AMERICAN REALTY INVESTORS INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTER ENDED MARCH 31, 2004

Commission File Number 1-15663

AMERICAN REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its Charter)


Nevada		75-2847135
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

1800 Valley View Lane, Suite 300, Dallas, Texas		75234
(Address of Principal Executive Offices)		(Zip Code)

(469) 522-4200

(Registrant’s Telephone Number, Including Area Code)

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.


Common Stock, $.01 par value		10,618,600
(Class)		(Outstanding at May 12, 2004)*

*	Does not include 746,972 shares issued to and owned by Transcontinental Realty Investors, Inc.

AMERICAN REALTY INVESTORS, INC.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants, but, in the opinion of the management of American Realty Investors, Inc. (“ARI”), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of consolidated results of operations, consolidated financial position and consolidated cash flows at the dates and for the periods indicated, have been included.

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS


	March 31, 2004			December 31, 2003
	(dollars in thousands, except per share)
Assets
Real estate held for investment	$	1,056,860		$	1,015,385
Less—accumulated depreciation		(178,587	)		(173,453	)

		878,273			841,932

Real estate held for sale		164,118			212,104

Notes and interest receivable
Performing ($37,083 in 2004 and $37,697 in 2003 from affiliates)		66,650			64,296
Nonperforming		10,932			10,932

		77,582			75,228
Less—allowance for estimated losses		(4,633	)		(4,633	)

		72,949			70,595

Pizza parlor equipment		12,688			12,237
Less—accumulated depreciation		(5,684	)		(5,385	)

		7,004			6,852

Marketable equity securities, at market value		5,772			5,020
Cash and cash equivalents		8,150			9,543
Investments in equity investees		5,628			4,987
Goodwill, net of accumulated amortization ($1,763 in 2004 and 2003)		11,858			11,858
Other intangibles, net of accumulated amortization ($834 in 2004 and $822 in 2003)		1,517			1,529
Other assets ($13,730 in 2004 and $8,098 in 2003 from affiliate)		74,964			75,761

	$	1,230,233		$	1,240,181

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS—Continued


	March 31, 2004			December 31, 2003
	(dollars in thousands, except per share)
Liabilities and Stockholders’ Equity
Liabilities
Notes and interest payable ($36,611 in 2004 and $34,775 in 2003 to affiliates)	$	857,821		$	886,615
Liabilities related to assets held for sale		120,153			100,154
Margin borrowings		20,747			21,194
Accounts payable and other liabilities ($2,795 in 2004 and $2,934 in 2003 to affiliates)		92,881			96,360

		1,091,602			1,104,323

Minority interest		59,804			60,178

Commitments and contingencies

Stockholders’ equity
Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding
Series A, 3,475,370 shares in 2004 and 3,225,370 shares in 2003 (liquidation preference $32,254), including 900,000 shares in 2004 and 2003 held by subsidiaries		5,151			4,651
Series E, 50,000 shares in 2004 and 2003 (liquidation preference $500)		100			100
Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,392,272 shares in 2004 and 2003		114			114
Paid-in capital		93,814			92,464
Treasury stock, at cost, 752,072 shares in 2004 and 746,972 shares in 2003		(9,966	)		(9,924	)
Accumulated deficit		(10,981	)		(11,826	)
Accumulated other comprehensive income		595			101

		78,827			75,680

	$	1,230,233		$	1,240,181

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS


	For the Three Months Ended March 31,
	2004			2003
	(dollars in thousands, except per share)
Property revenue
Rents ($321 in 2004 and $447 in 2003 from affiliates)	$	49,273		$	18,117
Property operations expenses ($900 in 2004 and $213 in 2003 to affiliates)		32,958			13,812

Operating income		16,315			4,305

Land operations
Sales		30,194			8,785
Cost of sales		21,283			8,711
Deferral of gains on current period sales		5,159			—
Recognition of previously deferred gains		—			19,897

Gain on land sales		3,752			19,971

Pizza parlor operations
Sales		8,169			7,867
Cost of sales		6,213			6,407

Gross margin		1,956			1,460

Income from operations		22,023			25,736

Other income (loss)
Interest income ($688 in 2004 and $890 in 2003 from affiliates)		1,049			2,230
Equity in loss of investees		(145	)		(4,339	)
Other		627			8

		1,531			(2,101	)

Other expenses
Interest ($642 in 2004 and $520 in 2003 to affiliates)		19,675			9,531
Depreciation and amortization		7,864			1,982
Discount on sale of notes receivable		398			1,558
General and administrative ($857 in 2004 and $972 in 2003 to affiliates)		4,634			3,308
Advisory fee to affiliate		2,852			2,028
Net income fee to affiliate		79			452
Incentive fee to affiliate		—			261
Minority interest		1,184			550

		36,686			19,670

Net income (loss) from continuing operations		(13,132	)		3,965

Discontinued operations:
Income (loss) from operations		(740	)		213
Gain on sale of real estate		13,934			3,013
Equity in gain on sale of real estate by equity investees		783			—

Net income from discontinued operations		13,977			3,226

Net income		845			7,191
Preferred dividend requirement		(650	)		(588	)

Net income applicable to Common shares	$	195		$	6,603

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS—Continued


	For the Three Months Ended March 31,
	2004			2003
	(dollars in thousands, except per share)
Basic earnings per share
Net income (loss) from continuing operations	$	(1.29	)	$	.30
Discontinued operations		1.31			.28

Net income applicable to Common shares	$	.02		$	.58

Diluted earnings per share
Net income (loss) from continuing operations	$	(1.29	)	$	.23
Discontinued operations		1.31			.22

Net income applicable to Common shares	$	.02		$	.45

Weighted average Common shares used in computing earnings per share:
Basic		10,644,666			11,375,127
Diluted		10,644,666			14,522,530

Convertible Preferred Stock (2,575,370 shares) and options to purchase 101,250 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three months ended March 31, 2004, because the effect of their inclusion would be antidilutive.

Options to purchase 105,750 shares of ARI’s Common Stock were excluded from the computation of diluted earnings per share for the three months ended March 31, 2003, because of the effect of their inclusion would be antidilutive.

