its balance sheet. We direct the acquisition of securities by the warehouse provider during this period, but we do not earn any fees for providing this service to either the warehouse provider or the issuer of the CDO, which will receive such securities upon the closing of the CDO. We contribute cash and other collateral, which is held in escrow by the warehouse provider, to back our commitment to purchase equity in the CDO and to cover our share of losses should securities need to be liquidated. Pursuant to the warehouse agreement, we share gains, including the net interest earned during the warehouse period, and losses, if any, with the warehouse provider. The investment parameters of this business reflect the risk management strategies and the portfolio characteristics that we have jointly developed with the warehouse provider.

In August 2003, NS Advisors, LLC, ("NS Advisors") completed its first CDO issuance, through N-Star Real Estate CDO I Ltd., or CDO I, and retained an approximately 83% equity interest in CDO I. The 16.67% balance of the equity interest is owned by unrelated third party investors. We also earn ongoing management fees for our management and monitoring of the CDO collateral of CDO I, which fees equal 0.35% of the related CDO collateral.

On November 11, 2003, NS Advisors entered into a second warehouse agreement with Citigroup Global Markets Inc., or Citigroup, whereby Citigroup agreed to purchase up to $400 million of primarily CMBS and REIT debt, with the expectation of selling such securities to our predecessor's CDO II. Pursuant to the warehouse agreement for the second CDO issuance, our predecessor agreed to a $10 million limited recourse arrangement whereby it escrowed approximately $5.8 million in cash and pledged its equity interest in CDO I to Citigroup to purchase future equity in CDO II upon formation by our predecessor. If either our predecessor, or we, caused an early termination, or unilaterally refused to proceed with the CDO issuance prior to the final determination date, then any losses resulting from the disposition of the securities acquired by Citigroup would have been for the account of our predecessor, or our account (if occurring after the consummation of the Offering), and any net gains arising from the disposition of the collateral would have been allocated to Citigroup. If the second CDO issuance was not completed, the CDO II deposit of $10 million would have been available to Citigroup for the purpose of covering a portion of any losses or costs associated with the liquidation of the accumulated securities. This warehouse facility was terminated in July 2004 when the Predecessor closed CDO II, through N-Star Real Estate CDO II Ltd., and acquired $35.0 million of subordinated securities of this second CDO issuance consisting of all of the "BB" rated junior classes of debt securities and unrated income securities. As part of any future CDO issuance, we intend to retain a significant portion of the equity and possibly some of the junior CDO debt securities in order to earn a spread between the yield on the assets and the yield on the CDO debt issued. The predecessor recognized unrealized losses of $0.1 million for the nine months ended September 30, 2004, related to the change in the fair value of the CDO II equity income and BB notes, which has been recorded as a component of other comprehensive income in owners' equity.

In September 2004, NS Advisors entered into a third warehouse arrangement with Citigroup whereby Citigroup agreed to purchase up to $400 million of CMBS and other real estate debt securities at our direction for future sale to CDO III. We are required to pledge up to $10 million as security for the purpose of covering a portion of any losses or costs associated with the accumulation of these securities under this warehouse agreement. This security is in the form of a pledge of our approximately 83% equity interest in CDO I for acquisitions of securities up to $150 million and cash deposits of up to approximately $5.7 million to cover the accumulation of securities from $150 million to the maximum of $400 million. The CDO I preferred interest was pledged as security for the CDO III warehouse in October, 2004. The other terms of the CDO III warehouse agreement are substantially similar to those of the warehouse agreement for CDO II. Approximately $100 million of the $400 million securities have been accumulated as of September 30, 2004 under the warehouse agreement. As of December 22, 2004, approximately $226 million of the $400 in securities have been accumulated. The predecessor recognized an unrealized gain on the warehouse agreement for CDO III of $0.3 million for the three months ended September 30, 2004.

During the warehouse period, our participation under the warehouse agreement is reflected in our combined financial statements as a non-hedge derivative, which is reflected at fair value and any unrealized gain or loss is charged to operations. Based on an analysis of our predecessor's interest in

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CDO I as a variable interest entity under FASB Interpretation No. 46R "Consolidation of Variable Interest Entities," the financial statements of CDO I were not consolidated into our predecessor's financial statements as of December 31, 2003 and September 30, 2004 since our predecessor is not the primary beneficiary of CDO I. Similarly, the financial statements of CDO II were not consolidated into our predecessor's financial statements as of September 30, 2004 since our predecessor is not the primary beneficiary of CDO II. Accordingly, our predecessor has designated these beneficial interests in preferred equity of CDO I and the unrated income notes of CDO II as available for sale securities as they meet the definition of a debt instrument due to their underlying redemption provisions. We anticipate that CDO III will be treated similarly for financial reporting purposes.

Short Sales

Our predecessor may sell securities that it does not own ("short sales"). Short sales are typically entered into by our predecessor as a hedge to offset a future liability or changes in the market value of an asset resulting from changes in interest rates. To complete a short sale, our Predecessor may arrange through a broker to borrow the securities to be delivered to the buyer. The proceeds received by our predecessor from the short sale are retained by the broker until our predecessor replaces the borrowed securities. In borrowing the securities to be delivered to the buyer, our predecessor becomes obligated to replace the securities borrowed at their market price at the time of the replacement, whatever that price may be. A gain, limited to the price at which our predecessor sold the security short, or a loss, unlimited as to dollar amount, will be realized upon the termination of a short sale if the market price is less than or greater than the proceeds originally received. Our predecessor's liability under the short sales is recorded at fair value, with unrealized gains or losses included in unrealized loss on short sales of securities in the combined statement of operations. Our predecessor is exposed to credit loss in the event of nonperformance by the broker that holds a deposit as collateral for securities borrowed. However, our predecessor does not anticipate nonperformance by the broker. In connection with a short sale of a FNMA security used for hedging purposes in July 2004, our predecessor has recognized a liability of $12.9 million which is reflected on the combined balance sheet as securities sold, not yet purchased. In addition, there is an unrealized loss of $0.4 million on the sale of shorted securities for the three months ended September 30, 2004.

Net Lease Properties

We invest in office, industrial and retail properties net leased to corporate tenants. Tenants subject to net leases generally pay for all or their pro rata portion of the operating expenses of the property. A net lease property is often leased to a single tenant for an original term of ten years or longer.

Our predecessor owns an indirect interest in a portfolio of well-located retail and commercial properties in the Times Square and midtown Manhattan area of New York City. This New York property portfolio, consisting of two fee and six leasehold interests in retail and commercial properties, is owned by ALGM I Owners LLC, or ALGM, an entity in which our predecessor held a non-managing majority interest. This portfolio was acquired at a substantial discount due to a loan default by the previous owner.

ALGM purchased the portfolio and proceeded to upgrade, reconfigure and reposition the assets, which at the time of purchase were leased to tenants at below market rents. The properties have since attracted new, higher-paying tenants, increasing the value of ALGM's interests in the properties.

As of December 31, 2002, ALGM had interests in ten properties. Two of ALGM's leases expired in 2003, one in March and one in October. As of September 30, 2004 the remaining eight properties, which vary in size from 4,200 square feet to 21,140 square feet, had a total of 96,114 net rentable square feet. Four of the properties are primarily leased or subleased to single users and four are leased or subleased to multiple tenants.

The results of operations for these properties are reflected in our predecessor's equity in earnings of uncombined ventures because our predecessor currently owns a 97.5% non-managing equity interest

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in ALGM. Concurrently with the contribution of the initial investments to our operating partnership and the consummation of our initial public offering, we purchased the remaining 2.5% managing equity interest, which is also entitled to a special allocation of profits in ALGM, from ALGM I Equity LLC, a related party, with $1.6 million of the proceeds of our initial public offering. Going forward, the results of these properties will be reflected on a consolidated basis.

In the future, we will originate net lease property investments through a variety of sources, which may include the purchase of office and industrial properties developed by Koll Development Company. These properties are generally leased to corporate tenants prior to or during the development process. Koll Development has developed 44 office and industrial properties totaling over 10 million square feet at a cost of approximately $1.1 billion of invested capital. We believe that our affiliation with Koll Development will provide us with an ongoing source of valuable market information and contacts in connection with our net lease investment business. No interest in Koll Development was contributed to us.

Application of Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles or GAAP, requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses.

