Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

For the quarterly period ended September 30, 2009

Commission File Number: 000-53650

Behringer Harvard Opportunity REIT II, Inc.

(Exact Name of Registrant as Specified in Its Charter)

15601 Dallas Parkway, Suite 600, Addison, Texas 75001

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code:  (866) 655-3600

None

(Former name, former address and former fiscal year, if changed since last report)

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 o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of October 30, 2009, Behringer Harvard Opportunity REIT II, Inc. had 13,073,832 shares of common stock, $.0001 par value, outstanding.

Table of Contents

BEHRINGER HARVARD OPPORTUNITY REIT II, INC.

FORM 10-Q

Quarter Ended September 30, 2009

2

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1.                                                           Financial Statements.

Behringer Harvard Opportunity REIT II, Inc.

Consolidated Balance Sheets

(in thousands, except share and per share amounts)

(Unaudited)

See Notes to Consolidated Financial Statements.

3

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Consolidated Statements of Operations

(in thousands, except per share amounts)

(Unaudited)

See Notes to Consolidated Financial Statements.

4

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Consolidated Statement of Stockholders’ Equity

(in thousands)

(Unaudited)

See Notes to Consolidated Financial Statements.

5

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

See Notes to Consolidated Financial Statements.

6

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

1.                                     Business and Organization

Business

Behringer Harvard Opportunity REIT II, Inc. (which may be referred to as the “Company,” “we,” “us,” or “our”) was organized as a Maryland corporation on January 9, 2007 and has elected to be taxed, and currently qualifies, as a real estate investment trust (“REIT”) for federal income tax purposes.

We acquire and operate commercial real estate and real estate-related assets.  In particular, we focus generally on acquiring commercial properties with significant possibilities for short-term capital appreciation, such as those requiring development, redevelopment, or repositioning, those located in markets and submarkets with high growth potential, and those available from sellers who are distressed or face time-sensitive deadlines.  In addition, given economic circumstances as of September 30, 2009, our opportunistic investment strategy may also include investments in real estate-related assets that present opportunities for higher current income.  Such investments may have capital gain characteristics, whether as a result of a discount purchase or related equity participations.  We may acquire a wide variety of commercial properties, including office, industrial, retail, hospitality, recreation and leisure, single-tenant, multifamily, and other real properties.  These properties may be existing, income-producing properties, newly constructed properties, or properties under development or construction and may include multifamily properties purchased for conversion into condominiums and single-tenant properties that may be converted for multi-tenant use.  Further, we may invest in real estate-related securities, including securities issued by other real estate companies, either for investment or in change of control transactions completed on a negotiated basis or otherwise.  We also may originate or invest in collateralized mortgage-backed securities, mortgage, bridge or mezzanine loans, and Section 1031 tenant-in-common interests (including those issued by affiliates of our advisor), or in entities that make investments similar to the foregoing.  We expect to make our investments in or in respect of real estate assets located in the United States and other countries based on our view of existing market conditions.  We completed our first property acquisition, an office building located in Denver, Colorado, on October 28, 2008.  On August 14, 2009, we entered into an agreement to provide up to $25 million of second lien financing for the privatization of and improvements to, approximately 3,200 hotel lodging units located on ten U.S. Army installations.  As of September 30, 2009, these are our only real estate investments.

Substantially all of our business is conducted through Behringer Harvard Opportunity OP II LP, a limited partnership organized in Delaware on January 12, 2007 (“Behringer Harvard Opportunity OP II”).  As of September 30, 2009, our wholly-owned subsidiary, BHO II, Inc., a Delaware corporation, was the sole general partner of Behringer Harvard Opportunity OP II and owned a 0.1% partnership interest in Behringer Harvard Opportunity OP II.  As of September 30, 2009, our wholly-owned subsidiary, BHO Business Trust II, a Maryland business trust, was the sole limited partner of Behringer Harvard Opportunity OP II and owned the remaining 99.9% interest in Behringer Harvard Opportunity OP II.

We are externally managed and advised by Behringer Harvard Opportunity Advisors II LP (“Behringer Opportunity Advisors II”), a Texas limited partnership formed in January 2007.  Behringer Opportunity Advisors II is responsible for managing our affairs on a day-to-day basis and for identifying and making acquisitions and investments on our behalf.

Our office is located at 15601 Dallas Parkway, Suite 600, Addison, Texas 75001, and our toll-free telephone number is (866) 655-3600.  The name Behringer Harvard is the property of Behringer Harvard Holdings, LLC (“Behringer Harvard Holdings”) and is used by permission.

Organization

On February 26, 2007, we filed a Registration Statement on Form S-11 with the Securities and Exchange Commission (“SEC”) to offer up to 125,000,000 shares of common stock for sale to the public (the “Offering”), of which 25,000,000 shares are being offered pursuant to our distribution reinvestment plan (the “DRP”).  We reserve the right to reallocate the shares we are offering between our primary offering and the DRP.  The SEC declared our Registration Statement effective on January 4, 2008, and we commenced our ongoing initial public offering on January 21, 2008.

In connection with our initial capitalization, on January 19, 2007, we issued 22,471 shares of our common stock and 1,000 shares of our convertible stock to Behringer Harvard Holdings, an affiliate of our advisor.  As of September 30, 2009, we had 12,316,894 shares of common stock outstanding, which includes the 22,471 shares issued to Behringer Harvard Holdings.  As of September 30, 2009, we had 1,000 shares of convertible stock issued and outstanding to Behringer Harvard Holdings.

We commenced operations on April 1, 2008 upon satisfaction of the conditions of our escrow agreement in all states except Pennsylvania and our acceptance of initial subscriptions of common stock.  On September 19, 2008, we satisfied the escrow conditions for Pennsylvania.  Upon admission of new stockholders, subscription proceeds are used for payment of

7

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

dealer manager fees and selling commissions and may be utilized as consideration for investments and the payment or reimbursement of offering expenses and operating expenses.  Until required for such purposes, net offering proceeds are held in short-term, liquid investments.  Through September 30, 2009, we had sold 12,338,736 shares in the Offering, including the DRP, for gross proceeds of $123 million.

Our common stock is not currently listed on a national securities exchange.  Depending upon then prevailing market conditions, it is our intention to consider beginning the process of liquidating our assets and distributing the net proceeds to our stockholders within three to six years after the termination of our primary offering.  If we do not begin an orderly liquidation within that period, we may seek to have our shares listed on a national securities exchange.

2.                                     Interim Unaudited Financial Information

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008, which was filed with the SEC on March 31, 2009.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted from this quarterly report pursuant to the rules and regulations of the SEC.

The results for the interim periods shown in this report are not necessarily indicative of future financial results.  The accompanying consolidated balance sheet and consolidated statement of stockholders’ equity as of September 30, 2009, the consolidated statements of operations for the three and nine months ended September 30, 2009 and 2008, and cash flows for the nine months ended September 30, 2009 and 2008 have not been audited by our independent registered public accounting firm.  In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments necessary to fairly present our consolidated financial position as of September 30, 2009 and December 31, 2008 and our consolidated results of operations and cash flows for the periods ended September 30, 2009 and 2008.  Such adjustments are of a normal recurring nature.

We have evaluated subsequent events after the balance sheet date of September 30, 2009 through November 12, 2009, which is the date the financial statements were issued.

3.                                     Summary of Significant Accounting Policies

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  These estimates include such items as purchase price allocation for real estate acquisitions, impairment of long-lived assets, depreciation and amortization, and allowance for doubtful accounts.  Actual results could differ from those estimates.