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Nine Months Ended March 31, 2004


	Series A Preferred Stock		Series E Preferred Stock		Common Stock		Paid-in Capital			Treasury Stock			Accumulated Deficit			Accumulated Other Comprehensive Income/(Loss)		Stockholders’ Equity
	(dollars in thousands, except per share)
Balance, January 1, 2004	$	4,651	$	100	$	114	$	92,464		$	(9,924	)	$	(11,826	)	$	101	$	75,680

Comprehensive income
Unrealized gain on foreign currency translation		—		—		—		—			—			—			97		97
Unrealized gain on marketable securities		—		—		—		—			—			—			397		397
Net income		—		—		—		—			—			845			—		845

																			1,339

Repurchase of Common Stock		—		—		—		—			(42	)		—			—		(42	)

Issuance of Preferred Stock		500		—		—		2,000			—			—			—		2,500

Preferred dividends
Series A Preferred Stock ($.25 per share)		—		—		—		(642	)		—			—			—		(642	)
Series E Preferred Stock ($.15 per share)		—		—		—		(8	)		—			—			—		(8	)

Balance, March 31, 2004	$	5,151	$	100	$	114	$	93,814		$	(9,966	)	$	(10,981	)	$	595	$	78,827

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


	For the Three Months Ended March 31,
	2004			2003
	(dollars in thousands)
Cash Flows From Operating Activities
Net income	$	845		$	7,191
Reconciliation of net income to net cash provided by (used in) operating activities
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Gain on sale of land and real estate		(18,469	)		(22,984	)
Depreciation and amortization		8,232			2,566
Amortization of deferred borrowing costs		1,832			1,105
Discount on sale of notes receivable		398			1,558
Equity in loss of investees		145			4,339
(Increase) decrease in accrued interest receivable		1,496			(1,099	)
(Increase) decrease in other assets		3,994			(1,271	)
Increase (decrease) in accrued interest payable		(625	)		766
Increase (decrease) in accounts payable and other liabilities		9,300			(437	)
Increase (decrease) in minority interest		324			(32	)

Net cash provided by (used in) operating activities		7,472			(8,298	)

Cash Flows From Investing Activities
Collections on notes receivable		39			9,304
Proceeds from sale of notes receivable		6,227			26,346
Acquisition of real estate		(19,943	)		—
Pizza parlor equipment purchased		(467	)		(767	)
Proceeds from sale of real estate		64,442			27,172
Notes receivable funded		(65	)		—
Earnest money/escrow deposits		(2,325	)		(34	)
Investment in real estate entities, net of cash acquired		—			(22,417	)
Short-term advances funded		—			(24,723	)
Real estate improvements		(55,836	)		(1,308	)
Purchase of marketable securities		(321	)		—
Distribution from equity investees		4			—

Net cash (used in) provided by investing activities		(8,245	)		13,573

Cash Flows From Financing Activities
Proceeds from notes payable		129,181			42,494
Payments on notes payable		(126,661	)		(37,912	)
Deferred borrowing costs		(2,934	)		(1,555	)
Net advances from (payments to) affiliates		933			(7,413	)
Repurchase of Common Stock		(42	)		—
Margin borrowings (payments), net		(447	)		—
Preferred dividends paid		(650	)		(581	)

Net cash used in financing activities		(620	)		(4,967	)

Net increase (decrease) in cash and cash equivalents		(1,393	)		308

Cash and cash equivalents, beginning of period		9,543			8,432

Cash and cash equivalents, end of period	$	8,150		$	8,740

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

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued


	For the Three Months Ended March 31,
	2004		2003
	(dollars in thousands)
Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$	17,652	$	9,610

Schedule of noncash investing and financing
Notes payable assumed by buyer on sale of real estate	$	9,014	$	3,439
Notes receivable from sale of real estate		10,448		19,178
Disposal of property to satisfy debt		—		8,050
Issuance of Preferred Stock		2,500		—
Note payable paid by affiliate		10,823		—
Refinancing proceeds received by affiliate		10,962		—

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

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

The accompanying Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Dollar amounts in tables are in thousands, except per share amounts. Certain balances for 2003 have been reclassified to conform to the 2004 presentation. Hereafter in this document, American Realty Investors, Inc. is referred to as ARI.

Operating results for the three month period ended March 31, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the Consolidated Financial Statements and Notes thereto included in ARI’s Annual Report on Form 10-K for the year ended December 31, 2003 (the “2003 Form 10-K”).

On November 15, 2002, ARI, through wholly-owned subsidiaries, commenced a tender offer for the common shares of Transcontinental Realty Investors, Inc. (“TCI”) and Income Opportunity Realty Investors, Inc. (“IORI”) not already owned by ARI. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock of non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares.

After the tender offer, ARI subsidiaries owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI subsidiaries and 15.6% through TCI’s ownership of IORI shares). ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. Through June 30, 2003, ARI had the same advisor as TCI and IORI, and TCI and IORI had the same board of directors. At March 31, 2004, ARI and TCI have the same advisor and Board of Directors. One Director of ARI (Ted Stokely) also serves as a Director of IORI.

On June 2, 2003, ARI subsidiaries exchanged all of their 674,971 IORI shares with Basic Capital Management, Inc. (“BCM”), receiving 650,000 TCI shares from BCM. In addition, BCM executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. “NOTES AND INTEREST RECEIVABLE”). After the exchange, ARI subsidiaries owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. “NOTES AND INTEREST RECEIVABLE”). After the transaction, ARI subsidiaries owned 76.8% of the outstanding shares of TCI. In December 2003, ARI subsidiaries purchased 88,600 TCI shares in market transactions and 204,633 TCI shares in transactions with related parties for a total of $1.4 million. At December 31, 2003 and March 31, 2004, ARI subsidiaries owned 80.0% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At December 31, 2003 and March 31, 2004, ARI subsidiaries owned 19.2% of IORI through TCI’s ownership of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

Effective July 1, 2003, Prime Asset Management, Inc. (“PAMI”) became the advisor to ARI and TCI. PAMI is owned by Realty Advisors, Inc. (“Realty Advisors”) (79%) and Syntek West, Inc. (“Syntek West”) (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc. (“PIAMI”). On October 1, 2003, Prime Income Asset Management, LLC (“Prime”), which is 100% owned by PIAMI, replaced PIAMI as the advisor to ARI and TCI.

The following pro forma information reflects the results of operations for ARI as though the consolidation of TCI’s operations had begun on January 1 of 2003.


	Three Months Ended March 31, 2003
Revenue, as reported	$	34,769
Revenue, pro forma		59,230

Net income, as reported		7,191
Net income, pro forma		6,258

Earnings per share:
Basic, as reported	$	.58
Basic, pro forma	$	.53

Diluted, as reported	$	.45
Diluted, pro forma	$	.41

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 1. BASIS OF PRESENTATION (Continued)

Stock-based employee compensation. Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” and related Interpretations are utilized by management in accounting for the option plans. All share options issued have exercise prices equal to the market price of the shares at the dates of grant. Accordingly, no compensation cost has been recognized for the option plans. Had compensation cost for the option plans been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation,” net income (loss) and net income (loss) per share would have been the pro forma amounts indicated below.


	Three Months Ended March 31,
	2004		2003
Net income applicable to common shares, as reported	$	195	$	6,603

Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects		22		19

Pro forma net income applicable to common shares	$	173	$	6,584

Earnings per share:
Basic, as reported	$	.02	$	.58
Basic, pro forma	$	.02	$	.58

Diluted, as reported	$	.02	$	.45
Diluted, pro forma	$	.02	$	.45

NOTE 2. REAL ESTATE

In 2004, ARI purchased the following property:


Property	Location	Units/Acres	Purchase Price		Net Cash Paid/ (Received)			Debt Incurred		Interest Rate		Maturity Date
*First Quarter*
Apartments
288 City Park⁽¹⁾	Houston, TX	240 Units	$	3,056	$	612		$	2,444	5.95	%	04/45
Blue Lake Villas II⁽¹⁾	Waxahachie, TX	70 Units		729		(164	)		729	5.80		04/45
Bridges on Kinsey⁽¹⁾	Tyler, TX	232 Units		2,291		596			1,687	5.74		08/45
Dakota Arms⁽¹⁾	Lubbock, TX	208 Units		2,472		681			1,791	5.85		06/45
Lake Forest⁽¹⁾	Houston, TX	240 Units		2,316		(470	)		2,316	5.60		03/45
Vistas of Vance Jackson⁽¹⁾	San Antonio, TX	240 Units		3,550		771			2,779	5.78		06/45
Land
Lubbock land	Lubbock, TX	2.9 Acres		224		224			—	—		—
Meloy Road	Kent, OH	54.2 Acres		4,900		343			4,900	5.00	⁽²⁾	01/06
Railroad land	Dallas, TX	.3 Acres		708		704			—	—		—

*Second Quarter*
Apartments
Wildflower Villas⁽¹⁾	Temple, TX	220 Units		2,045		79			1,966	—		—

Land
Rogers land ⁽¹⁾	Rogers, AR	20.1 Acres		1,390		506			1,130	10.50		04/05

⁽¹⁾	Land purchased for apartment construction.