Management has identified certain critical accounting policies that affect the more significant judgments and estimates used by management in the preparation of our predecessor's combined financial statements. Management evaluates on an ongoing basis estimates related to critical accounting policies, including those related to revenue recognition, allowances for doubtful accounts receivable and impairment of investments in uncombined ventures and debt securities available for sale. The estimates are based on information that is currently available to management, as well as on various other assumptions that management believes are reasonable under the circumstances.

Debt securities available for sale are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in owners' equity. Our predecessor's equity investment in CDO I and CDO II are relatively illiquid, and its value must be estimated by management. Fair value is based primarily upon broker quotes or management's estimates. These estimated values are subject to significant variability based on market conditions, such as interest rates and spreads. Changes in the valuations do not affect our predecessor's reported income or cash flows, but impact owners' equity. During the third quarter of 2004, based on current year experience and secondary market data, our predecessor changed its estimate of the call period for the CDO bonds of CDO I and the expected default rate of the underlying securities collateralizing these CDO bonds. The corresponding changes in estimated cash flow resulted in an increase in the estimated fair value of our investment in CDO I and an increase in the average yield to maturity of our residual interest.

Management is required to make subjective assessments as to whether there are impairments in the values of our investment in our predecessor's uncombined ventures accounted for using the equity method. As no public market exists for these investments, management estimates the recoverability of these investments based on projections and cash flow analysis. These assessments have a direct impact on our net income, since recording an impairment loss results in an immediate negative adjustment to net income.

The following is a summary of the accounting policies for our underlying uncombined ventures that are most affected by judgments, estimates and assumptions.

Subordinate Real Estate Debt

The NSF Venture purchases subordinate real estate debt and debt participations to be held for investment. As the managing member of NSF Venture's managing member, we must periodically evaluate each of these loans for possible impairment. Impairment is indicated when it is deemed

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probable that we will be unable to collect all amounts due according to the contractual terms of the loan. Upon a determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. Significant judgment is required both in determining impairment and in estimating the resulting loss allowance. Allowances for loan investment losses are established based upon a periodic review of the loan investments. Income recognition is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. In performing this review, management considers the estimated net recoverable value of the loan as well as other factors, including the fair market value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic conditions in the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized from the loan investments may differ materially from the carrying value at the balance sheet date. To date, all of the NSF Venture's debt investments are fully performing and we have determined that no loss allowances have been necessary with respect to the loans in our joint venture's portfolio.

The NSF Venture records the transfer of a participation or sub-participation in a loan investment of the NSF Venture as a sale when the attributes of the transaction meet the criteria for sale of SFAS 140, "Accounting for Transfers of Financial Assets and Extinguishments of Liabilities," including transferring the financial interest beyond the reach of its creditors and placing no substantive restrictions on the resale of the participation or sub-participation by the purchaser.

Net Lease Properties — ALGM

ALGM's rental revenue is recognized on a straight-line basis over the non-cancelable term of the respective leases. The excess of straight-line rents recognized over amounts contractually due pursuant to the underlying leases are included in straight-line (unbilled) rents receivable in the ALGM balance sheets. ALGM's management provides an allowance for doubtful accounts for estimated losses resulting from the inability of its tenants to make required rent and other payments as due. Additionally, ALGM establishes, on a current basis, an allowance for future tenant credit losses on unbilled rents receivable based upon an evaluation of the collectibility of such amounts. ALGM's management is required to make subjective assessments about the collectibility of the deferred rent receivable that in many cases will not be billed to tenants for many years from the balance sheet date. Management's determination is based upon an assessment of credit worthiness of private company tenants for which financial information is not readily available and as such is not subject to precise quantification.

Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board, FASB, issued Interpretation No. 46, "Consolidation of Variable Interest Entities," or FIN 46. In general, a variable interest entity is a corporation, partnership, trust or any other legal structure used for business purposes that either (1) does not have equity investors with voting rights or (2) has equity investors that do not provide sufficient financial resources for the entity to support its activities. Until adoption of FIN 46, our predecessor generally consolidated another entity in its financial statements only if it controlled the entity through voting interests. FIN 46 will require a variable interest entity to be consolidated by our predecessor if it is subject to a majority of the risk of loss from the variable interest entity's activities or is entitled to receive a majority of the entity's residual returns or both. FIN 46's consolidation requirements apply immediately to variable interest entities created or acquired after January 31, 2003. The consolidation requirements apply to older entities created prior to February 1, 2003 in the first fiscal year or interim period beginning after September 15, 2003. In December 2003, the FASB issued FIN 46R, deferring the effective date until the period ending March 31, 2004 for interests held by public companies in variable interest entities created before February 1, 2003, which were non-special purpose entities. Our predecessor has adopted FIN 46 and FIN 46R for variable interest entities created prior to February 1, 2003 in the fourth quarter of 2003 and has applied the provisions

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for all variable interest entities created after January 31, 2003. We do not anticipate that the adoption of FIN 46 or FIN 46R will have a material impact on our combined financial statements or results of operations taken as a whole. Based on an analysis of our predecessor's interests in CDO I and CDO II as a variable interest entity under FIN 46 or FIN 46R, CDO I and II's financial statements were not consolidated into our predecessor's financial statements as of September 30, 2004 and December 31, 2003 as our predecessor is not the primary beneficiary. Accordingly, our predecessor's beneficial interest in preferred securities of CDO I and CDO II have been designated as available for sale securities as they meet the definition of a debt instrument due to their redemption provisions. We anticipate that CDO III will be treated similarly for financial reporting purposes.

Effective January 1, 2003, our predecessor adopted the provisions of SFAS No. 123, "Accounting for Stock Based Compensation" (as amended by SFAS No. 148), which requires an estimate of the fair value of equity based compensation at the time of grant rather than the intrinsic value method formerly followed by our predecessor. Our predecessor has elected to use the prospective method for this adoption. All equity based awards or modifications of awards to employees after January 1, 2003, will be amortized to compensation expense over the award's vesting period based on the fair value of the award at the date of grant. The adoption of these provisions did not have a material effect on our predecessor's financial position or results of operations. Please refer to the Company's Registration Statement on Form S-11 dated October 25, 2004 for a detailed discussion of our incentive compensation plan.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity." This standard requires that certain financial instruments embodying an obligation to transfer assets or to issue equity securities be classified as liabilities. However, on October 29, 2003, the FASB deferred the provisions of SFAS 150 as they apply to certain mandatorily redeemable financial instruments. We do not expect the adoption of this standard to have a significant effect on our predecessor's financial statements taken as a whole.

Results of Operations of Our Predecessor

Comparison of the Three Months Ended September 30, 2004 to the Three Months Ended
September 30, 2003

Revenues

Advisory and management fee income from related parties increased by $0.7 million to $1.0 million for the three months ended September 30, 2004 from $0.3 million for the three months ended September 30, 2003. This increase is the result of increased asset advisory fees earned in 2004 by both the real estate securities and subordinate real estate debt businesses. The real estate securities and subordinate real estate debt businesses both had minimal operating activity in 2003. See "Related Party Transactions" for a description of our predecessor's agreements with Related Parties pursuant to which our predecessor received these advisory fees.

Interest income from debt securities increased by $0.7 million to $0.9 million for the three months ended September 30, 2004 from $0.2 million for the three months ended September 30, 2003. The CDO I issuer was newly formed in August 2003 which resulted in minimal income being recognized for the three months ended September 30, 2003 as opposed to 2004 which had a full quarter of activity. CDO II closed in July 2004 with interest income primarily derived from the "BB" rated junior classes of debt securities and unrated income securities.

Expenses

General and administrative expenses increased by $0.7 million, or 47%, to $2.2 million for the three months ended September 30, 2004 from $1.5 million for the three months ended September 30, 2003. The increase in expenses related primarily to the addition of new employees and an increase in allocated corporate overhead and direct expenses related to the increased business activity in the

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operations of the real estate securities business and the subordinate real estate debt business from NorthStar Capital. The decrease in direct salaries is due to the decrease in the annual bonus paid to a key executive employee and the reversal of an overaccrual due to a change in estimate.

Interest expense for the three months ended September 30, 2004 totaled $0.2 million. This expense relates to the Company's short term facility with Citigroup secured by the "BB" rated junior classes of debt securities and unrated income securities and its short sale of a FNMA security in the third quarter of 2004.