Principles of Consolidation and Basis of Presentation

Our consolidated financial statements include our accounts and the accounts of other subsidiaries over which we have control.  All inter-company transactions, balances, and profits have been eliminated in consolidation.  Interests in entities acquired will be evaluated based on applicable GAAP, which includes the requirement to consolidate entities deemed to be variable interest entities (“VIE”) in which we are the primary beneficiary.  If the interest in the entity is determined not to be a VIE, then the entities will be evaluated for consolidation based on legal form, economic substance, and the extent to which we have control and/or substantive participating rights under the respective ownership agreement.  In the Notes to Consolidated Financial Statements, all dollar and share amounts in tabulation are in thousands of dollars and shares, respectively, unless otherwise noted.

There are judgments and estimates involved in determining if an entity in which we have made an investment is a VIE and if so, whether we are the primary beneficiary.  The entity is evaluated to determine if it is a VIE by, among other things, calculating the percentage of equity being risked compared to the total equity of the entity.  Determining expected future losses involves assumptions of various possibilities of the results of future operations of the entity, assigning a probability to each possibility, and using a discount rate to determine the net present value of those future losses.  A change in the judgments, assumptions, and estimates outlined above could result in consolidating an entity that should not be consolidated or accounting for an investment using the equity method that should in fact be consolidated, the effects of which could be material to our financial statements.

8

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Real Estate

Upon the acquisition of real estate properties, we recognize the assets acquired, the liabilities assumed, and any noncontrolling interest as of the acquisition date, measured at their fair values.  The acquisition date is the date on which we obtain control of the real estate property.  The assets acquired and liabilities assumed may consist of buildings, any assumed debt, identified intangible assets and asset retirement obligations.  Identified intangible assets generally consist of the above-market and below-market leases, in-place leases, in-place tenant improvements and tenant relationships.  Goodwill is recognized as of the acquisition date and measured as the aggregate fair value of the consideration transferred and any noncontrolling interests in the acquiree over the fair value of identifiable net assets acquired.  Likewise, a bargain purchase gain is recognized in current earnings when the aggregate fair value of the consideration transferred and any noncontrolling interests in the acquiree is less than the fair value of the identifiable net assets acquired.  Acquisition-related costs are expensed in the period incurred.

Initial valuations are subject to change until our information is finalized, which is no later than twelve months from the acquisition date.

We determine the fair value of assumed debt by calculating the net present value of the scheduled note payments using interest rates for debt with similar terms and remaining maturities that we believe we could obtain.  Any difference between the fair value and stated value of the assumed debt is recorded as a discount or premium and amortized over the remaining life of the loan.

The fair value of the tangible assets acquired, consisting of land and buildings, is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land and buildings.  Land values are derived from appraisals, and building values are calculated as replacement cost less depreciation or management’s estimates of the relative fair value of these assets using discounted cash flow analyses or similar methods.  The value of the commercial office building is depreciated over the estimated useful life of 25 years using the straight-line method.

We determine the value of above-market and below-market in-place leases for acquired properties based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (1) the contractual amounts to be paid pursuant to the in-place leases and (2) management’s estimate of current market lease rates for the corresponding in-place leases, measured over a period equal to (a) the remaining non-cancelable lease term for above-market leases, or (b) the remaining non-cancelable lease term plus any fixed rate renewal option for below-market leases.  We record the fair value of above-market and below-market leases as intangible assets or intangible liabilities, respectively, and amortize them as an adjustment to rental income over the above determined lease term.

The total value of identified real estate intangible assets acquired is further allocated to in-place lease values and tenant relationships based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant.  The aggregate value of in-place leases acquired and tenant relationships is determined by applying a fair value model.  The estimates of fair value of in-place leases include an estimate of carrying costs during the expected lease-up periods for the respective spaces, considering current market conditions.  In estimating fair value of in-place leases, we consider items such as real estate taxes, insurance and other operating expenses, as well as lost rental revenue during the expected lease-up period and carrying costs that would have otherwise been incurred had the leases not been in place, including tenant improvements and commissions.  The estimates of the fair value of tenant relationships also include costs to execute similar leases, including leasing commissions, legal costs and tenant improvements as well as an estimate of the likelihood of renewal as determined by management on a tenant-by-tenant basis.

We amortize the value of in-place leases to expense over the term of the respective leases.  The value of tenant relationship intangibles is amortized to expense over the initial term and any anticipated renewal periods, but in no event does the amortization period for intangible assets exceed the remaining depreciable life of the building.  Should a tenant terminate its lease, the unamortized portion of the in-place lease value and tenant relationship intangibles is charged to expense.  As of September 30, 2009, the estimated remaining useful life for acquired lease intangibles was approximately 1.5 years.

9

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Anticipated amortization expense associated with the acquired lease intangibles as of September 30, 2009 is as follows:

Accumulated depreciation and amortization related to our consolidated investments in real estate assets and intangibles were as follows:

Cash and Cash Equivalents

We consider investments in highly-liquid money market funds or investments with original maturities of three months or less to be cash equivalents.  The carrying amount of cash and cash equivalents reported on the balance sheet approximates fair value.

Investment Impairment

For real estate we wholly own, we monitor events and changes in circumstances indicating that the carrying amounts of the real estate assets may not be recoverable.  When such events or changes in circumstances are present, we assess potential impairment by comparing estimated future undiscounted operating cash flows expected to be generated over the life of the asset and from its eventual disposition to the carrying amount of the asset.  In the event that the carrying amount exceeds the estimated future undiscounted operating cash flows, we recognize an impairment loss to adjust the carrying amount of the asset to estimated fair value.  We consider projected future undiscounted cash flows, trends, strategic decisions regarding future development plans, and other factors in our assessment of whether impairment conditions exist.  While we believe our estimates of future cash flows are reasonable, different assumptions regarding factors such as market rents, economic conditions, and occupancy rates could significantly affect these estimates.

In addition, we evaluate our investment in the real estate loan receivable each reporting date and if it is probable we will not collect all principal and interest in accordance with the terms of the loan, we will record an impairment charge based on these evaluations.  While we believe it is currently probable we will collect all scheduled principal and interest with respect to our real estate loan receivable, current market conditions with respect to credit availability and with respect to real estate market fundamentals create a significant amount of uncertainty.  Given this, any future adverse development in market conditions may cause us to re-evaluate our conclusions, and could result in material impairment charges with respect to our real estate loan receivable.

In evaluating our investments for impairment, management may use appraisals and makes estimates and assumptions, including, but not limited to, the projected date of disposition of the properties, the estimated future cash flows of the properties during our ownership, and the projected sales price of each of the properties.  A change in these estimates

10

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

and assumptions could result in understating or overstating the book value of our investments, which could be material to our financial statements.

We believe the carrying value of our operating real estate and loan investments is currently recoverable.  Accordingly, there were no impairment charges for the nine months ended September 30, 2009 or 2008.  However, if market conditions worsen beyond our current expectations, or if changes in our strategy significantly affect any key assumptions used in our fair value calculations, we may need to take charges in future periods for impairments related to our existing investments.  Any such non-cash charges would have an adverse effect on our consolidated financial position and results of operations.

Revenue Recognition

We recognize rental income generated from leases on real estate assets on a straight-line basis over the terms of the respective leases, including the effect of rent holidays, if any.  Straight-line rental revenue of less than $0.1 million was recognized in rental revenues for the nine months ended September 30, 2009.  There was no straight-line rental revenue recognized for the nine months ended September 30, 2008.