⁽²⁾	Variable interest rate.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

In 2003, ARI purchased the following property:

Property

Location

Units

Purchase

Price

Net Cash
Paid

Debt
Incurred

Interest
Rate

Maturity
Date

First Quarter

Apartments

Capitol Hill⁽¹⁾

Little Rock, AR

156 Units

1,904

615

1,289

5.50

10/44

⁽¹⁾	Land purchased for apartment construction.

In 2004, ARI sold the following property:


Property	Location	Units/Sq. Ft./ Acres	Sales Price		Net Cash Received		Debt Discharged			Gain on Sale
*First Quarter*
Apartments
Tiberon Trails	Merrillville, IN	376 Units	$	10,325	$	2,618	$	6,189	⁽¹⁾	$	48

Shopping Centers
Countryside Harmon	Sterling, VA	72,062 Sq. Ft.		2,650		216		2,200			1,861
Countryside Retail	Sterling, VA	133,422 Sq. Ft.		27,100		3,407		22,800			6,807
Plaza on Bachman Creek	Dallas, TX	80,278 Sq. Ft.		7,850		1,808		5,358			3,682

Land
Allen	Collin County, TX	492.5 Acres		19,962		7,956		4,088			7,915	⁽²⁾
Mason Goodrich	Houston, TX	5.7 Acres		686		45		588			379
Mason Goodrich	Houston, TX	8.0 Acres		1,045		248		200			617
Red Cross	Dallas, TX	2.9 Acres		8,500		2,842		4,450			—

Industrial Warehouse
Kelly (Pinewood)	Dallas, TX	100,000 Sq. Ft.		1,650		65		1,376			153
Ogden Industrial	Ogden, UT	107,112 Sq. Ft.		2,600		668		1,775			1,474
Texstar Warehouse	Arlington, TX	97,846 Sq. Ft.		2,400		—		1,148	⁽¹⁾		1,157	⁽³⁾

Shopping Center
K-Mart	Cary, NC	92,033 Sq. Ft.		3,200		—		1,677	⁽¹⁾		521	⁽³⁾

*Second Quarter*
Office Building
Atrium	Palm Beach, FL	74,603 Sq. Ft.		5,775		1,667		3,750			740

⁽¹⁾	Debt assumed by purchaser.

⁽²⁾	Includes deferred gain of $5.2 million. A portion of the land was sold on a contingent basis for a note receivable of $7.2 million. See Note 3. “NOTES AND INTEREST RECEIVABLE.”

⁽³⁾

Property sold to BCM, a related party, for assumption of debt and a note receivable. See Note 3. “NOTES AND INTEREST RECEIVABLE.” Gain deferred until sale to unrelated party. Failure to notify and receive approval from the lender for this transaction may constitute an event of default under the terms of the debt.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

In 2003, ARI sold the following properties:


Property	Location	Units/Sq.Ft./ Acres/Rooms	Sales Price		Net Cash Received/ (Paid)			Debt Discharged			Gain/ (Loss) on Sale
*First Quarter*
Apartments
Bay Anchor	Panama City, FL	12 Units	$	369	$	—		$	291		$	174
Georgetown	Panama City, FL	44 Units		1,175		323			789	⁽²⁾		72
Northside Villas	Tallahassee, FL	81 Units		5,575		1,806			2,784			915
Rolling Hills	Tallahassee, FL	134 Units		5,061		1,361			2,785			1,182
Seville	Tallahassee, FL	62 Units		2,795		—			2,360			697

Shopping Centers
Bridgeview Plaza	LaCrosse, WI	116,008 Sq. Ft.		8,700		—			—			8,700	⁽¹⁾
Cullman	Cullman, AL	92,466 Sq. Ft.		2,000		—			2,650	⁽²⁾		1,118	⁽¹⁾

Land
Katrina	Palm Desert, CA	89.3 Acres		8,550		(410	)		2,800			(40	)
Nashville	Nashville, TN	8.8 Acres		235		(11	)		217			114

Hotel
Grand Hotel Sofia	Sofia, Bulgaria	136 Rooms		24,750		6,258			4,209	⁽²⁾		(31	)⁽³⁾

(1)	Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.

(2)	Debt assumed by purchaser.

(3)	Includes recognition of $3.1 million of accumulated foreign currency translation gains.

At March 31, 2004, ARI had the following properties under construction:


Property	Location	Units	Amount Expended		Additional Amount to Expend		Construction Loan Funding
Apartments
288 City Park	Houston, TX	240 Units	$	4,748	$	11,939	$	15,005
Blue Lake Villas II	Waxahachie, TX	70 Units		407		4,264		4,234
Bluffs at Vista Ridge	Lewisville, TX	272 Units		8,423		12,162		15,500
Breakwater Bay	Beaumont, TX	176 Units		7,701		2,765		9,545
Bridges on Kinsey	Tyler, TX	232 Untis		1,643		14,437		14,477
Capitol Hill	Little Rock, AR	156 Units		9,029		1,550		9,500
Dakota Arms	Lubbock, TX	208 Units		1,930		12,007		12,549
Kingsland Ranch	Houston, TX	398 Units		21,925		3,729		23,000
Lake Forest	Houston, TX	240 Units		3,230		11,207		12,815
Vistas at Pinnacle Park	Dallas, TX	322 Units		17,529		3,652		19,149
Vistas of Vance Jackson	San Antonio, TX	240 Units		3,044		15,058		16,056

For the three months ended March 31, 2004, ARI completed the 248 unit DeSoto Ranch Apartments in DeSoto, Texas, the 314 unit Verandas at Cityview Apartments in Fort Worth, Texas and the 216 unit Mariposa Villas (Echo Valley) in Dallas, Texas.

NOTE 3. NOTES RECEIVABLE

In March 2004, ARI sold an 8.0 acre tract of its Mason Goodrich land parcel for $1.0 million, receiving $248,000 after payment of closing costs and providing purchase money financing of $523,000. The loan bears interest at 10.0% per annum, requires monthly payments of accrued interest and matures in March 2006. All principal and accrued but unpaid interest is due at maturity.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

In March 2004, ARI sold 492.5 acres in Collin County, Texas to a third party for $20.0 million. ARI provided $7.2 million of the purchase price as seller financing for a portion of the land on a contingent basis. The note bears interest at 7.0% and matures in September 2004. The buyer has the option to convey the contingent land back to ARI for cancellation of the note. The purchaser also has the option to extend the note to December 2004 with a $1.1 million extension payment prior to the maturity date.