Equity in Earnings

Equity in earnings of ALGM decreased by $0.2 million, or 40%, to $0.3 million for three months ended September 30, 2004 from $0.5 million for the three months ended September 30, 2003 primarily due to lower signage income in 2004 from one of the ALGM properties.

Gains on Warehouse Agreements

Net gains on warehouse agreements for the three months ended September 30, 2004 of $0.7 million consisted of a $0.2 million unrealized loss and a $0.6 million realized gain related to CDO II. The unrealized loss represents the change in the fair value of the warehouse arrangement up until July 2004, when the CDO II warehouse terminated. CDO III also had an unrealized gain of $0.3 million at September 30, 2004 related to the change in the fair value of that warehouse arrangement.

Net gains on warehouse agreements for the three months ended September 30, 2003, consisted of a $0.9 million unrealized loss and a $1.9 million realized gain relating to CDO I. The CDO I realized gain represented the increase in fair value of the warehouse arrangement from January 1, 2003 through August 21, 2003, the day the warehouse was terminated and the underlying securities were transferred into CDO I.

Other

An unrealized loss of approximately $0.4 million was recognized on a short sale of a FNMA security in the third quarter of 2004. No short positions were taken in the third quarter of 2003.

Comparison of the Nine Months Ended September 30, 2004 to the Nine Months Ended September 30, 2003

Revenues

Advisory and management fee income from related parties increased by approximately $1.6 million to approximately $2.1 million for the nine months ended September 30, 2004 from $0.5 million for the nine months ended September 30, 2003. This increase is the result of additional asset advisory fees earned by both the real estate securities business, due to the closing of CDO II in 2004 and higher loan balances in subordinate real estate debt businesses.

Interest income from CDO I and II increased by $1.3 million to $1.5 million for the nine months ended September 30, 2004 from $0.2 million for the nine months ended September 30, 2003. The CDO I issuer was newly formed in August 2003, resulting in minimal interest income being recognized for the nine months ended September 30, 2003 as opposed to September 30, 2004, which had nine months of interest income. In addition, CDO II closed in July 2004, and as a result had interest income generated primarily by the "BB" rated junior classes of debt securities and unrated income securities.

Expenses

General and administrative expenses increased by $1.2 million, or 32%, from $3.7 million for the nine months ended September 30, 2003 to $4.9 million for the nine months ended September 30, 2003. The increase in expenses related primarily to the addition of new employees, as well as to the new

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allocation of corporate overhead and direct expenses related to increased business activity in the operations of the real estate securities business and the subordinate real estate debt businesses from Northstar Capital.

Interest expense for the nine months ended September 30, 2004 totaled $0.2 million. This expense relates to the Company's short term facility with Citigroup secured by the "BB" rated junior classes of debt securities and unrated income securities and its short sale of a FNMA security in the third quarter of 2004.

Equity in Earnings

Equity in earnings of the NSF venture increased by $0.1 million, or 33%, to $0.4 million for the nine months ended September 30, 2004 from $0.3 million for the nine months ended September 30, 2003. The net income of the NSF Venture increased in 2004 due to increased income in 2004 from loan participations that closed in the fourth quarter of 2003.

Equity in earnings of ALGM decreased by $0.2 million, or 18%, to $0.9 million for the nine months ended September 30, 2004 from $1.1 million for the nine months ended September 30, 2003. This decrease is primarily due to lower signage income in 2004 from one of the ALGM properties. In addition, there was one leasehold termination in the first quarter of 2003 that was partially offset by rent increases from other properties.

Gains on Warehouse Agreements

Net gains on warehouse agreements for the nine months ended September 30, 2004 of $1.4 million consisted of a $0.5 million unrealized gain and a $0.6 million realized gain related to CDO II, with the unrealized portion of this gain representing the change in the fair value of the warehouse arrangement up until July 2004, when the CDO II warehouse terminated. CDO III also had an unrealized gain of $0.3 million at September 30, 2004 related to the change in the fair value of that warehouse arrangement.

Net gains on warehouse agreements for the nine months ended September 30, 2003, consisted of $2.9 million ($1.0 million unrealized and $1.9 million realized) related to CDO I. The CDO I unrealized gain represented the increase in fair value of the warehouse arrangement from January 1, 2003 through August 21, 2003, the day the warehouse was terminated and the underlying securities were transferred into CDO I.

Other

An unrealized loss of approximately $0.4 million was recognized on a short sale of a FNMA security in the third quarter of 2004. No short positions were taken in the third quarter of 2003.

Liquidity and Capital Resources

As of September 30, 2004, we had an unrestricted cash balance of $2.1 million and accrued expenses of $0.3 million. As a REIT, we will be required to distribute at least 90% of our taxable income to our stockholders on an annual basis, and we intend to distribute all or substantially all of our REIT taxable income in order to comply with the distribution requirements of the Internal Revenue Code and to avoid federal income tax and the nondeductible excise tax. We believe that with the proceeds from the Offering, our working capital, secured and unsecured credit facilities that we may have or obtain in the future, and cash provided by operations will be sufficient to allow us to fund the equity portion of our new investments, make distributions necessary to enable us to continue to qualify as a REIT and fund operations for the next 12 months. If our origination and investment activities over the next 12 months are greater than currently anticipated, we may seek to finance these investments either through additional borrowings or by raising equity capital, or both. In the event that we are unable to enter into additional credit facilities, we believe that we will be able to meet our cash requirements for the next twelve months from cash flow from operations and the proceeds of the Offering.

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Our predecessor's debt position and liquidity as of September 30, 2004 should be reviewed in conjunction with the contribution transactions and the other formation transactions entered into in connection with our initial public offering and liquidity position, each as discussed in our prospectus related to our initial public offering, dated October 25, 2004, as filed pursuant to Rule 424(b) of the SEC's rules and regulations. As a result of the contribution transactions and our initial public offering, our debt and liquidity has changed significantly from that of our predecessor at September 30, 2004.

The adjustment to the June 30, 2004 financial statements, as disclosed in Footnote 2 of the September 30, 2004 financial statements, primarily related to a mark to market adjustment to the value of the CDO II warehouse, which is a non-cash item that does not impact the cash flow of our investment in CDO II.

As of September 30, 2004, our predecessor had the following debt outstanding:

				Business Segment				Carrying Amount at 9/30/04 (in thousands)				Carrying Amount at 12/31/03 (in thousands)				Stated Maturity				Interest Rate				Weighted Average Expected Life (years)
Mortgage notes payable (ALGM)(1)				Net lease properties				$	40,899			$	41,881			01/01/2005				5.60%					0.25
Loan payable				CDO				$	17,517				—			07/21/05				LIBOR +1.25%					0.83

(1)

ALGM is uncombined as of September 30, 2004 and December 31, 2003. We acquired the remaining 2.5% managing equity interest, which is also entitled to a special allocation of profits, in ALGM with a portion of the proceeds of the Offering. ALGM will be consolidated in our financial statements subsequent to the Offering. The ALGM mortgage bears interest at the higher of the one-month LIBOR rate or 2% plus 3.60%, or 5.6%, and matures on January 1, 2005. The ALGM mortgage loan agreement includes the following financial covenants and restrictions: (a) ALGM must maintain a debt service coverage ratio in excess of 1.15 to 1, computed using an annual interest rate of 10.09%, and (b) ALGM must establish and maintain certain escrow reserve accounts for, among other things, payment of real estate taxes, capital expenditures and tenant rollover costs.

Additionally, our predecessor has a residual interest in CDO I and II, which, under EITF 99-20, is accounted for by our predecessor as a debt security. The CDO entities are leveraged as follows:

				Business Segment				Carrying Amount at 9/30/04 (in thousands)				Carrying Amount at 12/31/03 (in thousands)				Stated Maturity				Weighted Average Interest Rate				Weighted Average Expected Life (years)
CDO I Bonds(1)				Real estate securities				$	340,280			$	370,549			08/01/2038					6.5	%			7.4
CDO II Bonds(1)				Real estate securities				$	375,947				—			06/01/2039					6.0	%			8.1

(1)	CDO I is uncombined as of September 30, 2004 and December 31, 2003 and the venture will remain uncombined.

(2)	CDO II is uncombined as of September 30, 2004 and the venture will remain uncombined.

