickens

		Erin D. Pickens
		Executive Vice President and
		Chief Financial Officer
		(Principal Financial Officer)

Date: November 9, 2004	By:	/s/Stephanie D. Buffington

		Stephanie D. Buffington
		Director of Financial Reporting
		(Principal Accounting Officer)


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


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

(a)		Sales represent revenues recognized under the percentage of completion method. At September 30, 2004, 76% of the homes were under firm contracts totaling $33.4 million, and construction was 50% complete.

(b)		Sales represent revenues recognized under the percentage of completion method. At September 30, 2004, 71% of the homes were under firm contracts totaling $154.6 million, and construction was 93% complete. Through December 31, 2003, this was an unconsolidated project. Beginning January 1, 2004, we began reporting Las Olas River House as a consolidated project in connection with the adoption of the provisions of FIN 46R. Gross profit reported in 2004 is before interest on advances from Tarragon, which is eliminated upon consolidation.