In June 2003, ARI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million and provided $42,000 of the purchaser’s closing costs as seller financing. The note bears interest at a fixed rate of 5% and requires all interest and principal payments be paid at maturity on December 2003. This loan was extended until February 2004 and $10,000 was received in March 2004. Current negotiations are ongoing to extend the loan or collect payment.

In July 2003, an unsecured loan of $22,000 was made to an individual. The note bears interest at a fixed rate of 12% and requires all interest and principal payments be paid at maturity in January 2004. This note, including accrued and unpaid interest, was paid in full in March 2004.

In August 2001, ARI agreed to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bears interest at a variable rate, currently 9.0% per annum, requires monthly interest only payments and matured in January 2003. As of September 2003, ARI has funded a total of $4.3 million and the note is classified as nonperforming. The collateral used to secure ARI’s second lien was seized by the first lien holder. On March 11, 2004, ARI agreed to accept an assignment of claims in litigation as security for the note. ARI is also working on securing additional collateral for this note and restructuring the terms of the note but a new agreement has not been reached. The current agreement requires interest to accrue at the default rate of 18.0%.

In March 2002, ARI sold the 174,513 sq.ft. Hartford Office Building in Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien mortgage note. The note bears interest at a variable interest rate, currently 6.0% per annum, requires monthly interest only payments of $14,667 and matures in March 2007. As of March 2004, ARI funded $354,000 of the additional line of credit.

In July 2002, ARI entered into an agreement to fund up to $300,000 under a revolving line of credit secured by 100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum and requires monthly interest only payments, and matures in June 2005. As of March 2004, ARI has funded $300,000 of the line of credit.

In September 2003, ARI sold a 367.4 acre tract of its Pioneer Crossing land parcel for $22.5 million, receiving $4.9 million after payment of closing costs and providing purchase money financing of $16.9 million. The note bears interest at 8.0% per annum, matures in September 2006 and requires quarterly payments of accrued interest beginning in January 2004. All principal and accrued but unpaid interest are due at maturity. In November 2003, ARI sold an interest in $8.0 million of the note for $7.5 million, receiving $7.2 million in cash after payment of closing costs and debt paydown. In February 2004, ARI sold an additional interest in $6.6 million of the note for $6.3 million, receiving $6.3 million in cash after payment of closing costs.

In September 1999, in conjunction with the sale of two apartments in Austin, Texas, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required monthly payments of interest only at 6.0% per annum, beginning in February 2000 and required a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option of obtaining the buyer’s general and limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note and released one of the partnership interests, in exchange for a payment of $250,000 and executed deeds of trusts on certain properties owned by the buyer. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust. The borrower executed a replacement promissory note for the remaining note balance of $1.0 million, which was unsecured, non-interest bearing and matured in April 2003. In April 2004, a demand letter was sent to the debtor.

Related Party. In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco. A wholly-owned subsidiary of One Realco owns approximately 2.1% of the outstanding shares of ARI’s Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bore interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM, receiving 314,141 TCI shares from BCM (see NOTE 1. “BASIS OF PRESENTATION.”) In February 2004, $2.3 million in interest was collected, accrued but unpaid interest of

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

$161,000 was added to the principal, the maturity date was extended to February 2007, and the interest rate was changed to 2.0% over the prime rate, currently at 6.0%. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. Mr. Kimbrough does not participate in the day-to-day operations or management of One Realco.

In March 2004, ARI sold a K-Mart in Cary, North Carolina to BCM for $3.2 million, including the assumption of debt. ARI also provided $1.5 million of the purchase price as seller financing. The note bears interest at 2.0% over the prime rate, currently 6.0%, and matures in April 2005.

In March 2004, ARI sold the Texstar Warehouse in Arlington, Texas to BCM for $2.4 million, including the assumption of debt. ARI also provided $1.3 million of the purchase price as seller financing. The note bears interest at 2.0% over prime rate, currently 6.0%, and matures in April 2005.

NOTE 4. INVESTMENTS IN EQUITY INVESTEES

Real estate entities. Before 2003, ARI’s investment in real estate entities included equity securities of IORI and TCI, and interests in real estate joint venture partnerships. Prime, ARI’s advisor after June 30, 2003, serves as advisor to TCI.

Through March 31, 2003, ARI accounted for its investment in IORI and TCI and the joint venture partnerships using the equity method. ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003. See NOTE 1. “BASIS OF PRESENTATION.”

ARI’s investment in real estate entities, accounted for using the equity method, at March 31, 2004, was as follows:


Investee	Percentage of ARI’s Ownership at March 31, 2004		Carrying Value of Investment at March 31, 2004		Market Value of Investment at March 31, 2004
IORI	19.2	%	$	5,062	$	5,376
Other				566

			$	5,628

Set forth below are summarized results of operations of equity investees for the three months ended March 31, 2004:


	2004
Revenues	$	2,914
Property operating expenses		(2,064	)
Depreciation		(347	)
Interest		(1,097	)

Loss before gain on sale of real estate		(594	)
Gain on sale of real estate		3,257

Net income	$	2,663

ARI’s share of equity investees’ loss before gains on the sale of discontinued operations was $145,000 for the three months ended March 31, 2004. ARI’s share of equity investees’ gain on sale of real estate was $783,000 for the three months ended March 31, 2004.

ARI’s cash flow from IORI is dependent on the ability of IORI to make distributions. In the fourth quarter of 2000, IORI suspended distributions.

NOTE 5. MARKETABLE EQUITY SECURITIES

Since 1994, ARI has been purchasing equity securities of entities other than those of IORI and TCI to diversify and increase the liquidity of its margin accounts. Trading and available-for-sale portfolio securities are carried at market value. In the first quarter of 2004, ARI purchased $321,000 of marketable securities. No securities were sold. At March 31, 2004, ARI recognized an unrealized increase in the market value of its trading portfolio securities of $34,000. Unrealized and realized gains and losses on trading portfolio securities are included in other income in the accompanying Consolidated Statements of Operations. Also at March 31, 2004, ARI

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

recorded an unrealized increase in the market value of its available-for-sale portfolio securities of $397,000. Unrealized gains and losses on available-for-sale portfolio securities are included in accumulated other comprehensive income in the accompanying Consolidated Balance Sheets.

NOTE 6. NOTES PAYABLE

In February 2004, the Brandeis office building was returned to the lender via a Deed in Lieu of Foreclosure process. The outstanding debt and accrued interest was $8.8 million. ARI recorded a net impairment of $4.4 million in the fourth quarter of 2003 for this transaction.

In February 2003, the lender on one of ARI’s hotel properties located in Virginia and three hotel properties in Chicago notified ARI that the loans on the properties were in default, due to ARI’s failure to make timely debt service payments. The balance owed on the loans was $21.2 million. In April 2003, the lender and ARI agreed to terms to cure the default and extend the maturity dates of the loans. In May 2003, ARI failed to satisfy the conditions in the lender’s Loan Modification Offer (the “Offer”), and the Offer was revoked. In March 2004, ARI paid off these loans through other refinancings.