On July 21, 2004, NS CDO Holdings II, LLC entered into a financing arrangement with Citigroup Global Markets Inc. ("Citigroup") and originally borrowed $17.4 million, secured by the "BB" rated junior classes of debt securities and unrated income notes of CDO II. The principal amount outstanding is $17.5 million at September 30, 2004. The financing matures on July 21, 2005 and bears interest at LIBOR plus 125 basis points. On November 3, 2004, the Company repaid $7.3 million of the $17.5 million outstanding balance at September 30, 2004.

The terms of CDO I and II's real estate securities are by their nature matched with the terms of its uncombined non-recourse CDO liabilities. These CDO liabilities are repaid from principal payments received on the real estate securities when these payments are actually received. There is no refinancing risk associated with the CDO liabilities, as principal is only due to the extent that it has been collected on the underlying securities investments and the stated maturities are noted above.

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The real estate securities business produces a relatively predictable income stream based on the spread between the interest earned on the securities and the interest paid on the CDO liabilities. This spread may be reduced by credit losses on the securities or by hedging mismatches. CDO I and CDO II have not incurred any losses on any of their securities investments from the date of purchase through September 30, 2004. We receive quarterly cash distributions from CDO I and monthly cash distributions from CDO II, representing our proportionate share of the cash flow from the CDOs, as well as collateral advisory fees.

Our future net leased real estate investments will be financed on a long-term basis and are also expected to produce stable cash flow. Debt securing these properties will be primarily non-recourse and will be repaid primarily from the proceeds of sales or refinancing of the properties. We intend to finance approximately 70% to 80% of the value of these net lease assets. The properties currently held by ALGM are financed with a floating rate loan. The ALGM properties currently produce stable cash flow after debt service. The impact of changes in interest rates are mitigated through the use of interest rate cap agreements. These contracts are entered into as part of our management of interest rate exposure and effectively limit the amount of interest rate risk on ALGM's outstanding indebtedness.

The NSF Venture's subordinate real estate debt investments, as well as direct subordinate debt investments, will typically have maturities of less than five years and may be financed with moderate levels of debt. These investments are not presently subject to any financing, but we may use leverage in the future of approximately 50% to 75% of the value of these investments, on average. We receive monthly cash distributions from the NSF Venture representing our proportionate share of the interest income on the subordinate debt securities. In addition, we receive advisory fees from the NSF Venture and from the NSF Venture Investor for the management of the NSF Venture and certain of the NSF Venture Investor's senior participation and sub-participation interests, respectively. See "Related Party Transactions."

We expect to meet our long-term liquidity requirements, specifically the repayment of debt, and our investment funding needs, through additional borrowings, the issuance of debt and/or equity securities and the liquidation or refinancing of assets at maturity. We believe that the value of the New York property portfolio is, and will continue to be, sufficient to allow us to refinance its related debt at maturity.

On December 21, 2004, we entered into a $150 million master repurchase agreement with Deutsche Bank AG, Cayman Islands Branch to finance our investment in first mortgage loans, B notes, mezzanine loans and rated real estate securities. The agreement has a three-year term and one one-year extension option. Advances under the agreement bear interest at one-month LIBOR plus a spread ranging from 0.75% to 2.25%, which is reset monthly. The master repurchase agreement contains certain covenants, the most restrictive of which, is a requirement that we maintain a minimum tangible net worth, including the minority interest in the operating partnership, of no less than $125 million. As of December 30, 2004 $27.8 million was outstanding under this facility.

We have received a proposal by Citibank N.A. to provide us with a $150 million joint reverse repurchase and secured loan facility, subject to conditions, including Citibank's due diligence and credit and legal approval. We would use such a facility primarily to finance our subordinate real estate debt investments. We would expect such a facility to have a one-year term and a two-year extension option and advance rates to range from 50% to 85% of the collateral value, depending on the characteristics of the pledged assets.

We have committed to contribute approximately $10 million, or 5%, of the total equity commitment of $200 million of NSF Venture. The joint venture was formed to acquire and originate subordinate debt instruments on real estate assets. As of September 30, 2004 we had funded $6.7 million of the $10.0 million commitment.

With respect to our leased real estate assets owned through ALGM, we expect to incur costs of approximately $430,000 for tenant improvements in connection with new tenant leasing costs and capital expenditures during fiscal 2004. We anticipate the sources of funds for such commitment to be

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our working capital and lender reserves. With the contribution of the initial investments to us and the purchase of the remaining 2.5% managing equity interest, which was purchased by us with a portion of the proceeds of the IPO, we now bear the costs, including all capital expenditures and tenant improvements, related to the assets owned by ALGM. 729 Seventh Avenue, one of the ALGM fee properties, is currently in litigation with the net lessee of the property, a subsidiary of NRMI. If this claim is successful, it could result in a total economic loss to us of up to approximately $700,000 in the first year, including damages and lost rent, in addition to the cost of any legal proceedings or negotiations and approximately $650,000 to $850,000 in lost rent annually thereafter unless re-rented on the same terms.

Cash Flow

The net cash flow provided by operating activities increased by $4.2 million for the nine months ended September 30, 2004 to $2.4 million from a use of ($1.8) million for the nine months ended September 30, 2003 primarily due to the increased business activity in the operations of the real estate securities business and the subordinate real estate debt business.

The net cash flow used in investing activities increased by ($15.4) million for the nine months ended September 30, 2004 to ($19.9) million from a use of ($4.5) million for the nine months ended September 30, 2003. Net cash used in investing activities in 2004 consisted primarily of funds used to purchase our interest in the unrated income and the "BB" rated notes of CDO II.

The net cash flow provided by financing activities increased by $11.6 million for the nine months ended September 30, 2004 to $18.6 million from $7.0 million from financing activities for the nine months ended September 30, 2003. The primary sources of cash flow from financing activities in 2004 were loan proceeds to finance CDO II and contributions by owners.

Recent Investment Activity

Subsequent to our initial public offering and NorthStar Capital's simultaneous contribution of our initial portfolio of investments in subordinate real estate debt, real estate securities and net lease properties, we have made the investments described below.

On November 12, 2004, we purchased a $24 million subordinate debt participation from a bank in an $82 million senior mortgage loan secured by a 417,922 square foot, 17 story, class-B office building in New York City. The subordinate debt participation bears interest at LIBOR plus 375 basis points, with $6 million of the principal subject to a LIBOR floor of 1.5% and matures on August 9, 2006. In connection with the purchase of this participation, we received a 1% origination fee. In addition, the borrower has three one-year extension options.

On November 16, 2004, we purchased a $22 million mezzanine loan from a bank which is secured by an equity interest in the borrower that is the owner of nine Embassy Suites hotels with 2,150 rooms. The mezzanine loan bears interest at LIBOR plus 475 basis points and matures on June 9, 2006. In addition, the borrower has three one-year extension options.

On November 19, 2004, we entered into a contract for $63.5 million to purchase a portfolio of three net-leased office properties totaling 257,336 square feet of rentable space in Chatsworth, CA. The properties are net leased to a bank under leases that expire in June 2015. In connection with the contract, we made a deposit of $1.5 million which is non-refundable unless the seller of the properties doesn't meet certain conditions prior to closing.

We have made temporary investments in $1.32 billion of primarily AAA-rated, short-term, floating rate securities which are backed by commercial or residential mortgage loans. These investments have been financed through repurchase agreements with major banks and securities firms whereby we have borrowed approximately $1.27 billion and funded the remaining balance of $51 million in cash. In December 2004, the Company sold $431.9 million of these temporary investments and repaid the associated repurchase agreements with major banks. Our temporary investment strategy is designed to generate sufficient qualifying income during the two-month period before year-end so that it will be able to meet all of the REIT compliance requirements in advance of deploying capital pursuant to our long-term business plan.

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On December 30, 2004, we purchased an approximately $24.8 million subordinate participation interest in a senior mortgage loan secured by a 700,000 square foot hotel located in Miami, Florida that will be converted into residential condominiums. In connection with the purchase, we received a .50% origination fee. The subordinate debt participation initially bears interest at LIBOR plus 560 basis points, decreasing to LIBOR plus 440 basis points after certain principal repayments are made by the borrower. The subordinate participation has an initial maturity of September 14, 2006 and the borrower has the ability to extend the term for one additional year under certain conditions including the payment of a .25% fee.

