UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark one)

For the Quarterly Period Ended June 30, 2004

OR

For the Transition Period From                     to                    

Commission File Number 333-111643

DESERT CAPITAL REIT, INC.

2357 Renaissance Drive, Suite A, Las Vegas, Nevada 89119
(Address of principal executive office)
(Zip Code)

Registrant’s telephone number, including area code: (800) 419-2855

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 o

The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding as of August 13, 2004 was 20,000.

DESERT CAPITAL REIT, INC.

FORM 10-Q

For the Quarter Ended June 30, 2004

INDEX

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

DESERT CAPITAL REIT, INC. (A Development Stage Company)
BALANCE SHEETS

The accompanying notes are an integral part of these condensed financial statements

DESERT CAPITAL REIT, INC. (A Development Stage Company)
Income Statements

The accompanying notes are an integral part of these condensed financial statements

DESERT CAPITAL REIT, INC. (A Development Stage Company)
Statements of Cash Flows

The accompanying notes are an integral part of these condensed financial statements

DESERT CAPITAL REIT, INC. (A Development Stage Company)
Statement of Stockholders’ Equity

For the Six Months Ended
June 30, 2004
(Unaudited)

The accompanying notes are an integral part of these condensed financial statements

Desert Capital REIT, INC.
Notes to Financial Statements
June 30, 2004 (UNAUDITED)

Note 1 — Description of Business and Basis of Presentation

     Desert Capital REIT, Inc. (the “Company”), was organized and incorporated under the laws of the state of Maryland in December 2003. The principal business activity is the financing of and investment in mortgage loans, including acquisition and development loans, construction loans, commercial property loans, and residential loans. The financing will be provided through equity capital and leverage.

     The accompanying unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements, although management believes that the disclosures presented herin are adequate to make the information presented not misleading. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. The Company's primary activity to date has been organizational activities and the registration of the offering of its common stock with the SEC. The results of operations for the three months ended June 30, 2004 are not necessarily indicative of results that may be expected for the entire year ending December 31, 2004.

Note 2 – Summary of Significant Accounting Policies

     Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

     Cash

     The Company places its temporary excess cash with high quality financial institutions. Such deposits may exceed the FDIC insurance limits.

     Income Taxes

     The Company intends at all times to qualify as a real estate investment trust (“REIT”) for federal income tax purposes, under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended and applicable Treasury Regulations. Therefore, the Company generally will not be subject to federal corporate income taxes if the Company distributes at least 90% of its taxable income to its stockholders. To qualify as a REIT, the Company must elect to be so treated and must meet on a continuing basis certain requirements relating to the Company’s organization, sources of income, nature of assets, and distribution of income to stockholders. The Company must also maintain certain records and request certain information from its stockholders designed to disclose actual ownership of its stock in order to maintain REIT status.

     In addition the Company must satisfy certain gross income requirements annually and certain asset tests at the close of each quarter of its taxable year. If the trust fails to qualify for taxation as a REIT in any taxable year, and the relief provisions do not apply, the Company will be subject to tax on its taxable income at regular corporate rates. Distributions to stockholders in any year in which the Company fails to qualify will not be deductible by the Company nor will they be required to be made. Unless entitled to relief under specific statutory provisions, the Company will also be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost.

     Based on the Company’s belief that it has operated in a manner so as to allow it to be taxed as a REIT since inception, no provision for federal income taxes has been made in the financial statements.

     Organization Expenses

     Organization expenses are expensed as incurred.

     Deferred Offering Costs

     The costs attributable to the securities offering will be charged against the proceeds of the offering as a reduction to equity capital. Those costs include legal and accounting fees to prepare the securities filing. The Company will incur fees in selling the securities, which will also be charged against the proceeds of the offering.

Note 3 — Stock

     The Company has been initially capitalized by issuing 20,000 shares of its common stock for $200,000.

Note 4 – Basic Earnings Per Common Share

     Earnings per share is computed in accordance with SFAS No. 128, Earnings Per Share. Basic earnings per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding during each period.

Note 5 — Notes Payable

     As of June 30, 2004, the Company has borrowed $618,537 from its advisor, Burton Management Company, Ltd., (“Burton”), a related party.