Organization and Offering Expenses

We reimburse our advisor or its affiliates for any organization and offering expenses incurred on our behalf in connection with the primary offering (other than selling commissions and the dealer manager fee).  Through September 30, 2009 we did not reimburse expenses that caused our total organization and offering expenses (other than selling commissions and the dealer manager fee) related to our primary offering to exceed 1.5% of gross offering proceeds from the primary offering as of the date of reimbursement.  At each balance sheet date, we estimated the total gross public offering proceeds expected to be received under the Offering and recognized the amount of organization and offering reimbursement.  We recorded the amount of reimbursement at the lower of (a) 1.5% of the estimated gross public offering proceeds, or (b) the actual organization and offering costs incurred by our advisor or its affiliates.  Effective October 2, 2009, we changed the timing in determining the limit on the amount of the reimbursement of organization and offering expenses (other than selling commissions and the dealer manager fee) as described in Note 9.

Organization and offering expenses are defined generally as any and all costs and expenses incurred by us in connection with our formation, preparing for the Offering, the qualification and registration of the Offering, and the marketing and distribution of our shares.  Organization and offering expenses include, but are not limited to, accounting and legal fees, costs to amend the registration statement and supplement the prospectus, printing, mailing and distribution costs, filing fees, amounts to reimburse our advisor or its affiliates for the salaries of employees, and other costs in connection with preparing supplemental sales literature, telecommunication costs, fees of the transfer agent, registrars, trustees, escrow holders, depositories and experts, and fees and costs for employees of our advisor or its affiliates to attend industry conferences.

All offering costs are recorded as an offset to additional paid-in capital, and all organization costs are recorded as an expense at the time we become liable for the payment of these amounts.

Income Taxes

We have elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”), and have qualified as a REIT since the year ended December 31, 2008.  To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we distribute at least 90% of our REIT taxable income to our stockholders.  As a REIT, we generally will not be subject to federal income tax at the corporate level.  We are organized and operate in such a manner as to qualify for taxation as a REIT under the Code and intend to continue to operate in such a manner, but no assurance can be given that we will operate in a manner so as to qualify or remain qualified as a REIT.

Stock-Based Compensation

We have adopted a stock-based incentive award plan for our directors and consultants and for employees, directors and consultants of our affiliates.  We have not issued any stock-based awards under the plan as of September 30, 2009.

11

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Concentration of Credit Risk

At September 30, 2009, we had cash and cash equivalents deposited in certain financial institutions in excess of federally insured levels.  We have diversified our cash and cash equivalents among several banking institutions in an attempt to minimize exposure to any one of these entities.  We regularly monitor the financial stability of these financial institutions and believe that we are not exposed to any significant credit risk in cash and cash equivalents or restricted cash.  The Federal Deposit Insurance Corporation, or “FDIC,” generally only insures limited amounts per depositor per insured bank.  Beginning October 3, 2008 through December 31, 2009, the FDIC will insure up to $250,000 per depositor per insured bank; on January 1, 2010, the standard coverage limit will return to $100,000 for most deposit categories.  Unlimited deposit insurance coverage will be available to our non-interest bearing transaction accounts held at those institutions participating in FDIC’s Temporary Liquidity Guarantee Program through December 31, 2009.

Earnings per Share

Earnings (loss) per share is calculated based on the weighted average number of common shares outstanding during each period.  The weighted average shares outstanding used to calculate both basic and diluted income (loss) per share were the same for the three and nine months ended September 30, 2009 and 2008 as there were no stock-based awards outstanding.

4.                                     New Accounting Pronouncements

In November 2008, the Financial Accounting Standards Board (“FASB”) issued a standard which clarifies that an entity shall continue to use the cost accumulation model for its equity method investments.  It also confirms past accounting practices related to the treatment of contingent consideration and the use of the impairment model for equity method accounting. Additionally, it requires an equity method investor to account for a share issuance by an investee as if the investor had sold a proportionate share of the investment.  This standard was effective January 1, 2009, and applies prospectively.  The implementation of this guidance did not have a material impact on our consolidated financial statements.

In April 2009, the FASB issued a staff position providing additional guidance for estimating fair value when there has been a significant decrease in market activity for a financial asset.  This staff position re-emphasizes that regardless of market conditions the fair value measurement is an exit price concept.  It clarifies and includes additional factors to consider in determining whether there has been a significant decrease in market activity for an asset or liability and provides additional clarification on estimating fair value when the market activity for an asset or liability has declined significantly.  This guidance is applied prospectively to all fair value measurements where appropriate and is effective for interim and annual periods ending after June 15, 2009.  The implementation of this guidance on June 30, 2009 did not have a material impact on our consolidated financial statements.

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities.  The guidance eliminates exceptions to consolidating qualifying special-purpose entities, contains new criteria for determining the primary beneficiary, and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity.  It also contains a new requirement that any term, transaction, or arrangement that does not have a substantive effect on an entity’s status as a variable interest entity, a company’s power over a variable interest entity, or a company’s obligation to absorb losses or its rights to receive benefits of an entity must be disregarded.  The guidance is applicable for annual periods after November 15, 2009 and interim periods thereafter.  We are currently assessing the impact, if any, that this new guidance will have on our consolidated financial statements.

5.                                     Note Receivable

On August 14, 2009, we entered into a loan agreement with an unaffiliated third party to provide up to $25 million of second lien financing (“PAL Loan”) for the privatization of, and improvements to, approximately 3,200 hotel lodging units on ten U.S. Army installations.

The PAL Loan will be used to finance costs related to the construction, revitalization, renovation, and development of improvements of hotel lodging units located on U.S. Army installations at Fort Hood, Texas; Fort Leavenworth, Kansas; Fort Myer, Virginia; Fort Polk, Louisiana; Fort Riley, Kansas; Fort Rucker, Alabama; Fort Sam Houston, Texas; Tripler Army Medical Center and Fort Shafter, Hawaii; Fort Sill, Oklahoma; and Yuma Proving Ground, Arizona, through the U.S. Army’s Privatization of Army Lodging (“PAL”) program.

The aggregate principal amount available under the loan agreement is $25 million, of which approximately $12.8 million was outstanding as of September 30, 2009.  Future advances may be made not more frequently than monthly in accordance with the terms and conditions of the loan agreement.  Proceeds of our ongoing public offering were used to fund

12

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

the PAL Loan.  The PAL Loan accrues interest at 18% per annum and matures on September 1, 2016.  The PAL Loan is payable as follows:

·                  Monthly payments of interest only calculated at the rate of 10% per annum (the “Minimum Monthly Payment”) are required beginning on October 1, 2009 through September 1, 2011;

·                  Beginning on October 1, 2011, and ending on September 1, 2013, payments of the Minimum Monthly Payment, and (after payment of the senior indebtedness described below) accrued and unpaid interest to the extent of available cash flow;

·                  Beginning on October 1, 2013, and ending on August 1, 2016, payments of the Minimum Monthly Payment, and accrued and unpaid interest and principal to the extent of available cash flow; and

·                  Any remaining principal amount and accrued and unpaid interest are due and payable on September 1, 2016.

The loan may be prepaid at any time after the full $25 million has been disbursed, upon the fulfillment of certain conditions as described in the related promissory note and the payment of a prepayment premium in the circumstances described in such promissory note.  The loan is secured by a second lien leasehold mortgage encumbering certain real and personal property comprising approximately 3,200 hotel lodging units on the ten U.S. Army installations.  An affiliate of the borrower has provided a limited guaranty for payment of the full amount of the PAL Loan should the borrower file for bankruptcy and in certain other limited circumstances related to bankruptcy of the borrower.