NSF Venture

On December 11, 2004, the NSF Venture's $7.65 million subordinate loan participation collateralized by a portfolio of multifamily properties in the Pacific Northwest was repaid in full. There were no additional fees associated with the repayment since the yield maintenance period for the loan expired on October 11, 2004. The second extended maturity date for the loan was September 11, 2005.

On December 10, 2004, the borrower under the $9.48 million junior participation in a mezzanine loan collateralized by an office property in northern Florida held by the NSF Venture notified the Company that they would repay the loan in full on January 11, 2005. There will be no additional fees associated with the repayment since the yield maintenance period expired on November 11, 2004. The initial extended maturity date for the loan was August 11, 2005.

Related Party Transactions

Advisory Fee — NorthStar Funding LLC

In 2001, our predecessor entered into an advisory agreement with NorthStar Funding LLC, or the NSF Venture, whereby it receives as compensation for its management of investments of the NSF Venture an advisory fee equal to 1% per annum of the capital invested by the NSF Venture. Additionally, NorthStar Funding Managing Member LLC is entitled to an incentive profit participation equal to 10% of the profit after a minimum required return on the NSF Venture's capital and a return of and on capital based upon the operating performance of the NSF Venture's investments. Prior to the contribution of the initial investments to our operating partnership and the related formation transactions, NorthStar Funding Managing Member LLC received 75% of this incentive profit participation equal to 10% of the profit after a minimum required return on NSF Venture's capital and a return of and on capital based on the operating performance of the NSF Venture's investments. Our predecessor earned and recognized advisory fees from the NSF Venture of approximately $783,000 and $333,000 for the nine months ended September 30, 2004 and 2003, respectively. Our predecessor received profit participation distributions of $120,000 during the nine months ended September 30, 2004. Because such distributions may have to be refunded, no profit participation distributions were recognized as income pursuant to Method 1 of Emerging Issues Task Force Topic D-96.

Advisory Fees — CDO I and II

In August, 2003 and July, 2004, CDO I and II, respectively, entered into agreements with our predecessor, through NS Advisors, to perform certain advisory services. Our predecessor earned total fees of approximately $1,390,000 and $152,000 for the nine months ended September 30, 2004 and 2003, respectively, of which $100,000 and $117,000 is unpaid and included in our predecessor's balance sheets as of September 30, 2004 and December 31, 2003, respectively, as advisory and asset management fee receivable — related party. Our predecessor also earned structuring fees of $500,000 in connection with the closing of both CDO I and II for the nine months ended September 30, 2004 and 2003, which was used to reduce our predecessor's investments in debt securities available for sale.

ALGM

On December 28, 2004, ALGM terminated its existing asset management agreement with Emmes Asset Management Co. LLC ("Emmes"), an affiliate of Northstar Capital. Pursuant to the termination

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provisions of the agreement, ALGM paid Emmes a contractual termination payment of approximately $380,000, which is equal to two quarters of payments of the annual existing fee of $760,000. In addition, ALGM and Emmes entered into a new asset management agreement which is cancelable on 30 days notice by ALGM. The annual asset management fee under the new agreement is equal to 3.5% of gross collections from tenants of the properties not to exceed $350,000 or be less than $300,000 per year, subject to certain provisions.

Contractual Commitments

As of September 30, 2004, our predecessor had the following contractual commitments and commercial obligations:

				Payments Due by Period
Contractual Obligations — Combined Basis				Total				Less than 1 year				1-3 years				3-5 years				After 5 years
Mortgage Debt – ALGM(1)				$	40,899,000			$	40,899,000			$	—			$	—			$	—
Loan payable					17,517,000				17,517,000				—				—				—
Securities sold, not yet purchased					12,944,000				12,944,000				—				—				—
Operating leases					1,053,000				442,000				505,000				106,000				—
Total contractual obligations				$	72,413,000			$	71,802,000			$	505,000			$	106,000			$	—

(1)	ALGM is uncombined as of September 30, 2004. We have purchased the remaining 2.5% managing equity interest, which is also entitled to a special allocation of profits, in ALGM with a portion of the proceeds of the Offering. Accordingly, ALGM will be consolidated in future periods.

Off Balance Sheet Arrangements

As of September 30, 2004, our predecessor had the material off balance sheet arrangements described below:

•	As of September 30, 2004, we had an approximately $9.6 million equity interest in CDO I as described in Note 3 to our predecessor's combined financial statements.

•	As of September 30, 2004, we had an approximately $27.4 million equity interest in CDO II, which closed in July 2004, as described in Note 3 to our predecessor's combined financial statements.

•

In September 2004, NS Advisors entered into a warehouse arrangement with Citigroup in preparation for the securitization of CDO III. We were required to pledge up to $10 million as security for the purpose of covering a portion of any losses or costs associated with the accumulation of these securities under the warehouse agreement. This security is in the form of a pledge of our approximately 83% equity interest in CDO I for acquisitions of securities up to $150 million and cash deposits of up to approximately $5.7 million to cover the accumulation of securities from $150 million to the maximum of $400 million.

Our potential losses in CDO I and II are limited to our predecessor's carrying value of approximately $37.0 million, at September 30, 2004, as reflected in our combined financial statements. At this time, we do not anticipate a substantial risk of incurring a loss with respect to any of these arrangements.

Inflation

Our leases for tenants of ALGM are either:

•	net leases where the tenants are responsible for all real estate taxes, insurance and operating expenses and the leases provide for increases in rent either based on changes in the Consumer Price Index (CPI) or pre-negotiated increases; or

•	operating leases which provide for separate escalations of real estate taxes and operating expenses over a base amount, and/or increases in the base rent based on changes in the CPI.

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We believe that inflationary increases in expenses will generally be offset by the expense reimbursements and contractual rent increases described above to the extent of occupancy.

We believe that the risk that the market interest rates on the floating rate debt of our investments in ALGM, CDO I and CDO II will increase as a result of inflation is largely offset by our strategy of matching the terms of our assets with the terms of our liabilities and through our use of hedging instruments.

Funds From Operations

Management believes that funds from operations, or FFO, is an appropriate measure of performance of a REIT. Although FFO is a non-GAAP measure, we believe it provides useful information to our stockholders, potential investors and management. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income or loss, excluding gains or losses from sales of depreciable properties plus real estate depreciation and amortization, and after adjustments for uncombined partnerships and joint ventures. FFO does not represent cash generated from operating activities in accordance with GAAP and is not indicative of cash available to fund cash needs. FFO should not be considered as an alternative to net income as an indicator of our predecessor's operating performance or as an alternative to cash flow as a measure of liquidity.

Our predecessor's FFO for the three and nine months ended September 30, 2004 and 2003 are as follows:

				Three Months Ended September 30,								Nine Months Ended September 30,
				2004				2003				2004				2003
Net income				$	350,000			$	651,000			$	1,122,000			$	1,296,000
Real estate depreciation and amortization- uncombined ventures					489,000				515,000				1,461,000				1,630,000
Funds from operations				$	839,000			$	1,166,000			$	2,583,000			$	2,926,000

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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the exposure to loss resulting from changes in interest rates and equity prices. We are subject to credit risk and interest rate risk with respect to our investments in subordinate real estate debt and real estate securities. The primary market risk that we are exposed to is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Our interest rate risk sensitive assets, liabilities and related derivative positions are generally held for non-trading purposes.

Subordinate Real Estate Debt

We invest in subordinate real estate debt instruments including mezzanine loans and junior participations in mortgage loans. We generally hold these instruments for investment rather than trading purposes. These investments are either floating or fixed rate. The interest rates on our floating rate investments typically float at a fixed spread over an index such as LIBOR. These instruments typically reprice every 30 days based upon LIBOR in effect at that time. Given the frequent and periodic repricing of our floating rate investments, changes in interest rates are unlikely to affect the value of our floating rate portfolio. Changes in short term rates will, however, affect earnings from our investments. Increases in LIBOR will increase the interest income received by us on our investments and therefore increase our earnings. Decreases in LIBOR have the opposite effect. Over 50% of our subordinate real estate debt portfolio has interest rate floors ranging from 2% to 3%. Therefore, decreases in LIBOR from the rate of 1.78% in effect at September 30, 2004 would have an immaterial effect on our earnings. Increases of 100 or 200 basis points, respectively, in the one month LIBOR rate, above the September 30, 2004 LIBOR rate would have increased our annual income from the NSF Venture for the twelve month period ending September 30, 2004, assuming the same portfolio of loans, by $39,000 and $88,000, respectively, because of the effect of the interest rate floors.