Note 6 — Commitments and Related Parties

     The Company has contracted with Burton to serve as Advisor for the Company. Burton oversees the day-to-day operations including asset, liability and capital management. Burton is compensated based upon the advisory agreement that entitles Burton to a base management fee, incentive compensation and reimbursement of expenses. The president and owner of Burton is also the president and chief executive officer of the Company. The annual base management compensation is 1% of the first $200,000,000 of average invested assets plus 0.8% of the average invested assets in excess of $200,000,000, to be paid quarterly.

     The incentive compensation is a tiered percentage of the amount of our net income (taxable income) excluding capital losses, before deducting incentive compensation less a threshold return, which is the net income that would produce an annualized return on our average invested assets equal to the 10 year U.S. Treasury rate plus 1.0%. The tiered percentage is the weighted average of 20% of the first $200,000,000 of average invested assets and 10% of the excess over $200,000,000 of average invested assets. The incentive compensation will be calculated quarterly and any positive quarterly incentive amount shall be paid by the Company, along with the base management compensation, within 15 days of receipt of the computations. At the end of the fiscal year, the incentive compensation shall be calculated based upon the net income for the year. If the quarterly payments are less than the annual incentive amount, the Company shall pay Burton the difference. If the quarterly payments were to exceed the annual incentive compensation, Burton will refund the excess to the Company, which will reduce the previously recorded incentive fee expense. Should the Company not have sufficient cash available to pay the quarterly or

annual amounts, the Company would either borrow sufficient funds or sell assets to meet these contracted obligations.

     The Company has entered into a three year agreement with Consolidated Mortgage, Inc., which will provide for the right of first offer to purchase all residential mortgage and commercial bridge loans originated by Consolidated Mortgage. The officers of the Company were formerly officers with Consolidated Mortgage.

     The dealer-manager, CMC Financial Services, Inc., directs and oversees the sale of the Company’s equity securities. CMC Financial receives a sales commission and other fees based on the sale of these securities. The dealer-manager is an affiliate of both the Company and Burton, as the president and owner of CMC Financial Services, Inc. is also the president and chief executive officer of the Company.

Note 7 – Subsequent Event

     The Securities and Exchange Commission (“SEC”) declared the Company’s Registration Statement on Form S-11 effective on July 16, 2004. The Company incurred organizational costs prior to receiving SEC approval, but principal business activity did not begin until July 16, 2004.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this document. This discussion may contain certain forward-looking statements. Forwarding-looking statements are those that are not historical in nature. They can often be identified by their inclusion of words such as “will,” “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend” and similar expressions. Any projection of revenues, earnings or losses, capital expenditures, distributions, capital structure or other financial terms is a forward-looking statement.

     Our forward-looking statements are based upon our management’s beliefs, assumptions and expectations of our future operations and economic performance, taking into account the information currently available to us. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us, that might cause our actual results, performance or financial condition to be materially different from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. Some of the important factors that could cause our actual results, performance or financial condition to differ materially from expectations are:

	•		Our limited operating history and the lack of experience of our Advisor, Burton Management Company, Ltd., in managing a REIT;
	•		Changes in interest rates;
	•		Potential impacts of our leveraging policies and strategies without notice to you or stockholder approval;
	•		Our Advisor’s motivation to recommend riskier investments in an effort to maximize its incentive compensation under the advisory agreement; and
	•		Although we believe our proposed method of operations will be in conformity with the requirements for qualification as a REIT, we cannot assure you that we will qualify as a REIT or, if so qualified, will continue to qualify as a REIT. Our failure to qualify or remain qualified as a REIT could have material adverse effect on our performance and your investment.

     We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the events described by our forward-looking events might not occur. We qualify any and all of our forward-looking

statements by these cautionary factors. In addition, you should carefully review the risk factors describe in other documents we file from time to time with the Securities and Exchange Commission.

General

     Desert Capital REIT, Inc. is a REIT headquartered in Las Vegas, Nevada. We are externally managed and were formed in December 2003 to invest in mortgage loans. We expect to derive our revenues primarily from the receipt of interest and principal payments under loans acquired with our equity capital and borrowed funds. Our principal business objective is to generate net income for distribution to our stockholders from the spread between interest income on our mortgage assets and the costs of financing the acquisition of these assets. We expect that this spread, net of operating expenses, will provide both operating capital and distributable income. Our business will depend on our access to external sources of financing at a cost we can absorb while still generating an attractive risk-adjusted return on the loans we acquire using the proceeds of our financings. Our business will also depend on our ability to locate suitable investments to keep our capital fully deployed at favorable rates.