The PAL Loan is subordinate to a $35 million senior credit facility provided by Bank of America, N.A., an unrelated third party lender, and is senior to a $21.5 million subordinate loan provided by an affiliate of the borrower.

6.                                     Note Payable

The following table sets forth our note payable on 1875 Lawrence as of September 30, 2009.

(1) 30-day LIBOR was 0.246% at September 30, 2009. The loan has a minimum interest rate of 6.25%.

We have unconditionally guaranteed payment of the loan for an amount not to exceed the lesser of (i) $11.75 million and (ii) 50% of the total amount advanced under the loan agreement if the aggregate amount advanced is less than $23.5 million.

We are subject to certain reporting and financial covenants, all as set forth in the loan agreement.  As of September 30, 2009, we believe we were in compliance with the covenants under our loan agreement.

The following table summarizes our contractual obligations for principal payments as of September 30, 2009:

13

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

7.                                     Leasing Activity

Future minimum base rental payments due to us under non-cancelable leases in effect as of September 30, 2009 for 1875 Lawrence are as follows:

As of September 30, 2009, one of our tenants accounted for 10% or more of our aggregate annual rental revenues from our consolidated property, 1875 Lawrence.  Policy Studies, Inc. accounted for rental revenue of approximately $0.6 million, or approximately 15%, of our aggregate rental revenues for the nine months ended September 30, 2009.  There was no contingent rent included in rental revenue for the three and nine months ended September 30, 2009 or 2008.

8.                                     Distributions

We initiated the payment of monthly distributions in April 2008 in the amount of a 3% annualized rate of return, based on an investment in our common stock of $10.00 per share and calculated on a daily record basis of $0.0008219 per share.  The annualized rate of return was raised to 5% effective June 1, 2009, calculated on a daily record basis of $0.0013699 per share.  A portion of each distribution is expected to constitute a return of capital for tax purposes.  Pursuant to the DRP, stockholders may elect to reinvest any cash distribution in additional shares of common stock.  We record all distributions when declared, except that the stock issued through the DRP is recorded when the shares are actually issued.  Distributions declared and payable as of September 30, 2009 were $0.5 million, which included $0.1 million of cash distributions payable.

The following are the distributions declared by quarter for the nine months ended September 30, 2009 and 2008.

On September 29, 2009, the Company’s board of directors declared distributions payable to the stockholders of record each day during the months of October, November, and December 2009.  Distributions payable to each stockholder of record will be paid on or before the 16th day of the following month.

9.                                     Related Party Transactions

Our advisor and certain of its affiliates will receive fees and compensation in connection with the Offering, and in connection with the acquisition, management, and sale of our assets.

Behringer Securities LP (“Behringer Securities”), the dealer-manager and an affiliate of our advisor, receives commissions of up to 7% of gross offering proceeds.  Behringer Securities reallows 100% of selling commissions earned to participating broker-dealers.  In addition, we pay Behringer Securities a dealer manager fee of up to 2.5% of gross offering proceeds.  Pursuant to separately negotiated agreements, Behringer Securities may reallow a portion of its dealer manager fee

14

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

in an aggregate amount up to 2% of gross offering proceeds to broker-dealers participating in the Offering; provided, however, that Behringer Securities may reallow, in the aggregate, no more than 1.5% of gross offering proceeds for marketing fees and expenses, conference fees and non-itemized, non-invoiced due diligence efforts and no more than 0.5% of gross offering proceeds for out-of-pocket and bona fide, separately invoiced due diligence expenses incurred as fees, costs or other expenses from third parties.  Further, in special cases pursuant to separately negotiated agreements and subject to applicable limitations imposed by the Financial Industry Regulatory Authority, Behringer Securities may use a portion of its dealer manager fee to reimburse certain broker-dealers participating in the Offering for technology costs and expenses associated with the Offering and costs and expenses associated with the facilitation of the marketing and ownership of our shares by such broker-dealers’ customers.  No selling commissions or dealer manager fee will be paid for sales under the DRP.  For the nine months ended September 30, 2009, Behringer Securities earned selling commissions and dealer manager fees of $3.3 million and $1.2 million, respectively, which were recorded as a reduction to additional paid-in capital.  For the nine months ended September 30, 2008, Behringer Securities earned selling commissions and dealer manager fees of $3.7 million and $1.4 million, respectively, which were recorded as a reduction to additional paid-in capital.

We reimburse Behringer Opportunity Advisors II or its affiliates for any organization and offering expenses incurred on our behalf in connection with our primary offering (other than selling commissions and the dealer manager fee).  Through September 30, 2009 we would not reimburse expenses that would cause our total organization and offering expenses related to the primary offering (other than selling commissions and the dealer manager fee) to exceed 1.5% of gross offering proceeds from the primary offering as of the date of reimbursement.  Since our inception through September 30, 2009, approximately $8.5 million of organization and offering expenses had been incurred by Behringer Opportunity Advisors II or its affiliates on our behalf.  Of this amount, $1.8 million had been reimbursed by us and $6.7 million of reimbursements payable is included in payables to affiliates on our balance sheet.  Of the $6.7 million of reimbursements payable as of September 30, 2009, $0.1 million had been expensed as organizational costs with the remainder recorded as a reduction of additional paid-in capital.  Behringer Opportunity Advisors II or its affiliates determines the amount of organization and offering expenses owed based on specific invoice identification as well as an allocation of costs to us and other Behringer Harvard programs, based on respective equity offering results of those entities in offering.

On October 2, 2009, we entered into an Amended and Restated Advisory Management Agreement with Behringer Opportunity Advisors II.  The Amended and Restated Advisory Management Agreement changes the timing in determining the reimbursement of organization and offering expenses by us during the offering and waives the reimbursement of $3.5 million of organization and offering expenses (other than selling commissions and the dealer manager fee) the advisor incurred on our behalf through December 31, 2008.  Pursuant to the Amended and Restated Advisory Management Agreement we will reimburse our advisor for organization and offering expenses (other than selling commissions and the dealer manager fee) incurred on our behalf until an aggregate of $7.5 million of such organization and offering expenses have been reimbursed to our advisor.  Thereafter, we will not reimburse any such organization and offering expenses until the completion of our primary offering.  Upon completion of our primary offering, we will reimburse our advisor for any additional organization and offering expenses (other than selling commissions and the dealer manager fee) incurred up to 1.5% of the gross proceeds from the completed primary offering; provided however, we will not be required to reimburse our advisor any additional amounts and our advisor will be required to reimburse us to the extent that the total amount spent by us on organization and offering expenses (other than selling commissions and the dealer manager fee) would exceed 1.5% of the gross proceeds from the completed primary offering.  In connection with the Amended and Restated Advisory Management Agreement, we reimbursed $2.7 million of organization and offering expenses to Behringer Opportunity Advisors II on October 20, 2009.

Our advisor or its affiliates will also receive acquisition and advisory fees of 2.5% of the amount paid and/or budgeted in respect of the purchase, development, construction, or improvement of each asset we acquire, including any debt attributable to these assets.  Our advisor and its affiliates will also receive acquisition and advisory fees of 2.5% of the funds advanced in respect of a loan or other investment.

