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EXCEL - IDEA: XBRL DOCUMENT - United Development Funding IVFinancial_Report.xls
EX-32.1 - EXHIBIT 32.1 - United Development Funding IVv237808_ex32-1.htm
EX-10.1 - LOAN AGREEMENT - United Development Funding IVv237808_ex10-1.htm
EX-31.2 - EXHIBIT 31.2 - United Development Funding IVv237808_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - United Development Funding IVv237808_ex31-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
[Mark One]

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2011

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ____________ to ____________

Commission File Number: 000-54383

United Development Funding IV
(Exact Name of Registrant as Specified in Its Charter)

Maryland
 
26-2775282
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

1301 Municipal Way, Suite 100, Grapevine, Texas 76051
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code:  (214) 370-8960

N/A
(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 ¨

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 x   No  ¨

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.

Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer x (Do not check if a smaller reporting company)
Smaller reporting company ¨

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

The number of shares outstanding of the Registrant’s common shares of beneficial interest, par value $0.01 per share, as of the close of business on November 9, 2011 was 6,475,092.
 
 
 

 
 
UNITED DEVELOPMENT FUNDING IV
FORM 10-Q
Quarter Ended September 30, 2011

PART I
FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements.
   
       
 
Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010 (Audited)
 
3
       
 
Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 (Unaudited)
 
4
       
 
Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 (Unaudited)
 
5
       
 
Notes to Consolidated Financial Statements (Unaudited)
 
6
       
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
30
       
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
 
49
       
Item 4.
Controls and Procedures.
 
49
PART II
OTHER INFORMATION
       
Item 1.
Legal Proceedings.
 
51
       
Item 1A.
Risk Factors.
 
51
       
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
 
51
       
Item 3.
Defaults Upon Senior Securities.
 
52
       
Item 4.
(Removed and Reserved)
 
52
       
Item 5.
Other Information.
 
52
       
Item 6.
Exhibits.
 
52
       
Signatures.
   
53
 
 
2

 
 
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
UNITED DEVELOPMENT FUNDING IV
CONSOLIDATED BALANCE SHEETS

   
September 30,
2011
   
December 31,
2010
 
   
(unaudited)
   
(audited)
 
Assets
           
Cash and cash equivalents
  $ 6,735,150     $ 2,543,501  
Restricted cash
    -       689,967  
Accrued interest receivable
    3,927,301       1,503,367  
Accrued receivable – related parties
    879,182       553,515  
Loan participation interest – related parties
    12,600,736       6,190,133  
Notes receivable, net
    87,602,042       53,800,754  
Notes receivable – related parties
    14,557,835       5,627,299  
Deferred offering costs
    8,464,424       7,372,116  
Other assets
    1,132,982       1,290,132  
Total assets
  $ 135,899,652     $ 79,570,784  
                 
Liabilities and Shareholders’ Equity
               
Liabilities:
               
Accrued liabilities
  $ 302,009     $ 237,391  
Accrued liabilities – related parties
    8,286,071       8,103,153  
Distributions payable
    472,938       451,510  
Senior credit facility
    2,785,037       1,929,669  
Lines of credit
    8,299,645       4,087,797  
Notes payable
    14,022,052       18,167,025  
Total liabilities
    34,167,752       32,976,545  
                 
Commitments and contingencies
               
                 
Shareholders’ equity:
               
Shares of beneficial interest; $0.01 par value; 400,000,000 shares authorized; 5,897,849 shares issued and 5,872,909 shares outstanding at September 30, 2011, and 2,681,454 shares issued and 2,678,954 shares outstanding at December 31, 2010, respectively
    58,979       26,814  
Additional paid-in-capital
    102,963,330       46,750,375  
Accumulated deficit
    (791,603 )     (132,950 )
      102,230,706       46,644,239  
Less:  Treasury stock, 24,940 shares at September 30, 2011 and 2,500 shares at December 31, 2010, at cost
    (498,806 )     (50,000 )
Total shareholders’ equity
    101,731,900       46,594,239  
Total liabilities and shareholders’ equity
  $ 135,899,652     $ 79,570,784  

See accompanying notes to consolidated financial statements (unaudited).
 
 
3

 
 
UNITED DEVELOPMENT FUNDING IV
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues:
                       
Interest income
  $ 2,476,567     $ 724,373     $ 6,325,189     $ 1,053,807  
Interest income – related parties
    935,361       509,284       2,277,080       1,073,637  
Commitment fee income
    128,067       162,820       198,976       162,820  
Commitment fee income – related parties
    11,242       -       28,859       -  
Total revenues
    3,551,237       1,396,477       8,830,104       2,290,264  
                                 
Expenses:
                               
Interest expense
    406,907       306,913       1,293,222       518,450  
Advisory fee – related party
    511,254       212,082       1,284,948       375,488  
Provision for loan losses
    135,634       56,836       341,756       87,022  
General and administrative
    177,453       82,694       451,677       286,919  
General and administrative – related parties
    181,718       147,037       518,599       210,525  
                                 
Total expenses
    1,412,966       805,562       3,890,202       1,478,404  
                                 
Net income
  $ 2,138,271     $ 590,915     $ 4,939,902     $ 811,860  
                                 
Net income per share of beneficial interest
  $ 0.41     $ 0.36     $ 1.20     $ 0.79  
                                 
Weighted average shares outstanding
    5,207,240       1,632,222       4,103,100       1,033,233  
                                 
Distributions per weighted average share outstanding
  $ 0.45     $ 0.36     $ 1.36     $ 0.97  

See accompanying notes to consolidated financial statements (unaudited).
 