     We intend to elect to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ending December 31, 2004, thereby generally avoiding U.S. federal income taxes on our taxable income that we distribute currently to our stockholders.

Risks Factors

     Investment in our common stock involves a high degree of risk. The risk factors that should be considered when making an investment in our common stock include, but are not limited to, those described in the following paragraphs and more fully described in our Registration Statement.

     There are a number of risks associated with ownership of our common stock, including, but not limited to, reliance on our Advisor, potential conflicts of interest and investment in a development stage enterprise. We are totally reliant on our Advisor, which is an affiliate of several of our officers and directors, to manage our business and assets. Certain of our officers and directors will be subject to substantial conflicts of interest. We may incur substantial debt, which could hinder our ability to pay dividends to our stockholders. We may not be able to invest in a diverse portfolio of loans and the value of our shares would then fluctuate with the performance of specific loans.

     We are evaluating the market of available loans and will acquire or fund loans that meet our investment criteria. Each of the types of loans we expect to acquire are subject to risks: balloon loan payments are risky because repayment depends on the borrower’s ability to refinance the loan or sell the property, commercial loans are risky partly due to the fact that they generally have higher loan balances than our other categories of loans, .and subordinated loans are subject to a greater risk of loss than loans secured by first liens. If we cannot fund loan acquisitions on favorable terms to meet financial expectations, our earnings could be adversely affected.

Public Offering of Equity Securities/Use of Proceeds

     We are currently in the process of responding to comments on our Registration Statement on Form S-11 under the Securities Act of 1933, as amended, by the SEC, with the goal of having the Registration Statement declared effective. Therefore we have not yet commenced a public offering of equity securities.

     As of June 30, 2004, we had sold 20,000 shares of our common stock (“Shares”) to our Advisor for aggregate gross proceeds before Offering costs and selling commissions of $200,000.

     In connection with the Offering, we incurred approximately $696,958 of costs related to the issuance and distribution of the Shares through the quarter ended June 30, 2004. We will continue to incur similar costs in the future as additional shares are sold.

Critical Accounting Policies and Management Estimates

     Our financial statements are prepared in accordance with GAAP. The application of these accounting policies will require our management to make certain judgments and estimates that directly affect our financial reporting results. We consider the policies discussed below to be critical to an understanding of our financial statements. Specific risks for these critical accounting policies are described in the following paragraphs. In regard to these policies, we caution you that we have no operating history and future events rarely develop exactly as forecasted, and the best estimates of our management will likely require adjustment. See “Note 2 – Summary of Significant Accounting Policies” to our financial statements for a more complete description of these policies.

     Basis of Accounting and Presentation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Management believes that the estimates and assumptions utilized in preparing our financial statements and accompanying notes are reasonable and prudent. Actual results could differ from those estimates.

     Organization Expenses. Organization expenses are expensed as incurred.

     Deferred Offering Costs. Costs attributable to the securities offering are charged against the proceeds of the offering as a reduction to equity capital. These costs include legal and accounting fees to prepare the securities filing as well as the fees incurred in selling the securities, such as underwriting commissions.

     Income Taxes. For our taxable year ending December 31, 2004, we intend to elect to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code and, upon the election being made, we will be taxed as such beginning with our taxable year ending December 31, 2004. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to currently distribute at least 90% of our REIT taxable income to stockholders. As a REIT, we generally will not be subject to U.S. federal income tax on taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to U.S. federal income taxes on our taxable income at regular corporate rates starting with that year and will not be permitted to qualify for treatment as a REIT for U.S. federal income tax purpose for four years following the year during which qualification is lost unless the IRS were to grant us relief under certain statutory provisions. Such an event could have a material adverse effect on our net income and net cash available for distribution to stockholders. However, we believe that we will be organized and operate in such a manner as to qualify for treatment as a REIT and we intend to operate in the foreseeable future in such a manner so that we will qualify as a REIT for U.S. federal income tax purposes.