Our advisor or its affiliates also receive an acquisition expense reimbursement in the amount of 0.25% of the funds paid for purchasing an asset, including any debt attributable to the asset, plus 0.25% of the funds budgeted for development, construction, or improvement in the case of assets that we acquire and intend to develop, construct, or improve.  Our advisor or its affiliates will also receive an acquisition expense reimbursement in the amount of 0.25% of the funds advanced in respect of a loan or other investment.  In addition, to the extent our advisor or its affiliates directly provide services formerly provided or usually provided by third parties, including without limitation accounting services related to the preparation of audits required by the SEC, property condition reports, title services, title insurance, insurance brokerage or environmental services related to the preparation of environmental assessments in connection with a prospective or completed investment the direct employee costs and burden to our advisor of providing these services will be acquisition expenses.  We also pay

15

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

third parties, or reimburse the advisor or its affiliates, for any investment-related expenses due to third parties in the case of a completed investment, including, but not limited to, legal fees and expenses, travel and communication expenses, costs of appraisals, accounting fees and expenses, third-party brokerage or finder’s fees, title insurance, premium expenses, and other closing costs.  In addition, acquisition expenses include any payments made to (i) a prospective seller of an asset, (ii) an agent of a prospective seller of an asset, or (iii) a party that has the right to control the sale of an asset intended for investment by us that are not refundable and that are not ultimately applied against the purchase price for such asset.  Except as described above with respect to services customarily or previously provided by third parties, our advisor is responsible for paying all of the expenses it incurs associated with persons employed by the advisor to the extent dedicated to making investments for us, such as wages and benefits of the investment personnel.  Our advisor or its affiliates are also responsible for paying all of the investment-related expenses that we or our advisor or its affiliates incur that are due to third parties with respect to investments we do not make.  For the nine months ended September 30, 2009, we incurred $0.3 million in acquisition and advisory fees and $0.1 million in acquisition expense reimbursements.  We incurred no acquisition and advisory fees or acquisition expense reimbursements for the nine months ended September 30, 2008.

We pay our advisor or its affiliates a debt financing fee of 1% of the amount available under any loan or line of credit made available to us.  It is anticipated that our advisor will pay some or all of these fees to third parties with whom it subcontracts to coordinate financing for us. We incurred no such fees for the nine months ended September 30, 2009 or 2008.

We pay our advisor or its affiliates a development fee in an amount that is usual and customary for comparable services rendered to similar projects in the geographic market of the project if such affiliate provides the development services and if a majority of our independent directors determines that such development fee is fair and reasonable and on terms and conditions not less favorable than those available from unaffiliated third parties.  We incurred no such fees for the nine months ended September 30, 2009 or 2008.

We pay our property manager and affiliate of our advisor, Behringer Harvard Opportunity II Management Services, LLC (“BHO II Management”), or its affiliates, fees for the management, leasing, and construction supervision of our properties.  Property management fees are 4.5% of the gross revenues of the properties managed by BHO II Management or its affiliates plus leasing commissions based upon the customary leasing commission applicable to the same geographic location of the respective property.  In the event that we contract directly with a third-party property manager in respect of a property, BHO II Management or its affiliates receives an oversight fee equal to 0.5% of the gross revenues of the property managed.  In no event will BHO II Management or its affiliates receive both a property management fee and an oversight fee with respect to any particular property.  In the event we own a property through a joint venture that does not pay BHO II Management directly for its services, we will pay BHO II Management a management fee or oversight fee, as applicable, based only on an economic interest in the property.  We incurred and expensed property management fees or oversight fees to BHO II Management of less than $0.1 million for the nine months ended September 30, 2009.  We incurred no such fees for the nine months ended September 30, 2008.

We pay our advisor or its affiliates a monthly asset management fee of one-twelfth of 1.0% of the sum of the higher of the cost or value of each asset.  For the nine months ended September 30, 2009, we expensed $0.3 million of asset management fees.  We incurred no such fees for the nine months ended September 30, 2008.

Our advisor or its affiliates also will be paid a disposition fee if the advisor or its affiliates provide a substantial amount of services, as determined by our independent directors, in connection with the sale of one or more assets.  In such event, our advisor or its affiliates will receive a disposition fee equal to (1) in the case of the sale of real property, the lesser of: (A) one-half of the aggregate brokerage commission paid (including the disposition fee) or, if none is paid, the amount that customarily would be paid, or (B) 3% of the sales price of each property sold, and (2) in the case of the sale of any asset other than real property, 3% of the sales price of such asset.

We reimburse our advisor or its affiliates for all expenses paid or incurred by the advisor in connection with the services provided to us, subject to the limitation that we will not reimburse our advisor for any amount by which its operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceeds the greater of:  (A) 2% of our average invested assets, or (B) 25% of our net income determined without reduction for any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of our assets for that period.  Notwithstanding the above, we may reimburse the advisor for expenses in excess of this limitation if a majority of our independent directors determines that such excess expenses are justified based on unusual and non-recurring factors.  For the nine months ended September 30, 2009 and 2008, we incurred and expensed such costs for administrative services totaling $0.3 million and $0.1 million, respectively.

We are dependent on Behringer Securities, Behringer Opportunity Advisors II, and BHO II Management for certain services that are essential to us, including the sale of shares of our common stock, asset acquisition and disposition decisions,

16

Table of Contents

Behringer Harvard Opportunity REIT II, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

property management and leasing services, and other general administrative responsibilities.  In the event that these companies were unable to provide us with their respective services, we would be required to obtain such services from other sources.

10.                              Fair Value Disclosure of Financial Instruments

We determined the following disclosure of estimated fair values using available market information and appropriate valuation methodologies.  However, considerable judgment is necessary to interpret market data and develop the related estimates of fair value.  Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized upon disposition of the financial instruments.  The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

As of September 30, 2009 and December 31, 2008, management estimated that the carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, other liabilities, payables/receivables from related parties, and distributions payable were at amounts that reasonably approximated their fair value based on their highly-liquid nature and/or short-term maturities.

As of September 30, 2009 and December 31, 2008, our note payable totaled $18.5 million and consisted of one variable interest loan that we entered into on December 31, 2008.  The loan has a variable interest rate with a minimum rate of 6.25%.  We believe that the carrying value of this loan approximates its fair value at September 30, 2009 and December 31, 2008.

As of September 30, 2009, the principal balance of our real estate loan receivable totaled $12.8 million.  The loan is a fixed rate loan and accrues interest at 18% per annum.  We invested in this loan on August 14, 2009.  We believe that the carrying value of the real estate loan receivable approximates its fair value as of September 30, 2009.  We did not have any real estate loans receivable outstanding as of December 31, 2008.

The fair value estimates presented herein are based on information available to our management as of September 30, 2009 and December 31, 2008.  Although our management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since that date, and current estimates of fair value may differ significantly from the amounts presented herein.

11.                              Supplemental Cash Flow Information

Supplemental cash flow information is summarized below:

12.                              Subsequent Event

On October 2, 2009, we purchased through a joint venture, at a discount, a 90% interest in a promissory note secured by a first lien mortgage for $25.4 million plus closing costs from the Federal Deposit Insurance Corporation as Receiver for Corus Bank, N.A.  The borrower is currently in default under the promissory note and the principal balance and accrued interest owed at the date of purchase was $65.8 million.  The collateral for the promissory note is a 408-unit multi-family complex, Palms of Monterrey, on a 28-acre site located in Fort Myers, Florida.  We are pursuing remedies available under the promissory note, including enforcement of the first lien mortgage through judicial foreclosure, involuntary receivership, or accepting a deed-in-lieu of foreclosure of the property securing the loan.  The investment was funded with proceeds from our ongoing public offering.

*****

17

Table of Contents

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

The following discussion and analysis should be read in conjunction with our accompanying financial statements and the notes thereto.