In 2004, ARI financed/refinanced or obtained second mortgage financing on the following:


Property	Location	Sq.Ft./Rooms/ Acres	Debt Incurred		Debt Discharged		Net Cash Received/(Paid)			Interest Rate		Maturity Date
Hotel
Williamsburg Hospitality House	Williamsburg, VA	296 Rooms	$	11,500	$	12,332	$	(13,689	)⁽³⁾	7.00	%⁽¹⁾	03/05

Office Building
Centura Tower	Farmers Branch, TX	410,901 Sq. Ft.		34,000		36,889		(4,588	)	5.50	⁽¹⁾	04/06

Land
Centura	Farmers Branch, TX	8.8 Acres		4,485		4,000		(183	)	7.00	⁽¹⁾	11/04
Dominion/Hollywood	Farmers Branch, TX	66.1 Acres		6,985		6,222		(67	)	7.00	⁽¹⁾	02/05
Katy	Harris County, TX	130.6 Acres		7,500		—		18		6.00		02/07
Marine Creek ⁽²⁾	Ft. Worth, TX	54.0 Acres		1,286		991		192		5.75		06/05

⁽¹⁾	Variable interest rate

⁽²⁾	Construction loan for apartment construction.

⁽³⁾	Cash of $11.0 million was received by an affiliate, increasing ARI’s affiliate receivable.

In 2003, ARI financed/refinanced or obtained second mortgage financing on the following:


Property	Location	Units/Acres	Debt Incurred		Debt Discharged		Net Cash Received/ (Paid)			Interest Rate		Maturity Date
*First Quarter*
Land
Elm Fork	Denton County, TX	101.0 Acres	$	5,000	$	1,551	$	2,885		10.750	%	03/04
Nashville	Nashville,TN	113.8 Acres		6,059		807		4,725		14.000		03/04
Vineyards II	Tarrant County, TX	18.6 Acres		3,280		3,750		(583	)	6.750	⁽¹⁾	02/06

Apartments
Arlington Place	Pasadena, TX	230 Units		1,500		—		—	⁽²⁾	5.000		05/03	⁽³⁾

⁽¹⁾	Variable interest rate.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 7. MARGIN BORROWINGS

ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowing of up to 50% of the market value of marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of TCI and ARI’s trading portfolio securities and bear interest rates ranging from 5.0% to 24.0%. Margin borrowing totaled $20.7 million at March 31, 2004.

In October 2001, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bore interest at 1.0% over the prime rate, currently 5.0% per annum, required monthly payments of interest only and matured in October 2003. The loan is callable upon 60 days prior notice, and is secured by 250,000 shares of ARI Common Stock held by BCM, ARI’s advisor. In October 2003, the maturity date was extended to December 2003. In February 2004, ARI paid $450,000 in principal, and the maturity date was extended to January 2005. At April 2004, the remaining balance is $338,000.

NOTE 8. RELATED PARTY TRANSACTIONS

In January 2004, ARI issued 200,000 shares of Series A 10% Cumulative Convertible Preferred Stock to Prime, ARI’s advisor. In February 2004, 50,000 additional shares were issued to Prime.

In February 2004, ARI obtained an unsecured loan of $5.0 million. The proceeds of $5.0 million were received by an affiliate of ARI, increasing ARI’s affiliate receivable.

In February 2004, ARI obtained financing of $7.5 million on the Katy land tract. The funds, along with additional cash of $6.3 million, were sent to an affiliate. Subsequently, the affiliate paid off the existing loan balance on an ARI property.

In March 2004, ARI obtained financing of $11.5 million on a hotel property. The proceeds of $11.0 million were received by an affiliate, increasing ARI’s affiliate receivable.

In March 2004, a related party purchased the loans on ARI’s three Chicago hotels for $10.8 million. This amount increased the affiliate payable balance by $10.8 million.

In March 2003, ARI sold the Bridgeview Plaza and Cullman shopping centers to TCI for $10.7 million to satisfy debt. TCI assumed debt of $2.7 million on Cullman. TCI received $5.1 million cash on the subsequent financing of the shopping centers.

The following table reconciles the beginning and ending balances of accounts receivable from and (accounts payable to) affiliates as of March 31, 2004.


	BCM			PRIME			IORI
Balance, December 31, 2003	$	1,999		$	4,393		$	(627	)
Cash transfers to affiliates		1			46,216			—
Cash transfers from affiliates		(574	)		(47,040	)		—
Advance through receipt of refinancing proceeds		—			(10,823	)		—
Other additions		—			44,934			367
Other repayments		—			(26,581	)		—

Balance, March 31, 2004	$	1,426		$	11,099		$	(260	)

Also at March 31, 2004, ARI owed $1.4 million to affiliates related to cash received upon the sale of apartments to Metra.

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 9. OPERATING SEGMENTS

Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow. Items of income that are not reflected in the segments are equity in loss of investees, equity in gain on sale of real estate by equity investees and other income which totaled $1.3 million for the three months ended March 31, 2004 and $(4.3) million for 2003. Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, minority interest, incentive fees, advisory fees, net income fees, and income (loss) from discontinued operations which totaled $9.9 million for the three months ended March 31, 2004 and $7.9 million for 2003. Excluded from operating segment assets are assets of $94.0 million in 2004 and $134.0 million in 2003, which are not identifiable with an operating segment. There are no intersegment revenues and expenses, and ARI conducted all of its business within the United States, with the exception of Hotel Sofia (Bulgaria), which began operations in 2001 and was sold in March 2003; Realty Advisors Korea, Ltd. (South Korea), which ARI acquired in 2002 and sold in 2003, and Hotel Akademia (Poland), which began operations in 2002.

Presented below are ARI’s reportable segments’ operating income for the three months ended March 31, and segment assets at March 31.


2004	Commercial Properties		Apartments			Hotels		Land			Pizza Parlors		Receivables/ Other			Total
Operating revenue	$	18,791	$	21,982		$	7,982	$	156		$	8,169	$	362		$	57,442
Interest income		—		—			—		—			—		1,049			1,049
Operating expenses		10,843		14,608			6,772		954			6,213		(219	)		39,171

Operating income (loss)	$	7,948	$	7,374		$	1,210	$	(798	)	$	1,956	$	1,630		$	19,320

Depreciation	$	3,393	$	3,251		$	880	$	—		$	328	$	12		$	7,864
Interest		5,819		7,666			1,486		2,951			386		1,367			19,675
Capital expenditures		1,893		53,503			261		179			467		—			56,303
Assets		293,270		451,587			87,607		209,927			20,906		72,949			1,136,246

	Commercial Properties		Apartments					Land								Total
Property Sales:
Sales price	$	47,450	$	10,325				$	30,194							$	87,969
Cost of sale		31,886		10,277					21,283								63,446
Deferred current gain		1,678		—					5,159								6,837

Gain on sale	$	13,886	$	48				$	3,752							$	17,686


2003	Commercial Properties		Apartments			Hotels		Land			Pizza Parlors		Receivables/ Other			Total
Operating revenue	$	6,524	$	6,022		$	5,525	$	13		$	7,867	$	33		$	25,984
Interest income		—		—			—		—			—		2,230			2,230
Operating expenses		3,670		3,691			4,875		1,570			6,407		6			20,219