We also make fixed rate investments. The value of these investments may be affected by changes in long-term interest rates. To the extent that long-term interest rates increase, the value of long-term fixed rate assets is diminished. Any fixed rate subordinate debt investments which we hold would be similarly impacted. We do not generally seek to hedge this type of risk unless the asset is leveraged as the costs of such a hedging transaction over the term of such an investment would generally outweigh the benefits. If fixed rate subordinate debt is funded with floating rate liabilities, the funding cost will be fixed through the use of interest rate caps or other hedges. Because the interest rates on our fixed rate investments are generally fixed through maturity of the investment, changes in interest rates do not affect the income we earn from our fixed rate investments.

In our subordinate real estate debt business we are also exposed to credit risk, which is the risk that the borrower under our loan documents cannot repay its obligations to us in a timely manner. While we have never experienced a payment default or even a late payment to date, our subordinate position in the capital structure may expose us to losses as a result of such default in the future. Our rights to control the default or bankruptcy process following a default will vary from transaction to transaction. The subordinate real estate debt that we intend to invest in may not give us the right to demand foreclosure as a subordinate real estate debtholder. To the extent the value of our collateral exceeds the amount of our loan (including all debt senior to us) and the expenses we incur in collecting on our loan, we would collect 100% of our loan amount. To the extent that the amount of our loan plus all debt senior to our position exceeds the realizable value of our collateral, then we would incur a loss. We also incur credit risk in our periodically scheduled interest payments, which may be interrupted as a result of the operating performance of the underlying collateral.

We seek to manage credit risk through a thorough financial analysis of a transaction before we make such an investment. Our analysis is based upon a broad range of real estate, financial, economic and borrower-related factors, which we believe are critical to evaluating the credit risk inherent in a transaction.

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We expect our investments to be denominated in U.S. dollars or, if they are denominated in another currency, to be converted back to U.S. dollars through the use of currency swaps. It may not be possible to eliminate all of the currency risk as the payment characteristics of the currency swap may not exactly match the payment characteristics of the investments.

Real Estate Securities

In our real estate securities business, we mitigate credit risk through credit analysis, subordination and diversification. The commercial mortgage-backed securities we invest in are generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate classes of securities or other form of credit support within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect comparable credit risk. Credit risk refers to each individual borrower's ability to make required interest and principal payments on the scheduled due dates. We believe that these securities offer attractive risk-adjusted returns with reasonable long-term principal protection under a variety of default and loss scenarios. While the expected yield on these securities is sensitive to the performance of the underlying assets, the more subordinated securities and certain other features of a securitization, in the case of mortgage backed securities, and the issuer's underlying equity and subordinated debt, in the case of REIT securities, are designed to bear the first risk of default and loss. CDO I's and CDO II's real estate securities portfolios are diversified by asset type, industry, location and issuer. We further minimize credit risk by actively monitoring CDO I's and CDO II's real estate securities portfolios and the underlying credit quality of their holdings and, where appropriate, liquidating our investments to mitigate the risk of loss.

At September 30, 2004, the real estate securities that serve as collateral for CDO I and CDO II each had an overall weighted average credit rating of approximately BBB- and approximately 73.6% and 73.2%, respectively, of these securities had an investment grade rating (BBB- or higher).

The real estate securities underlying CDO I and CDO II are also subject to spread risk. The majority of these securities are fixed rate securities, which are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the market, as based on their credit relative to U.S. Treasuries. An excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher or "wider" spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value these securities. Under these conditions, the value of our real estate securities portfolio would tend to decrease. Conversely, if the spread used to value these securities were to decrease or "tighten," the value of our real estate securities would tend to increase. Such changes in the market value of our real estate securities portfolio may affect our net equity or cash flow either directly through their impact on unrealized gains or losses on available-for-sale securities by diminishing our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.

Returns on our real estate securities are sensitive to interest rate volatility. If interest rates increase, the funding cost on liabilities that finance the securities portfolio will increase if these liabilities are at a floating rate or have maturities shorter than the assets.

Our general financing strategy focuses on the use of "match-funded" structures, which means that we seek to align the maturities of our debt obligations with the maturities of our investments in order to minimize the risk of being forced to refinance our liabilities prior to the maturities of our assets, as well as to reduce the impact of fluctuating interest rates on earnings. In addition, we generally match interest rates on our assets with like-kind debt, so that fixed rate assets are financed with fixed rate debt and floating rate assets are financed with floating rate debt, directly or through the use of interest rate swaps, caps or other financial instruments or through a combination of these strategies. CDO I and CDO II utilize interest rate swaps to minimize the mismatch between their fixed rate assets and floating rate liabilities. An increase in LIBOR of 100 basis points or 200 basis points over the September 30, 2004 LIBOR rate would have decreased our income from CDO I by $11,000 and $22,000, respectively, on an annualized basis. With respect to CDO II, an increase in LIBOR of 100

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basis points or 200 basis points over the September 30, 2004 LIBOR rate would have decreased our income by $3,000 and $6,000, respectively, on an annualized basis. We expect to hedge the interest rate risk in future CDOs in a similar manner.

Our financing strategy is dependent on our ability to place the match-funded debt we use to finance our real estate securities at spreads that provide a positive arbitrage. If spreads on the bonds issued by CDOs widen or if demand for these liabilities ceases to exist, then our ability to execute future CDO financings will be severely restricted.

Interest rate changes may also impact our net book value as our investments in debt securities are marked-to-market each quarter with changes in fair value reflected in other comprehensive income (a separate component of owners' equity). Generally, as interest rates increase, the value of fixed rate securities within the CDO, such as CMBS, decreases and as interest rates decrease, the value of these securities will increase. These swings in value have a corresponding impact on the value of our investment in the CDO. Within the CDO, we seek to hedge against changes in cash flows attributable to changes in interest rates by entering into interest rate swaps/caps and other derivative instruments as allowed by our predecessor's risk management policy. Such derivatives are designated as cash flow hedge relationships according to SFAS No. 133.

During the warehouse period for CDOs, the market value of the securities in the warehouse is hedged, typically by short selling U.S. Agency (FNMA or FHLMC) debentures or U.S. Treasury securities in the warehouse. Movements in interest rates are expected to result in a price movement for the hedge position that is opposite to and offsets the price movement of the fixed rate securities in the warehouse.

Net Lease Properties

Our ability to manage the interest rate risk and credit risk associated with the assets we acquire will be integral to the success of our net lease properties investment strategy. Although we may, in special situations, finance our purchase of net lease assets with floating rate debt, our general policy will be to mitigate our exposure to rising interest rates by financing our purchases with fixed rate mortgages. We will seek to match the term of fixed rate mortgages to our expected holding period for the underlying asset. Factors we will consider to assess the expected holding period will include, among other things, the primary term of the lease as well as any extension options that may exist.

We expect the credit profiles of our tenants will primarily be unrated and below investment grade. In order to ensure that we have as complete an understanding as possible of a tenant's ability to satisfy its obligations under its lease, we expect to undertake a rigorous credit evaluation of each tenant prior to executing sale/leaseback or net lease asset acquisitions. This analysis will include an extensive due diligence investigation of the tenant's business as well as an assessment of the strategic importance of the underlying real estate to the tenant's core business operations. Where appropriate, we may seek to augment the tenant's commitment to the facility by structuring various protection mechanisms into the underlying leases. These mechanisms could include security deposit requirements or affiliate guarantees from entities we deem to be creditworthy.

ALGM's interest rate cap limits the one-month LIBOR rate applicable to its mortgage debt to no more than 5%. Therefore, a 100 basis point increase in LIBOR would have increased the interest component of our predecessor's debt service by approximately $0.4 million for the year ended December 31, 2003 and $0.3 million for the nine months ended September 30, 2004.