Forward-Looking Statements

This section contains forward-looking statements, including discussion and analysis of us and our subsidiaries, our financial condition, anticipated capital expenditures required to complete projects, amounts of anticipated cash distributions to our stockholders in the future and other matters.  These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on their knowledge and understanding of the business and industry.  Words such as “may,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “would,” “could,” “should,” and variations of these words and similar expressions are intended to identify forward-looking statements.  These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.

Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false.  We caution investors not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report on Form 10-Q.  We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results.  Factors that could cause actual results to differ materially from any forward-looking statements made in the Form 10-Q include changes in general economic conditions, changes in real estate conditions, construction costs that may exceed estimates, construction delays, increases in interest rates, lease-up risks, inability to obtain new tenants upon the expiration of existing leases, and the potential need to fund tenant improvements or other capital expenditures out of operating cash flow.  The forward-looking statements should be read in light of the risk factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2008, and the risks identified in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, each as filed with the SEC and the risks identified in Part II, Item 1A of this Quarterly Report on Form 10-Q.

Cautionary Note

The representations, warranties, and covenants made by us in any agreement filed as an exhibit to this quarterly report are made solely for the benefit of the parties to the agreement, including, in some cases, for the purpose of allocating risk among the parties to the agreement, and should not be deemed to be representations, warranties, or covenants to or with any other parties.  Moreover, these representations, warranties or covenants should not be relied upon as accurately describing or reflecting the current state of our affairs.

Executive Overview

We were formed primarily to acquire and operate commercial real estate and real estate-related assets on an opportunistic basis.  In particular, we focus generally on acquiring commercial properties with significant possibilities for short-term capital appreciation, such as those requiring development, redevelopment or repositioning, those located in markets and submarkets with high growth potential, and those available from sellers who are distressed or face time-sensitive deadlines.  In addition, given current economic circumstances, our opportunistic investment strategy may also include investments in loans secured by or related to real estate at more attractive rates of current return than have been available for some time.  Such loan investments may have capital gain characteristics, whether as a result of a discount purchase or related equity participations.  We may acquire a wide variety of commercial properties, including office, industrial, retail, hospitality, recreation and leisure, single-tenant, multifamily, and other real properties.  These properties may be existing, income-producing properties, newly constructed properties or properties under development or construction, and may include multifamily properties purchased for conversion into condominiums and single-tenant properties that may be converted for multi-tenant use.  Further, we may invest in real estate-related securities, including securities issued by other real estate companies, either for investment or in change of control transactions completed on a negotiated basis or otherwise.  We also may originate or invest in collateralized mortgage-backed securities, mortgage, bridge or mezzanine loans, and Section 1031 tenant-in-common interests (including those issued by affiliates of our advisor), or in entities that make investments similar to the foregoing.  We expect to make our investments in or in respect of real estate assets located in the United States and other countries based on our new and existing market conditions.  We completed our first property acquisition, an office building located in Denver, Colorado, on October 28, 2008.  On August 14, 2009, we entered into an agreement to provide up to $25 million of second lien financing for the privatization of and improvements to, approximately 3,200 hotel lodging units located on ten U.S. Army installations.  As of September 30, 2009, these are our only real estate investments.  On October 2, 2009, we purchased through a joint venture, at a discount, a 90% interest in a promissory note secured by a first lien

18

Table of Contents

mortgage for $25.4 million plus closing costs from the Federal Deposit Insurance Corporation as Receiver for Corus Bank, N.A.

On February 26, 2007, we filed a Registration Statement on Form S-11 with the SEC to offer up to 125,000,000 shares of common stock for sale to the public, of which 25,000,000 shares are being offered pursuant to our DRP.  We reserve the right to reallocate the shares we are offering between our primary offering and the DRP.  The SEC declared our Registration Statement effective on January 4, 2008, and we commenced our ongoing initial public offering on January 21, 2008.  We commenced operations on April 1, 2008 upon satisfaction of the conditions of our escrow agreement and acceptance of initial subscriptions of common stock.

Market Outlook

During 2008 and continuing into 2009, the U.S. and global economy experienced a significant downturn.  This downturn included disruptions in the broader financial and credit markets, declining consumer confidence, and an increase in unemployment rates.  These conditions have contributed to weakened market conditions.  Due to the struggling U.S. and global economies, we believe that overall demand across most real estate sectors including office, multifamily, hospitality, and retail will continue to decline due to losses in the financial and professional services industries and increasing unemployment.  Further, we believe that corresponding rental rates will also remain weak at least through the remainder of the current year.  The national vacancy percentage for office space increased from 14.5% in the fourth quarter of 2008 to 15.9% in the second quarter of 2009.  We also believe that tenant defaults across the nation are likely to increase in the short-term.  To date, we have not experienced any significant tenant defaults.

Our operating real estate asset is located in Denver, Colorado.  According to Property and Portfolio Research (“PPR”), although the Denver market has been hit hard by the current economic crisis, this market is expected to be one of the first to rebound with the recovery beginning in mid-2010.  It is anticipated that any rebound will be led in large part by increases in jobs in business and professional services and government hiring, as well as the education, health services, and information industries.  According to PPR, office vacancy rates in the Denver market will continue to rise through the remainder of 2009.

While it is unclear as to when the overall economy will recover, we do not expect conditions to improve significantly in the near future.  Management expects that the current volatility in the capital markets will continue, at least in the short-term.  This volatility has significantly impacted the availability of credit for borrowers. This tightening of credit may hinder our ability to take advantage of current opportunities in the marketplace.  We have placed a high priority on maintaining strong relationships with banks and other lenders.  We believe, though the opportunities for obtaining new credit have diminished, that our strong relationships with our lenders will enhance our opportunities for securing credit for future investments.

As a result of the existing economic conditions, our primary objectives are to raise capital and to take advantage of favorable investment opportunities.  We believe that the current economic environment will result in investment opportunities for many high-quality real estate and real estate-related assets.  To the extent that we have capital available to invest, we plan to actively pursue investment opportunities.

Liquidity and Capital Resources

Our principal demands for funds will be for the acquisition of real estate and real estate-related assets, for the payment of operating expenses and distributions, and for the payment of interest on our outstanding indebtedness.  Generally, we expect to meet cash needs for items other than acquisitions from our cash flow from operations, and we expect to meet cash needs for acquisitions from the net proceeds of the Offering and from financings.

We expect to fund our short-term liquidity requirements by using the net proceeds realized from the Offering and cash flow from the operations of investments we acquire.  Operating cash flows are expected to increase as additional real estate assets are added to the portfolio.  For both our short-term and long-term liquidity requirements, other potential future sources of capital may include proceeds from secured or  unsecured financings from banks or other lenders, proceeds from the sale of our investments, if and when any are sold, and undistributed funds from operations.  If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures.

Our advisor may, but is not required to, establish capital reserves from gross offering proceeds, out of cash flow generated by operating properties and other investments, or out of non-liquidating net sale proceeds from the sale of our properties and other investments.  Capital reserves are typically utilized for non-operating expenses such as tenant improvements, leasing commissions and major capital expenditures.  Alternatively, a lender may require its own formula for escrow of capital reserves.

We intend to borrow money to acquire properties and make other investments.  There is no limitation on the amount we may invest in any single property or other asset or on the amount we can borrow for the purchase of any individual

19

Table of Contents

property or other investment.  Under our charter, the maximum amount of our indebtedness shall not exceed 300% of our “net assets” (as defined by the NASAA REIT Guidelines) as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent directors.  In addition to our charter limitation, our board of directors has adopted a policy to generally limit our aggregate borrowings to approximately 75% of the aggregate value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests.  Our policy limitation, however, does not apply to individual real estate assets and will only apply once we have ceased raising capital under the Offering or any subsequent offering and invested substantially all of our capital.  As a result, we expect to borrow more than 75% of the contract purchase price of each real estate asset we acquire during the early periods of our operations to the extent our board of directors determines that borrowing at these levels is prudent.