Operating income (loss)	$	2,854	$	2,331		$	650	$	(1,557	)	$	1,460	$	2,257		$	7,995

Depreciation	$	633	$	418		$	482	$	—		$	446	$	3		$	1,982
Interest		1,586		2,076			982		4,138			206		543			9,531
Capital expenditures		700		(70	)		335		343			767		—			2,075
Assets		411,679		396,262			92,978		238,830			22,033		76,578			1,268,360

			Apartments			Hotels		Land								Total
Property Sales:
Sales price			$	14,975		$	24,750	$	8,785							$	48,510
Cost of sale				12,174			24,538		8,711								45,423
Recognized prior deferred gain				—			—		19,897								19,897

Gain on sale			$	2,801		$	212	$	19,971							$	22,984

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

NOTE 10. DISCONTINUED OPERATIONS

For the three months ended March 31, 2004 and 2003, income from discontinued operations relates to 32 properties that ARI sold during 2003 and nine properties that ARI sold during 2004. The following table summarizes revenue and expense information for these properties sold and held-for-sale.


	For the Three Months Ended March 31,
	2004			2003
Revenue
Rental	$	1,874		$	6,988
Property operations		1,267			4,241

		607			2,747
Expenses
Interest		979			1,950
Depreciation		368			584

		1,347			2,534

Net income (loss) from discontinued operations		(740	)		213
Gain on sale of real estate		13,934			3,013
Equity in gain on sale of real estate by equity investees		783			—

Net income from discontinued operations	$	13,977		$	3,226

Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.

NOTE 11. COMMITMENTS AND CONTINGENCIES

Liquidity. Management expects that excess cash generated from operations during the remainder of 2004 will not be sufficient to discharge all of ARI’s debt obligations as they mature. Therefore, ARI will rely on aggressive land sales, selected income producing property sales and, to the extent necessary, additional borrowings to meet its cash requirements.

Commitments. During 2002, Milano Restaurants International, Inc. (“MRI”), a then wholly-owned subsidiary of ARI, sold two restaurants to a corporation owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt incurred by the related party. The guaranty applies to all current debt, and to all future debt of the related party until such time as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $1.1 million at March 31, 2004.

Litigation. ARI is involved in various lawsuits arising in the ordinary course of business. In the opinion of management the outcome of these lawsuits will not have a material impact on ARI’s financial condition, results of operations or liquidity.

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

Introduction

ARI was organized in 1999. In August 2000, ARI acquired ART and NRLP. ART was organized in 1961 to provide investors with a professionally managed, diversified portfolio of real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income. ART owns a portfolio of real estate and mortgage loan investments. NRLP was organized in 1987, and subsequently acquired all of the assets and assumed all of the liabilities of 35 public and private limited partnerships. NRLP also owns a portfolio of real estate and mortgage loan investments.

On November 15, 2002, ARI commenced a tender offer for the common shares of TCI and IORI not already owned by ARI. The tender offer was completed on March 19, 2003. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares.

On June 2, 2003, ARI subsidiaries exchanged all of their 674,971 IORI shares with Basic Capital Management, Inc. (“BCM”), receiving 650,000 TCI shares from BCM. In addition, BCM executed a promissory note in favor of an ARI subsidiary in the amount of $526,000. After the exchange, ARI subsidiaries owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM. After the transaction, ARI subsidiaries owned 76.8% of the outstanding shares of TCI. In December 2003, ARI subsidiaries purchased 88,600 TCI shares in open market transactions and 204,633 TCI shares in transactions with related parties for a total of $1.4 million. At March 31, 2004, ARI subsidiaries owned 80.0% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At March 31, 2004, TCI owned 24.0% of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

Critical Accounting Policies

Critical accounting policies are those that are both important to the presentation of ARI’s financial condition and results of operations and require management’s most difficult, complex or subjective judgements. ARI’s critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.

If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. ARI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. ARI’s estimates are subject to revision as market conditions and ARI’s assessments of them change.

ARI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and ARI’s assessment of its ability to meet its lease or interest obligations. ARI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.

ARI’s management periodically discusses criteria for estimates and disclosures of its estimates with the Audit Committee of its Board of Directors.

Liquidity and Capital Resources

ARI reported net income of $845,000 for the three months ended March 31, 2004, which included the following non-cash charges and credits: depreciation and amortization from real estate held for investment of $8.2 million, gain on sale of real estate of $18.5 million and equity in loss of equity investees of $145,000. Net cash provided by operating activities amounted to $7.5 million for the three months ended March 31, 2004, interest receivable decreased by $1.5 million due to collection of accrued interest receivable, other assets decreased by $4.0 million primarily due to a reduction in escrows, interest payable decreased by $625,000 due to a decreased balance of notes payable and other liabilities increased by $9.3 million primarily due to an increase in deferred gains on property sales.

Net cash used in investing activities of $8.2 million was primarily due to real estate improvements of $55.8 million, acquisitions of real estate of $19.9 million, earnest money deposits of $2.3 million, $321,000 for the purchase of marketable securities and purchases of pizza parlor equipment of $467,000. These outflows for investing activities were offset by the collection of $39,000 on notes receivable, $64.4 million from the sale of real estate and $6.2 million from the sale of notes receivable.

Net cash used in financing activities of $620,000 was comprised of proceeds received from the funding or refinancing of notes payable of $129.2 million and advances from affiliates of $933,000; offset by cash payments of $126.7 million to paydown existing notes payable, $2.9 million for financing costs, net payments on stock loans of $447,000, $42,000 to repurchase common stock, and $650,000 in dividends on Preferred Stock.

In 2004, ARI purchased the following property:


Property	Location	Units/Acres	Purchase Price		Net Cash Paid/ (Received)			Debt Incurred		Interest Rate		Maturity Date
*First Quarter*
Apartments
288 City Park⁽¹⁾	Houston, TX	240 Units	$	3,056	$	612		$	2,444	5.95	%	04/45
Blue Lake Villas II⁽¹⁾	Waxahachie, TX	70 Units		729		(164	)		729	5.80		04/45
Bridges on Kinsey⁽¹⁾	Tyler, TX	232 Units		2,291		596			1,687	5.74		08/45
Dakota Arms⁽¹⁾	Lubbock, TX	208 Units		2,472		681			1,791	5.85		06/45
Lake Forest⁽¹⁾	Houston, TX	240 Units		2,316		(470	)		2,316	5.60		03/45
Vistas of Vance Jackson⁽¹⁾	San Antonio, TX	240 Units		3,550		771			2,779	5.78		06/45

Land
Lubbock land	Lubbock, TX	2.9 Acres		224		224			—	—		—
Meloy Road	Kent, OH	54.2 Acres		4,900		343			4,900	5.00	⁽²⁾	01/06
Railroad land	Dallas, TX	.3 Acres		708		704			—	—		—

*Second Quarter*
Apartments
Wildflower Villas⁽¹⁾	Temple, TX	220 Units		2,045		79			1,966	—		—

Land
Rogers land ⁽¹⁾	Rogers, AR	20.1 Acres		1,390		506			1,130	10.50		04/05

⁽¹⁾	Land purchased for apartment construction.