ITEM 4.    CONTROLS AND PROCEDURES

The Company became subject to the periodic and other reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), on October 25, 2004, the effective date of the Company's registration statement relating to its initial public offering. On October 29, 2004, the date of the closing of the Company's initial public offering, an initial portfolio of real estate related investments were contributed to the Company and the Company began operations. The financial statements included in this Quarterly Report on Form 10-Q are for NorthStar Realty Finance Corp.

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Predecessor (the "Predecessor"), a combination of certain controlling and non-controlling interests in real estate-related entities, which represent the initial portfolio of investments that were contributed to the Company subsequent to the quarter ended September 30, 2004.

The Company formed a Disclosure Committee in November 2004 in order to have disclosure controls and procedures that ensure that information required to be disclosed in the Company's filings under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. The Disclosure Committee is currently comprised of all of the Company's executive officers, as well as certain other employees with knowledge of information that may be considered material in the SEC reporting process. The Disclosure Committee has been given the responsibility of developing and assessing the financial and non-financial information to be included in the reports filed by the Company with the SEC and assisting the Company's chief executive officer and chief financial officer in connection with their certifications contained in the Company's SEC reports. The Disclosure Committee will meet and report to the Audit Committee on a quarterly or more frequent basis.

During the course of the Company's review in December 2004 of the Predecessor's financial statements for the three and nine months ended September 30, 2004 to be included in this Form 10-Q, management identified certain deficiencies in the Predecessor's internal controls over financial reporting which include (i) the communication between business unit personnel and financial reporting personnel with respect to the accounting for certain transactions associated with the Predecessor's CDO investments and other Company activity, (ii) the level of training of accounting and financial reporting personnel, and (iii) the level of detailed, quality control review of the Predecessor's financial statements. Taken together, these deficiencies rise to the level of a material weakness in internal controls over financial reporting. Based upon further investigation, the Company discovered certain errors in the accounting for transactions entered into during June and the third quarter of 2004 in connection with the Predecessor's CDO II and in the reporting of allocated general and administrative expenses. These errors required the Company to adjust the Predecessor's financial statements for the six months ended June 30, 2004 as disclosed in Note 2 to the financial statements included in this Form 10-Q.

In addition, during the course of its review of this Form 10-Q and the Predecessor's financial statements to be included herein, the Company's Disclosure Committee determined that the Predecessor's disclosure controls and procedures were not effective at September 30, 2004 to ensure that financial information related to such items was recorded, processed, summarized and reported accurately within the time periods specified in the SEC's rules and forms. The Disclosure Committee reached this conclusion after the Company was apprised by its independent auditors of a number of adjustments to the Predecessor's financial statements for the three and nine months ended September 30, 2004 with respect to the accounting for (1) the reporting of allocated general and administrative expenses and (2) certain transactions associated with the Company's investment in CDO II. The Company's chief executive officer and chief financial officer have evaluated the Predecessor's disclosure controls and procedures at September 30, 2004, the end of the period covered by this Form 10-Q and, as a result of the material weakness identified in the Predecessor's internal controls over financial reporting and the issues that arose during the course of the review in December 2004 of the third quarter 2004 financial statements, have concluded that the Predecessor's disclosure controls and procedures at September 30, 2004 were not effective.

In December 2004, the Company has undertaken a number of initiatives to remedy the weakness discovered in the Predecessor's internal controls over financial reporting so that the Company's disclosure controls and procedures are effective in the future. In this regard, the Company has hired a chief accounting officer who has significant U.S. GAAP and SEC reporting experience, accelerated its search for additional accounting and financial reporting personnel, implemented policies to enhance communication between business unit and financial reporting personnel in order to ensure comprehensive review by management level business unit personnel of the recording of Company transactions, retained an outside accounting firm to review processes and procedures that the Company has adopted in connection with its financial reporting and to assist in the preparation and review of its financial reports and adopted a written policy for the accounting for CDO related

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transactions. The Company is also in the process of reviewing its reporting standards for third party service providers, including its CDO warehouse lender, with the objective of outlining clearer, more comprehensive periodic reporting standards. In addition, the Company will also provide for training of accounting and financial reporting personnel in the nature and type of transactions entered into by each business segment of the Company and the appropriate accounting related thereto. The Company will continue to evaluate the effectiveness of its disclosure controls and procedures and internal controls over financial reporting on an ongoing basis and will take corrective action and implement improvements as appropriate.

Except as noted above, there were no changes in the Company's internal control over financial reporting during the fiscal quarter ended September 30, 2004 that materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

729 7th Avenue Realty Corp. v. 729 Demi-Tasse LLC

On August 21, 2003, 729 7th Avenue Realty Corp., the net lessee of 729 Seventh Avenue and a subsidiary of National Restaurants Management Inc., filed an action against 729 Demi-Tasse LLC, the fee owner of 729 Seventh Avenue and one of our subsidiaries, in New York State Supreme Court, New York County to enforce certain rights it claims to have under its net lease with Demi-Tasse. 729 Seventh Avenue is one of the retail properties in the New York property portfolio in which we have a fee interest.

In its complaint, 729 7th Avenue Realty Corp. sought specific performance of its alleged right to require Demi-Tasse to provide a subordination, non-disturbance and attornment agreement, or an SNDA, to a proposed subtenant so that in the event the net lease is terminated, the proposed sublease would remain in effect. The plaintiff also sought a judgment in the amount of approximately $600,000 for damages 729 7th Avenue Realty Corp. allegedly suffered by reason of Demi-Tasse's refusal to provide the subtenant with SNDA protection.

Demi-Tasse has refused to grant SNDA protection to the subtenant on the grounds that the sublease is configured in such a way so as to extract the most economically desirable portion of the property for the subtenant, an affiliate of 729 7th Realty Corp., rendering the remaining space that would revert to Demi-Tasse upon a termination of the net lease unmarketable. Under the terms of the net lease, Demi-Tasse has no obligation to provide SNDA protection to a proposed sublease where, in Demi-Tasse's discretion, the remaining space would be rendered unmarketable.

On September 18, 2003, Demi-Tasse moved to dismiss the claim for $600,000 in damages on the grounds that the net lease prohibits the recovery of monetary damages that may result from Demi-Tasse's refusal to provide a proposed subtenant with SNDA protection. Demi-Tasse's time to answer the first cause of action was stayed until a decision was rendered on the motion. Demi-Tasse's motion to dismiss the claim for monetary damages was granted on March 29, 2004. Demi-Tasse intends to vigorously oppose 729 7th Realty Corp.'s claim that it has the right to obtain SNDA protection for its subtenant under the current circumstances.

If the claim for SNDA protection is successful, it would result in a total economic loss to us of up to approximately $700,000, including lost rent, leasing commissions and concessions in the first year following the litigation, in addition to the cost of any legal proceedings or negotiations, and up to approximately $650,000 to $850,000 in lost rent annually thereafter unless re-rented on the same terms. ALGM has established a collectibility reserve totaling $2,323,000 as of September 30, 2004 in its financial statements, related to straight-line (unbilled) rents receivable under this lease. However, this reserve may not be adequate to protect ALGM against any loss.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a)    None.

(b)    Pursuant to a registration statement that was declared effective on October 25, 2004 (File No. 333-114675), we registered (i) 20,000,000 shares of our common stock to be sold in an initial public offering through Friedman, Billings, Ramsey & Co., Inc, Deutsche Bank Securities Inc., Credit Suisse First Boston LLC, and JMP Securities LLC, as managing underwriters, and (ii) up to an additional 3,000,000 shares of our common stock to be sold upon the exercise of the underwriters' over-allotment option. The offering price per share was $9.00. We issued 20,000,000 shares of our common stock upon the closing of our initial public offering on October 29, 2004. On November 19, 2004, the underwriters exercised their over-allotment option and we issued an additional 1,160,750 shares of common stock. 21,160,750 shares of common stock were sold before the termination of the offering. The aggregate offering price of our initial public offering was approximately $190.5 million. The underwriters received a discount of approximately $0.63 per share on 20,636,528 of the 21,160,750

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shares issued in our initial public offering, for a total underwriting discount of $13.0 million. On October 29, 2004, we granted 50,000 shares of our common stock to Friedman, Billings, Ramsey & Co., Inc. as partial compensation for its services as an underwriter of our initial public offering. The issuance of these 50,000 shares was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof.