Recently, the U.S. credit markets and the sub-prime residential mortgage market have experienced severe dislocations and liquidity disruptions. Sub-prime mortgage loans have experienced increasing rates of delinquency, foreclosure and loss. These and other related events continue to have a significant impact on the capital markets associated not only with sub-prime mortgage-backed securities, asset-backed securities and collateralized debt obligations, but also with the U.S. housing, credit and financial markets as a whole.

The commercial real estate debt markets are currently experiencing volatility as a result of certain factors, including the tightening of underwriting standards by lenders and credit rating agencies and the significant inventory of unsold collateralized mortgage-backed securities in the market.  Credit spreads for major sources of capital have widened significantly as investors have demanded a higher risk premium.  This is resulting in lenders increasing the cost for debt financing.  Consequently, there is greater uncertainty regarding our ability to access the credit markets in order to attract financing on reasonable terms. Our ability to borrow funds to finance future acquisitions could be adversely affected by our inability to secure permanent financing on reasonable terms, if at all.

Should the overall cost of borrowings increase, either by increases in the index rates or by increases in lender spreads, we will need to factor such increases into the economics of our acquisitions, developments and property contributions.  This may result in our investment operations generating lower overall economic returns and a reduced level of cash flow, which could potentially impact our ability to make distributions to our stockholders at current levels.  In addition, the recent dislocations in the debt markets have reduced the amount of capital that is available to finance real estate, which, in turn: (i) leads to a decline in real estate values generally; (ii) slows real estate transaction activity; (iii) reduces the loan to value upon which lenders are willing to extend debt; and, (iv) results in difficulty in refinancing debt as it becomes due, all of which may reasonably be expected to have a material adverse impact on the value of real estate investments and the revenues, income or cash flow from the acquisition and operations of real properties and mortgage loans.  In addition, the current state of the debt markets has negatively impacted the ability to raise equity capital.

If the current debt market environment persists, we may modify our investment strategies in order to seek to optimize our portfolio performance.  Our strategies may include, among other options, limiting or eliminating the use of debt and focusing on those investments that do not require the use of leverage to meet our portfolio goals.

Debt Financings

We may, from time to time, make mortgage, bridge, or mezzanine loans and other loans for acquisitions and investments as well as property development.  We may obtain financing at the time an asset is acquired or an investment is made or at such later time as determined to be necessary, depending on multiple factors.

At September 30, 2009, our note payable balance was $18.5 million and consisted of the note payable related to 1875 Lawrence.  We have unconditionally guaranteed payment of the loan for an amount not to exceed the lesser of (i) $11.75 million and (ii) 50% of the total amount advanced under the loan agreement if the aggregate amount advanced is less than $23.5 million.  At September 30, 2009, the interest rate on this note was 6.25%, and the loan matures on December 31, 2012.  Our loan agreement stipulates that we comply with certain reporting and financial covenants.  These covenants include, among other things, maintaining minimum debt service coverage ratios.  As of September 30, 2009, we believe we were in compliance with the debt covenants under our loan agreement.

20

Table of Contents

One of our principal long-term liquidity requirements includes the repayment of maturing debt.  The following table provides information with respect to the maturities and scheduled principal repayments of our indebtedness as of September 30, 2009.  The table does not represent any extension options.

Results of Operations

As of September 30, 2009, we had invested in two real estate assets:  1875 Lawrence, an office building located in Denver, Colorado, and a real estate loan receivable to provide up to $25 million of second lien financing (“PAL Loan”) for the privatization of and improvements to, approximately 3,200 hotel lodging units on ten U.S. Army installations.  As of September 30, 2008, we had no real estate or real estate-related assets.  Accordingly, our results of operations for the respective periods presented reflect increases in most categories due to the growth of our portfolio.  Management expects increases in most categories in the future as we purchase additional real estate and real estate-related assets and as we begin to realize the full year impact of our existing acquisitions.

Three months ended September 30, 2009 as compared to the three months ended September 30, 2008

Revenues.  Revenues for the three months ended September 30, 2009 were $1.6 million and were generated by our two consolidated real estate investments.  Of the total $1.6 million in revenue, $0.3 million was interest income from the PAL Loan, a real estate loan receivable entered into on August 14, 2009.  No revenue was generated for the three months ended September 30, 2008.  We expect increases in revenue in the future as we purchase additional real estate assets.

Property Operating Expenses.  Property operating expenses for the three months ended September 30, 2009 were $0.3 million and were comprised of operating expenses of 1875 Lawrence.  We incurred no property operating expenses for the three months ended September 30, 2008. We expect increases in property operating expenses in the future as we purchase additional real estate assets.

Interest Expense.  Interest expense for the three months ended September 30, 2009 was $0.3 million and was comprised of interest related to our note payable on 1875 Lawrence.  There was no interest expense for the three months ended September 30, 2008.  We expect increases in interest expense in the future as we purchase additional real estate assets and assume additional debt.

Property Management Fees.  Property management fees for the three months ended September 30, 2009 were less than $0.1 million and were comprised of fees related to 1875 Lawrence.  There were no property management fees for the

21

Table of Contents

three months ended September 30, 2008.  We expect increases in property management fees in the future as we purchase additional real estate assets.

Asset Management Fees.  Asset management fees for the three months ended September 30, 2009 were $0.1 million and were comprised of fees related to 1875 Lawrence and the PAL Loan.  There were no asset management fees for the three months ended September 30, 2008.  We expect increases in asset management fees in the future as we purchase additional real estate assets.

General and Administrative Expenses.  General and administrative expenses for the three months ended September 30, 2009 were $0.5 million as compared to $0.1 million for the three months ended September 30, 2008, and were comprised of auditing fees, legal fees, board of directors’ fees, and other administrative expenses.  We expect increases in general and administrative expenses in the future as we purchase additional real estate assets.

Nine months ended September 30, 2009 as compared to nine months ended September 30, 2008

Revenues.  Revenues for the nine months ended September 30, 2009 were $4.4 million and were generated by our consolidated real estate investments, 1875 Lawrence and the PAL Loan.  No revenue was generated for the nine months ended September 30, 2008.  We expect increases in revenue in the future as we purchase additional real estate assets.

Property Operating Expenses.  Property operating expenses for the nine months ended September 30, 2009 were $0.9 million and were comprised of operating expenses of 1875 Lawrence.  We incurred no property operating expenses for the nine months ended September 30, 2008. We expect increases in property operating expenses in the future as we purchase additional real estate assets.

Interest Expense.  Interest expense for the nine months ended September 30, 2009 was $1 million and was comprised of interest related to our note payable on 1875 Lawrence.  There was no interest expense for the nine months ended September 30, 2008.  We expect increases in interest expense in the future as we purchase additional real estate assets and assume additional debt.

Property Management Fees.  Property management fees for the nine months ended September 30, 2009 were      $0.1 million and were comprised of fees related to 1875 Lawrence.  There were no property management fees for the nine months ended September 30, 2008.  We expect increases in property management fees in the future as we purchase additional real estate assets.

Asset Management Fees.  Asset management fees for the nine months ended September 30, 2009 were $0.3 million and were comprised of fees related to 1875 Lawrence and the PAL Loan.  There were no asset management fees for the nine months ended September 30, 2008.  We expect increases in asset management fees in the future as we purchase additional real estate assets.