⁽²⁾	Variable interest rate.

In 2004, ARI sold the following properties:


Property	Location	Units/Sq. Ft./ Acres	Sales Price		Net Cash Received		Debt Discharged			Gain on Sale
*First Quarter*
Apartments
Tiberon Trails	Merrillville, IN	376 Units	$	10,325	$	2,618	$	6,189	⁽¹⁾	$	48

Shopping Centers
Countryside Harmon	Sterling, VA	72,062 Sq. Ft.		2,650		216		2,200			1,861
Countryside Retail	Sterling, VA	133,422 Sq. Ft.		27,100		3,407		22,800			6,807
Plaza on Bachman Creek	Dallas, TX	80,278 Sq. Ft.		7,850		1,808		5,358			3,682

Land
Allen	Collin County, TX	492.5 Acres		19,962		7,956		4,088			7,915	⁽²⁾
Mason Goodrich	Houston, TX	5.7 Acres		686		45		588			379
Mason Goodrich	Houston, TX	8.0 Acres		1,045		248		200			617
Red Cross	Dallas, TX	2.9 Acres		8,500		2,842		4,450			—

Industrial Warehouse
Kelly (Pinewood)	Dallas, TX	100,000 Sq. Ft.		1,650		65		1,376			153
Ogden Industrial	Ogden, UT	107,112 Sq. Ft.		2,600		668		1,775			1,474
Texstar Warehouse	Arlington, TX	97,846 Sq. Ft.		2,400		—		1,148	⁽¹⁾		1,157	⁽²⁾

Shopping Center
K-Mart	Cary, NC	92,033 Sq. Ft.		3,200		—		1,677	⁽¹⁾		521	⁽³⁾

*Second Quarter*
Office Building
Atrium	Palm Beach, FL	74,603 Sq. Ft.		5,775		1,667		3,750			740

⁽¹⁾	Debt assumed by purchaser.

⁽²⁾	Includes deferred gain of $5.2 million. A portion of the land was sold on a contingent basis for a note receivable of $7.2 million. See Note 3. “NOTES AND INTEREST RECEIVABLE.”

⁽³⁾

In 2004, ARI financed/refinanced or obtained second mortgage financing on the following:


Property	Location	Sq.Ft./Rooms/Acres	Debt Incurred		Debt Discharged		Net Cash Received/(Paid)			Interest Rate		Maturity Date
Hotel
Williamsburg Hospitality House	Williamsburg, VA	296 Rooms	$	11,500	$	12,332	$	(13,689	)⁽³⁾	7.00	%⁽¹⁾	03/05

Office Building
Centura Tower	Farmers Branch, TX	410,901 Sq. Ft.		34,000		36,889		(4,588	)	5.50	⁽¹⁾	04/06
Land
Centura	Farmers Branch, TX	8.8 Acres		4,485		4,000		(183	)	7.00	⁽¹⁾	11/04
Dominion/Hollywood	Farmers Branch, TX	66.1 Acres		6,985		6,222		(67	)	7.00	⁽¹⁾	02/05
Katy	Harris County, TX	130.6 Acres		7,500		—		18		6.00		02/07
Marine Creek ⁽²⁾	Ft. Worth, TX	54.0 Acres		1,286		991		192		5.75		06/05

⁽¹⁾	Variable interest rate.

⁽²⁾	Construction loan for apartment construction.

⁽³⁾	Cash of $11.0 million was received by an affiliate, increasing ARI’s affiliate receivable.

ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowing up to 50% of the market value of ARI’s marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of IORI and TCI and ARI’s trading portfolio and bear interest rates ranging from 5.0% to 24.0%. Margin borrowing totaled $20.7 million at March 31, 2004.

Management expects that it will be necessary for ARI to sell $60.2 million, $10.5 million and $31.6 million of its land holdings during each of the next three years to satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the debt obligations on such land as it matures, or, if it is not able to extend such debt, ARI intends to sell other of its assets, specifically income producing properties, to pay the debt.

Management reviews the carrying values of ARI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings to the extent that the investment in the note exceeds management’s estimate of the fair value of the collateral property securing each note. The mortgage note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes: (1) selective property inspections; (2) a review of the property’s current rents compared to market rents; (3) a review of the property’s expenses; (4) a review of maintenance requirements; (5) a review of the property’s cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.

Related Party Transactions

In January 2004, ARI issued 200,000 shares of Series A 10% Cumulative Convertible Preferred Stock to Prime, ARI’s advisor. In February 2004, 50,000 additional shares were issued to Prime.

In February 2004, ARI obtained an unsecured loan of $5.0 million. The proceeds of $5.0 million were received by an affiliate of ARI, increasing ARI’s affiliate receivable.

In March 2004, ARI obtained financing of $11.5 million on a hotel property. The proceeds of $11.0 million were received by an affiliate, increasing ARI’s affiliate receivable.

In March 2004, a related party purchased the loans on ARI’s three Chicago hotels for $10.8 million. This amount increased the affiliate payable balance by $10.8 million.

Commitments and Contingencies

ARI has contractual obligations and commitments primarily with regards to payment of mortgages.

Results of Operations

For the three months ended March 31, 2004, ARI reported net income of $845,000, compared to net income of $7.2 million for the three months ended March 31, 2003. The primary factors contributing to ARI’s net income are discussed in the following paragraphs.

ARI began consolidating TCI’s operations effective March 31, 2003. The consolidation is the principal factor for the increase during the three months ended March 31, 2004 in the following areas: rents, property operations expense, interest expense, depreciation and amortization, general and administrative expense, advisory fees, and gain on sale of real estate. For these items, 2004 results are also presented without the effect of the consolidation of TCI’s operations.

Rents (dollars in thousands)


	2004				2003
	with TCI		without TCI		2003
Commercial	$	18,791	$	6,546	$	6,524
Apartments		21,982		6,301		6,022
Hotels		7,982		6,503		5,525
Land		156		15		13
Other		362		362		33

	$	49,273	$	19,727	$	18,117

The increase in hotel rents, without the effect of the consolidation of TCI’s operations, was primarily attributable to increased occupancy. Rents are expected to increase in 2004, as a result of completed apartment construction.

Property Operations Expenses (dollars in thousands)


	2004						2003
	With TCI			without TCI			2003
Commercial	$	10,843		$	3,896		$	3,670
Apartments		14,608			5,202			3,691
Hotels		6,772			5,364			4,875
Land		954			576			1,570
Other		(219	)		(219	)		6

	$	32,958		$	14,819		$	13,812

The increase in apartment operations expense, without the effect of the consolidation of TCI’s operations, was primarily attributable to property replacements. The increase in hotel operations expense was primarily attributable to increased personnel costs and an increase in repairs and replacement expenses. The decrease in land operations expense was primarily attributable to lower property taxes due to land sales. Property operations expense is expected to increase in 2004, as a result of completed apartment construction.

Pizza parlor sales and cost of sales of $8.2 million and $6.2 million, respectively, in the three months ended March 31, 2004, approximated the $7.9 million and $6.4 million in the three months ended March 31, 2003.