We have incurred offering expenses of approximately $7.3 million. The net offering proceeds of the offering to us, after deducting the underwriting discount and expenses were approximately $170.1 million. The net proceeds were used to pay NorthStar Partnership, L.P. $36.1 million, of which it used approximately $32 million to repay debt associated with our initial investments, repay $7.3 million of an approximately $17.4 million short-term loan payable which was secured by our interest in the unrated income notes of CDO II, purchase the 2.5% minority interest in ALGM for approximately $1.6 million, pay approximately $0.9 million in transfer taxes due in connection with the acquisition of membership interests in ALGM which owns fee and leasehold interests in eight commercial properties located in New York City, use $46 million to make investments in subordinate debt and posted approximately $51 million as collateral for temporary investments of $1.32 billion of primarily AAA-rated, short-term, floating rate securities.

(c)    None.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES.

None.

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

None.

ITEM 5.    OTHER INFORMATION

a)    None

b)    There have been no material changes to the procedures by which stockholders may recommend nominees to our board of directors.

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

a)    Exhibits

Exhibit No.				Description
2.1				Contribution Agreement, dated as of October 29, 2004, by and among NS Advisors Holdings LLC, Presidio Capital Investment Company, LLC and NorthStar Realty Finance Limited Partnership
2.2				Contribution Agreement, dated as of October 29, 2004, by and among NorthStar Partnership, L.P., NorthStar Funding Managing Member Holdings LLC and NorthStar Realty Finance Limited Partnership
2.3				Purchase and Sale Agreement, dated as of October 29, 2004, between NorthStar Realty Finance Limited Partnership and ALGM I Equity, LLC
3.1				Articles of Amendment and Restatement of NorthStar Realty Finance Corp., as filed with the State Department of Assessments and Taxation of Maryland on October 20, 2004 (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
3.2				Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-11 (File No. 333-114675))

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Exhibit No.				Description
4.1				Registration Rights Agreement, dated as of October 29, 2004, by and among NorthStar Realty Finance Corp., NorthStar Partnership, L.P., NorthStar Funding Managing Member Holdings LLC and NS Advisors Holdings LLC
10.1				Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of October 19, 2004, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time
10.2				Non-Competition Agreement, dated as of October 29, 2004, by and among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership, NorthStar Capital Investment Corp. and NorthStar Partnership, L.P.
10.3				Shared Facilities and Services Agreement, dated as of October 29, 2004, by and between NorthStar Realty Finance Corp. and NorthStar Capital Investment Corp.
10.4				Amended, Restated and Consolidated Fee and Leasehold Mortgage, Assignment of Leases and Rents and Security Agreement, dated as of December 4, 2002, by and among 729 Demi-Tasse LLC, 1552 Lonsdale LLC, ALGM Leasehold II LLC, ALGM Leasehold III LLC, ALGM Leasehold VI LLC, ALGM Leasehold VIII LLC, ALGM Leasehold IX LLC, ALGM Leasehold X LLC, ALGM Leasehold XII LLC and Greenwich Capital Financial Products, Inc. (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.5				Executive Employment Agreement, dated as of October 22, 2004, between David T. Hamamoto and NorthStar Realty Finance Corp.
10.6				Executive Employment Agreement, dated as of October 22, 2004, between Mark E. Chertok and NorthStar Realty Finance Corp.
10.7				Executive Employment Agreement, dated as of October 22, 2004, between Jean-Michel Wasterlain and NorthStar Realty Finance Corp.
10.8				Executive Employment Agreement, dated as of October 22, 2004, between Daniel R. Gilbert and NorthStar Realty Finance Corp.
10.9				NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan
10.10				LTIP Unit Vesting Agreement under the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and NRF Employee, LLC
10.11				Form of Vesting Agreement for Units of NRF Employee, LLC, each dated as of October 29, 2004, between NRF Employee, LLC and certain employees and co-employees of NorthStar Realty Finance Corp.
10.12				Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.7(a) to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.13				NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan
10.14				Form of Notification under NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan
10.15				Form of Indemnification Agreement for directors and officers of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-11 (File No. 333-114675))

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Exhibit No.				Description
10.16				Master Repurchase Agreement, dated as of December 21, 2004 between NRFC DB Holdings, LLC and Deutsche Bank AG, Cayman Islands Branch
31.1				Certification of David T. Hamamoto, Chief Executive Officer pursuant to Rule 13a - 14(a)
31.2				Certification of Mark E. Chertok, Chief Financial Officer pursuant to Rule 13a - 14(a)
32.1				Certification of David T. Hamamoto, Chief Executive Officer pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
32.2				Certification of Mark E. Chertok, Chief Financial Officer pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code

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SIGNATURES

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

NORTHSTAR REALTY FINANCE CORP.

Date:    December 30, 2004

By:    /s/ David T. Hamamoto   Name: David T. Hamamoto Title: Chief Executive Officer

By:    /s/ Mark E. Chertok   Name: Mark E. Chertok Title: Chief Financial Officer

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EXHIBIT INDEX

Exhibit No.				Description
2.1				Contribution Agreement, dated as of October 29, 2004, by and among NS Advisors Holdings LLC, Presidio Capital Investment Company, LLC and NorthStar Realty Finance Limited Partnership
2.2				Contribution Agreement, dated as of October 29, 2004, by and among NorthStar Partnership, L.P., NorthStar Funding Managing Member Holdings LLC and NorthStar Realty Finance Limited Partnership
2.3				Purchase and Sale Agreement, dated as of October 29, 2004, between NorthStar Realty Finance Limited Partnership and ALGM I Equity, LLC
3.1				Articles of Amendment and Restatement of NorthStar Realty Finance Corp., as filed with the State Department of Assessments and Taxation of Maryland on October 20, 2004 (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
3.2				Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
4.1				Registration Rights Agreement, dated as of October 29, 2004, by and among NorthStar Realty Finance Corp., NorthStar Partnership, L.P., NorthStar Funding Managing Member Holdings LLC and NS Advisors Holdings LLC
10.1				Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of October 19, 2004, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time
10.2				Non-Competition Agreement, dated as of October 29, 2004, by and among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership, NorthStar Capital Investment Corp. and NorthStar Partnership, L.P.
10.3				Shared Facilities and Services Agreement, dated as of October 29, 2004, by and between NorthStar Realty Finance Corp. and NorthStar Capital Investment Corp.
10.4				Amended, Restated and Consolidated Fee and Leasehold Mortgage, Assignment of Leases and Rents and Security Agreement, dated as of December 4, 2002, by and among 729 Demi-Tasse LLC, 1552 Lonsdale LLC, ALGM Leasehold II LLC, ALGM Leasehold III LLC, ALGM Leasehold VI LLC, ALGM Leasehold VIII LLC, ALGM Leasehold IX LLC, ALGM Leasehold X LLC, ALGM Leasehold XII LLC and Greenwich Capital Financial Products, Inc. (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.5				Executive Employment Agreement, dated as of October 22, 2004, between David T. Hamamoto and NorthStar Realty Finance Corp.
10.6				Executive Employment Agreement, dated as of October 22, 2004, between Mark E. Chertok and NorthStar Realty Finance Corp.
10.7				Executive Employment Agreement, dated as of October 22, 2004, between Jean-Michel Wasterlain and NorthStar Realty Finance Corp.

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Exhibit No.				Description
10.8				Executive Employment Agreement, dated as of October 22, 2004, between Daniel R. Gilbert and NorthStar Realty Finance Corp.
10.9				NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan
10.10				LTIP Unit Vesting Agreement under the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and NRF Employee, LLC
10.11				Form of Vesting Agreement for Units of NRF Employee, LLC, each dated as of October 29, 2004, between NRF Employee, LLC and certain employees and co-employees of NorthStar Realty Finance Corp.
10.12				Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.7(a) to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.13				NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan
10.14				Form of Notification under NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan
10.15				Form of Indemnification Agreement for directors and officers of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.16				Master Repurchase Agreement, dated as of December 21, 2004 between NRFC DB Holdings, LLC and Deutsche Bank AG, Cayman Islands Branch
31.1				Certification of David T. Hamamoto, Chief Executive Officer pursuant to Rule 13a - 14(a)
31.2				Certification of Mark E. Chertok, Chief Financial Officer pursuant to Rule 13a - 14(a)
32.1				Certification of David T. Hamamoto, Chief Executive Officer pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code
32.2				Certification of Mark E. Chertok, Chief Financial Officer pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code

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