General and Administrative Expenses.  General and administrative expenses for the nine months ended September 30, 2009 were $1.2 million, as compared to $0.4 million for the nine months ended September 30, 2008, and were comprised of auditing fees, legal fees, board of directors’ fees, and other administrative expenses.  We expect increases in general and administrative expenses in the future as we purchase additional real estate assets.

22

Table of Contents

Cash Flow Analysis

Cash used in operating activities for the nine months ended September 30, 2009 was $0.7 million, and was comprised primarily of the net loss of $1 million, changes in prepaid expenses and other assets of $0.1 million, an increase in interest receivable of $0.3 million principally related to the PAL Loan, and changes in net payables to related parties of $0.3 million, offset by depreciation and amortization of $1 million and changes in accrued liabilities of $0.3 million.  Cash used in operating activities for the nine months ended September 30, 2008 was $0.8 million and was comprised of the net loss of $0.2 million, changes in net payables to related parties of $0.5 million and changes in prepaid expenses and other assets of $0.2 million.

Cash used in investing activities for the nine months ended September 30, 2009 was $36.7 million, and was comprised primarily of acquisition deposits for the purchase of a 90% interest in a discounted promissory note (see Note 12 to the unaudited financial statements) of $23.7 million, and the net investment in real estate loan receivable of $12.6 million.  Cash used in investing activities for the nine months ended September 30, 2008 was $1 million which was escrow deposits and other assets related to our acquisition of 1875 Lawrence.

Cash provided by financing activities for the nine months ended September 30, 2009 was $42.1 million, and was comprised of the issuance of common stock, net of offering costs, of approximately $43 million offset by distributions of $0.7 million and redemptions of common stock of $0.2 million.  Cash provided by financing activities for the nine months ended September 30, 2008 was $49.5 million, and was primarily comprised of the issuance of common stock, net of offering costs, of $49.5 million.

Total Operating Expenses

In accordance with the Statement of Policy Regarding Real Estate Investment Trusts published by the North American Securities Administrators Association, also known as the NASAA REIT Guidelines, our charter requires that we monitor our expenses on a trailing twelve month basis.  Our charter defines the following terms and requires that our Total Operating Expenses (“TOE”) are deemed to be excessive if at the end of any quarter they exceed for the prior trailing twelve month period the greater of 2% of our Average Invested Assets (“AIA”) or 25% of our Net Income (“NI”).  For the trailing twelve months ended September 30, 2009, TOE of $1.8 million exceeded the greater of 2% of our AIA or 25% of our NI by $1 million.  Our Board of Directors, including all of our independent directors, have reviewed this analysis and unanimously determined the excess to be justified because the Company did not acquire its first real estate or real estate-related asset until October 28, 2008, which caused the expenses it incurred in connection with its organization and as a result of being a public company for audit and legal services, director and officer liability insurance, and fees and expenses for board members in connection with service on the board and its committees to be disproportionate to the Company’s AIA and its NI.

Funds from Operations and Modified Funds from Operations

Funds from operations (“FFO”) is a non-GAAP financial measure that is widely recognized as a measure of REIT operating performance.  We use FFO, defined by the National Association of Real Estate Investment Trusts as net income (loss), computed in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains (or losses) from sales of property, plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships, joint ventures, and subsidiaries, as one measure to evaluate our operating performance.  In addition to FFO, we use modified funds from operations (“Modified Funds from Operations” or “MFFO”), which excludes from FFO acquisition-related costs, impairment charges, and adjustments to fair value for derivatives not qualifying for hedge accounting, to further evaluate our operating performance.

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate diminishes predictably over time.  Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting alone to be insufficient.  As a result, our management believes that the use of FFO and MFFO, together with the required GAAP presentations, provides a more complete understanding of our performance.

We believe that FFO is helpful to investors and our management as a measure of operating performance because it excludes depreciation and amortization, gains and losses from property dispositions, and extraordinary items, and as a result, when compared year to year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, which is not immediately apparent from net income.  We believe MFFO is helpful to our investors and our management as a measure of operating performance because it excludes costs that management considers more reflective of investing activities and other non-operating items included in FFO.  By providing MFFO, we present information which assists investors in aligning their analysis with management’s analysis of long term, core operating activities.  We believe fluctuations in MFFO are more indicative of changes in operating activities and provide comparability in evaluating our performance over time and as compared to other real estate companies that may not have acquisition activities, derivatives, or affected by impairments.

23

Table of Contents

As explained below, management’s evaluation of our operating performance excludes the items considered in the calculation of MFFO based on the following economic considerations:

·                  Acquisition-related costs.  In evaluating investments in real estate, including both business combinations and investments accounted for under the equity method of accounting, management’s investment models and analysis differentiates costs to acquire the investment from the operations derived from the investment.  Prior to 2009, acquisition costs for these types of investments were capitalized; however beginning in 2009 acquisition costs related to business combinations are expensed.  We believe by excluding expensed acquisition costs, MFFO provides useful supplemental information that is comparable for each type of our real estate investments and is consistent with management’s analysis of the investing and operating performance of our properties.

·                  Impairment charges.  An impairment charge represents a downward adjustment to the carrying amount of a long-lived asset to reflect the current valuation of the asset even when the asset is intended to be held long-term.  Such adjustment, when properly recognized under GAAP, may lag the underlying consequences related to rental rates, occupancy and other operating performance trends.  The valuation is also based, in part, on the impact of current market fluctuations and estimates of future capital requirements and long-term operating performance that may not be directly attributable to current operating performance.  Because MFFO excludes impairment charges, management believes MFFO provides useful supplemental information by focusing on the changes in our operating fundamentals rather than changes that may reflect only anticipated losses.

·                  Adjustments to fair value for derivatives not qualifying for hedge accounting.  Management uses derivatives in the management of our debt and interest rate exposure.  We do not intend to speculate in these interest rate derivatives and accordingly period-to-period changes in derivative valuations are not primary factors in management’s decision-making process.  We believe by excluding the gains or losses from these derivatives, MFFO provides useful supplemental information on the realized economic impact of the hedges independent of short-term market fluctuations.

FFO or MFFO should not be considered as an alternative to net income (loss), as an indication of our liquidity, nor as an indication of funds available to fund our cash needs, including our ability to make distributions and should be reviewed in connection with other GAAP measurements.  For the three and nine months ended September 30, 2009 and 2008, we present only FFO as we did not report any such acquisition-related expenses, impairment charges, or adjustments to fair value for derivatives not qualifying for hedge accounting in our Consolidated Statements of Operations nor did we have any derivative financial instruments for the periods presented.  Our FFO as presented may not be comparable to amounts calculated by other REITs.

For the three and nine months ended September 30, 2009, FFO per share has been impacted by the increase in net proceeds realized from our existing offering of shares.  For the three and nine months ended September 30, 2009, we sold 1.8 million and 4.8 million shares of our common stock, respectively, increasing our outstanding shares by 24% and 65%, respectively.  The proceeds from the issuance are temporarily invested in short-term cash equivalents until they can be invested in real estate and real estate-related assets.  Due to lower interest rates on cash equivalent investments, interest earnings were minimal.  We expect to invest these proceeds in higher earning real estate and real estate-related assets consistent with our investment policy.  We believe this will add value to our stockholders over our longer term investment horizon, even if this results in less current period earnings.

24

Table of Contents

Our calculation of FFO for the three and nine months ended September 30, 2009 and 2008 is presented below (amounts in thousands except per share amounts):