Interest income from notes receivable decreased to $1.0 million in the three months ended March 31, 2004 from $2.2 million in 2003, due to the collection of $34.3 million of notes receivable in 2003.

Equity in loss of investees improved to $(145,000) in the three months ended March 31, 2004, from $(4.3) million in 2003. Prior to March 31, 2003, ARI’s equity in loss of investees included equity in TCI’s operations.

Interest Expense (dollars in thousands)


	2004				2003
	with TCI		without TCI		2003
Commercial	$	5,819	$	2,219	$	1,586
Apartments		7,666		2,029		2,076
Hotels		1,486		932		982
Land		2,951		2,373		4,138
MRI		386		386		206
Other		1,367		1,367		543

	$	19,675	$	9,306	$	9,531

The increase in commercial interest expense, without the effect of the consolidation of TCI’s operations, was primarily attributable to the completion of Four Hickory Centre during the third quarter of 2003. During construction, mortgage loan interest was capitalized as part of the cost of the building. The decrease in land interest expense was primarily attributable to reduced principal balances payable and interest rates on land mortgages. The increase in other interest expense was primarily attributable to increased stock loans.

Depreciation and Amortization (dollars in thousands)


	2004				2003
	with TCI		without TCI		2003
Commercial	$	3,393	$	890	$	633
Apartments		3,251		512		418
Hotels		880		555		482
MRI		328		328		446
Other		12		1		3

	$	7,864	$	2,286	$	1,982

The increase in commercial depreciation and amortization, without the effect of the consolidation of TCI’s operations, was primarily attributable to the completion of Four Hickory Centre during the third quarter of 2003.

Discount on sale of notes receivable decreased to $398,000 in the three months ended March 31, 2004, from $1.6 million in 2003. This represents the discount from the face amount given by ARI to purchasers of notes receivable.

General and administrative expenses increased to $4.6 million in the three months ended March 31, 2004, from $3.3 million in 2003. Without the effect of the consolidation of TCI’s operations, general and administrative expenses decreased to $1.7 million. The decrease was primarily attributable to reduced legal fees and reduced expense reimbursements paid to ARI’s advisors.

Advisory fees increased to $2.9 million in the three months ended March 31, 2004, from $2.0 million in 2003. Without the effect of the consolidation of TCI’s operations, advisory fees decreased to $1.2 million. In 2003, an additional month of fees was recorded.

Net income fee to affiliate decreased to $79,000 in the three months ended March 31, 2004, from $452,000 in 2003. The net income fee payable to ARI’s advisor is 10% of the year-to-date net income, in excess of a 10% return on shareholders’ equity.

Incentive fee to affiliate was $261,000 in the three months ended March 31, 2003. The incentive fee is only due if ARI is also subject to the net income fee. This fee represents 10% of the excess of net capital gains over net capital losses from sales of operating properties. The amount of this fee for the remainder of 2004 will be dependent on the number of operating properties sold, the net capital gains realized and whether the net income fee is due.

Minority interest increased to $1.2 million in the three months ended March 31, 2004, from $550,000 in 2003. The increase is primarily attributable to the consolidation of TCI’s operations by ARI, as the 19.99% minority share of TCI’s net income is recorded as minority interest expense by ARI.

Net income from discontinued operations increased to $14.0 million in the three months ended March 31, 2004 from $3.2 million in 2003. The net income relates to 32 properties that ARI sold during 2003 and nine properties that ARI sold during 2004. The following table summarizes revenue and expense information for the properties sold and held-for-sale.


	For the Three Months Ended March 31,
	2004			2003
Revenue
Rental	$	1,874		$	6,988
Property operations		1,267			4,241

		607			2,747
Expenses
Interest		979			1,950
Depreciation		368			584

		1,347			2,534

Net income (loss) from discontinued operations		(740	)		213
Gain on sale of real estate		13,934			3,013
Equity in gain on sale of real estate by equity investees		783			—

Net income from discontinued operations	$	13,977		$	3,226

Tax Matters

Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. ARI had a taxable loss for federal income tax purposes for the first three months of 2004 and had no taxable income for federal income tax purposes after the use of net operating loss carryforwards in the first three months of 2003; therefore, it recorded no provision for income taxes.

At March 31, 2004, ARI had a net deferred tax asset of $77.2 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that ARI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.

TCI had a loss for federal income tax purposes after the use of net operating loss carryforwards in the first three months of 2004 and a loss for federal income tax purposes in the first three months of 2003; therefore, it recorded no provision for income taxes.

At March 31, 2004, TCI had a net deferred tax asset of $7.0 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that TCI will realize the benefit of the deferred tax assets, a 100% valuation allowance has been established.

Environmental Matters

Under various federal, state and local environmental laws, ordinances and regulations, ARI may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.

Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on ARI’s business, assets or results of operations.

Inflation

The effects of inflation on ARI’s operations are not quantifiable. Revenues from apartment operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new borrowings as well as the cost of variable interest rate debt will be affected.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

At March 31, 2004, ARI’s exposure to a change in interest rates on its debt is as follows:


	Balance		Weighted Average Interest Rate		Effect of 1% Increase In Base Rates
Notes payable:
Variable rate	$	212,916	6.412	%	$	2,129

Total decrease in ARI’s annual net income					$	2,129

Per share					$	.20

ITEM 4. CONTROLS AND PROCEDURES

(a)

As of the end of the period covered by this report, ARI carried out an evaluation, under the supervision and with the participation of ARI’s management, including ARI’s Acting Principal Executive Officer and principal accounting officer, of the effectiveness of the design and operation of ARI’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 and 15d-15. Based upon the evaluation, ARI’s Acting Principal Executive Officer and principal accounting officer concluded that ARI’s disclosure controls and procedures are effective in timely alerting him to material information relating to ARI (including its consolidated subsidiaries) required to be included in ARI’s periodic SEC filings.

(b)	There have been no significant changes in ARI’s internal controls or in other factors that could significantly affect ARI’s internal controls subsequent to the date ARI carried out this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II. OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES


Period	(a) Total Number of Shares Purchased	(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs⁽¹⁾	(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs⁽¹⁾
January 2004	—	$	—	—	625,793
February 2004	—		—	—	625,793
March 2004	5,100		8.42	5,100	620,693

Total	5,100	$	8.42	5,100	620,693

(1)	The repurchase program was announced in September, 2000. A total of 1,000,000 shares may be repurchased through the program. The program has no expiration date.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits:


Exhibit Number		Description
31.1		Certification Required by Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

(b)	Reports on Form 8-K as follows:

A Current Report on Form 8-K, dated February 19, 2004, was filed with respect to Item 5. “Other Events and Regulation FD Disclosure” which reports an increase in the number of directors, the election of two new independent directors, and the resignation of one director.

SIGNATURE PAGE

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.


	AMERICAN REALTY INVESTORS, INC.

Date: May 17, 2004	By:	/s/ Ronald E. Kimbrough
		Ronald E. Kimbrough
		Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Acting Principal Executive Officer)

AMERICAN REALTY INVESTORS, INC.

EXHIBITS TO

QUARTERLY REPORT ON FORM 10-Q

For the Quarter ended March 31, 2004


Exhibit Number	Description	Page Number
31.1	Certification Required by Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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