Recent Accounting Developments

     In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The statement specifies the accounting for certain employee termination benefits, contract termination costs and costs to consolidate facilities or relocate employees and is effective for exit and disposal activities initiated after December 31, 2002. We do not expect the statement to have a material effect on our financial condition or results of operations.

     In November 2002, the FASB issued FASB Interpretation (FIN) No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 specifies the disclosures to be made about obligations under certain issued guarantees and requires a liability to be recognized for the fair value of a guarantee obligation. The recognition and measurement provisions of the interpretation apply prospectively to guarantees issued after September 30, 2002. We do not expect the recognition and measurement provisions to have a material effect on our financial condition or results of operations.

     In January 2003, the FASB issued FASB Interpretation (FIN) No. 46 “Consolidation of Variable Interest Entities.” FIN No. 46 requires a company to consolidate a variable interest entity (VIE) if the company has variable interests that give it a majority of the expected losses or a majority of the expected residual returns of the entity. Prior to FIN No. 46, VIEs were commonly referred to as SPEs. FIN No. 46 is effective immediately for VIEs

created after January 31, 2003. We do not expect the interpretation to have a material effect on our financial condition or results of operations.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150, which is effective at the beginning of the first interim period beginning after June 15, 2003, must be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption. The statement requires that a financial instrument which falls within the scope of the statement to be classified and measured as a liability. The following financial instruments are required to be classified as liabilities: (1) shares that are mandatorily redeemable, (2) an obligation to repurchase the issuer’s equity shares or one indexed to such an obligation and that requires or may require settlement by transferring assets and (3) the embodiment of an unconditional obligation that the issuer may or may not settle by issuing a variable number of equity shares if, at inception, the monetary value of the obligation is based on certain measurements defined in the statement. We do not expect the statement to have a material effect on our financial condition or results of operations.

Results of Operations

     For the three months ended June 30, 2004, net (loss) was $(64,856) or $(3.24) per weighted average share outstanding (basic and diluted),. Due to the fact that we have not yet commenced a public offering or our operations, operating results for the three months ended June 30, 2004 are not indicative of future operating results.

     Operating expenses for the three months ended June 30, 2004, were $64,856.

     Other expenses for the three months ended June 30, 2004, included $48,000 in compensation expense related to the compensation of our board of directors, and $14,652 in travel expenses related to the travel and lodging of our board of directors.

     Because the Company has yet to commence a public offering of its shares, the only comparative 2003 financial data presented is the balance sheet as of December 31, 2003.

Off-Balance Sheet Arrangements

     Since inception, we have not maintained any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide additional funding to any such entities. Accordingly, we are not materially exposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such relationships.

Liquidity and Capital Resources

     At June 30, 2004, we had $50,722 of cash to meet our immediate short-term liquidity requirements. We expect that future short-term liquidity requirements will be financed by net cash flow from operations and existing working capital. Operating cash flows are expected to increase once we begin to sell shares and add loans to our portfolio. Cash and cash equivalents decreased since December 31, 2003 principally as a result of the payment of costs related to the offering.

     On July 16, 2004, the SEC declared our Registration Statement on Form S-11 effective. We anticipate that adequate cash will be generated from operations to fund our operating and administrative expenses, continuing debt service obligations, and the payment of dividends in the foreseeable future.

     We paid no dividends for the six months ended June 30, 2004. Dividends are determined by our board of directors and are dependent on a number of factors, including the amount of funds available for distribution, our financial condition, any decision by our board of directors to reinvest funds rather than to distribute the funds, the annual distribution required to meet REIT status under the Internal Revenue Code and other factors our board of directors may deem relevant.

     Cash Flows used in Operating Activities. Net cash used by operating activities was $64,856. We expect cash flows from operating activities to increase once we begin to sell shares and acquire loans.

     Cash Flows used in Investing Activities. We did not engage in any investing activities for the three months ended June 30, 2004.

     Cash Flows from Financing Activities. Net cash provided by financing activities amounted to $64,656 for the three months ended June 30, 2004, consisting of $151,880 in offering costs during the three-months ended June 30, 2004 and $216,536 in borrowings under our credit facility. For the three months ended June 30, 2004, we paid offering costs, totaling $151,880. We will continue to incur similar costs in the future as additional shares are sold.

     In order to qualify as a REIT and to avoid corporate-level tax on the income we distribute to our stockholders, we are required to distribute at least 90% of our REIT taxable income on an annual basis. Therefore, one the net proceeds we receive from this offering are substantially fully invested, we will need to borrow in order to grow our business and acquire additional assets. Our sources of funds will primarily be the net proceeds from the offering, operating cash flows and borrowings. Operating cash flows will consist of interest received on and maturities of mortgage loans and investments. Liquidity will also be generated through lines of credit with commercial banks. We believe that we will be able to obtain financing in amounts and on terms that are acceptable to us and consistent with our business strategy prior to the closing of the offering. We believe that these cash resources will be sufficient to satisfy our immediate liquidity requirements, and we do not anticipate a need to raise funds from other than these sources within the next 12 months.

     Our income calculated for tax purposes may differ from income calculated in accordance with GAAP. For example, we record a reserve for credit losses for GAAP purposes whereas only actual credit losses are deducted in calculating taxable income. The distinction between taxable income and GAAP income is important to our stockholders because distributions are declared on the basis of taxable income. While we generally will not be required to pay income taxes as long as we satisfy the REIT provisions on the Internal Revenue Code, each year we

will be required to complete a U.S. federal income tax return wherein taxable income is calculated. This taxable income level will determine the minimum level of distribution we must pay to our stockholders.

     Our advisory agreement with our Advisor requires us to pay incentive compensation on a quarterly basis to our Advisor based on the application of the incentive compensation formula at the end of each quarter. Because we will be paying out at least 90% of our REIT taxable income to stockholders on a quarterly basis, we may not have sufficient cash at the end of a particular quarter to pay the incentive fee, which would require us to borrow under our credit facility, if any, or sell assets to meet the contractual obligation. In addition, it is possible that our liquidity may be further impaired if we generate substantial net income in the first three quarters of a fiscal year and have a significant drop off in the fourth quarter, but our capital resources may be limited by the fact that we have overpaid our Advisor for the year (through the first three quarters) will not be reimbursed for the over payment until year-end. Nevertheless, our total annual operating expenses, including the incentive compensation payable to the Advisor, will not exceed the greater of 2% of average invested assets or 25% of our net income, unless specifically approved by our independent directors.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk refers to the risk of loss from adverse changes in the level of one or more market prices, rate indices or other market factors. We are exposed to market risk primarily from changes in interest rates that are very sensitive to a variety of factors including political, economic and other factors outside of our control.

Interest rate risk arises primarily as a result of our core business activities of acquiring mortgage loans and funding a portion of the purchases with borrowings and the associated asset and liability management required to match maturities of loans to funding sources. The principal objective of our asset and liability management is to maximize net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of liquidity.

The primary interest rate exposure to which we are subject relates to our mortgage loan portfolio. Any change in the general level of interest rates in the market can affect our net interest income and net income in either a positive or negative manner. Net interest income is the difference between the income earned from interest bearing assets less the expense incurred relating to interest bearing liabilities. Fluctuations in the interest rate environment can also affect our ability to acquire new loans, the value of our loans for sale portfolio and our ability to sell the loans held for sale and the related income associated with a sale.

We do not intend to use any derivative instruments to manage our interest rate exposure. Given the short time horizon of our anticipated investments and our related borrowings, we do not believe a hedging strategy is necessary. In addition, our actions are limited by rules with which REITs must comply.

Item 4. Controls and Procedures

As of the end of the period covered by this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Company management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that these disclosure controls and procedures are effective as of the end of the period covered by this report. There has been no change in the Company’s internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

None.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

None.

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

a)

Exhibits

b)

Reports on Form 8-K

     No reports on Form 8-K were filed during the period covered by this report.

SIGNATURES

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

	DESERT CAPITAL REIT, INC.
November 29, 2004		/s/ TODD B. PARRIOTT
		Todd B. Parriott,
		Chairman of the Board, Chief Executive Officer, President and Chief Investment Officer (Principal Executive Officer)
November 29, 2004		/s/ JONATHAN G. ARENS
		Jonathan G. Arens,
		Chief Financial Officer (Principal Accounting Officer)

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