 
4

 
 
UNITED DEVELOPMENT FUNDING IV
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Nine Months Ended September 30,
 
   
2011
   
2010
 
Operating Activities
           
Net income
  $ 4,939,902     $ 811,860  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Provision for loan losses
    341,756       87,022  
Amortization expense
    289,938       99,363  
Changes in assets and liabilities:
               
Accrued interest receivable
    (2,423,934 )     (801,767 )
Accrued receivable – related parties
    (325,667 )     (56,651 )
Other assets
    (132,788 )     (543,109 )
Accrued liabilities
    64,618       194,275  
Net cash provided by (used in) operating activities
    2,753,825       (209,007 )
                 
Investing Activities
               
Investments in loan participation interests – related parties
    (18,408,632 )     (18,127,614 )
Principal receipts from loan participation interests – related parties
    11,998,029       9,241,095  
Investments in notes receivable
    (46,699,907 )     (41,850,082 )
Principal receipts from notes receivable
    12,556,863       2,471,289  
Investments in notes receivable – related parties
    (15,323,923 )     (4,414,884 )
Principal receipts from notes receivable – related parties
    6,393,387       1,382,386  
Net cash used in investing activities
    (49,484,183 )     (51,297,810 )
                 
Financing Activities
               
Proceeds from issuance of shares of beneficial interest
    62,243,519       34,747,997  
Purchase of treasury shares
    (443,782 )     (50,000 )
Proceeds from senior credit facility
    1,048,649       2,408,277  
Payments on senior credit facility
    (193,281 )     (129,118 )
Net borrowings on lines of credit
    4,211,848       4,725,000  
Proceeds from notes payable
    2,319,507       14,450,000  
Payments on notes payable
    (6,464,480 )     -  
Distributions
    (5,577,126 )     (1,000,031 )
Shareholders’ distribution reinvestment
    2,084,390       381,944  
Escrow payable
    -       (692,300 )
Restricted cash
    689,967       525,400  
Payments of offering costs
    (8,087,814 )     (4,516,921 )
Deferred offering costs
    (1,092,308 )     (2,307 )
Accrued liabilities – related parties
    182,918       1,383,207  
Net cash provided by financing activities
    50,922,007       52,231,148  
                 
Net increase in cash and cash equivalents
    4,191,649       724,331  
Cash and cash equivalents at beginning of period
    2,543,501       520,311  
Cash and cash equivalents at end of period
  $ 6,735,150     $ 1,244,642  
Supplemental Cash Flow Information:
         
Cash paid for interest
  $ 1,329,041     $ 404,704  
 
See accompanying notes to consolidated financial statements (unaudited).
 
 
5

 
 
UNITED DEVELOPMENT FUNDING IV
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

A. Nature of Business
 
United Development Funding IV (which may be referred to as the “Trust,” “we,” “our,” or “UDF IV”) was organized on May 28, 2008 (“Inception”) as a Maryland real estate investment trust (a “REIT”).  The Trust is the sole general partner of and owns a 99.999% partnership interest in United Development Funding IV Operating Partnership, L.P. (“UDF IV OP”), a Delaware limited partnership.  UMTH Land Development, L.P. (“UMTH LD”), a Delaware limited partnership and the affiliated asset manager of the Trust, is the sole limited partner and owner of 0.001% (minority interest) of the partnership interests in UDF IV OP.  At September 30, 2011 and December 31, 2010, UDF IV OP had no assets, liabilities or equity.  The Trust owns a 100% limited partnership interest in UDF IV Home Finance, LP (“UDF IV HF”), UDF IV Finance I, LP (“UDF IV FI”), UDF IV Finance II, LP (“UDF IV FII”), UDF IV Acquisitions, LP (“UDF IV AC”) and UDF IV Finance III, LP (“UDF IV FIII”), all Delaware limited partnerships.  The Trust is the sole member of (i) UDF IV HF Manager, LLC (“UDF IV HFM”), a Delaware limited liability company, the general partner of UDF IV HF; (ii) UDF IV Finance I Manager, LLC (“UDF IV FIM”), a Delaware limited liability company, the general partner of UDF IV FI; (iii) UDF IV Finance II Manager, LLC (“UDF IV FIIM”), a Delaware limited liability company, the general partner of UDF IV FII; (iv) UDF IV Acquisitions Manager, LLC (“UDF IV ACM”), a Delaware limited liability company, the general partner of UDF IV AC; and (v) UDF IV Finance III Manager, LLC (“UDF IV FIIIM”), a Delaware limited liability company, the general partner of UDF IV FIII.
 
As of September 30, 2011 and December 31, 2010, UDF IV HFM, UDF IV FIM, UDF IV FIIM, UDF IV ACM and UDF IV FIIIM had no assets, liabilities, or equity.
 
The Trust uses substantially all of the net proceeds from the public offering of common shares of beneficial interest in the Trust to originate, purchase, participate in and hold for investment secured loans made directly by the Trust or indirectly through its affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots, and the construction of model and new single-family homes, including development of mixed-use master planned residential communities. The Trust also makes direct investments in land for development into single-family lots, new and model homes and portfolios of finished lots and homes; provides credit enhancements to real estate developers, homebuilders, land bankers and other real estate investors; and purchases participations in, or finances for other real estate investors the purchase of, securitized real estate loan pools and discounted cash flows secured by state, county, municipal or other similar assessments levied on real property. The Trust also may enter into joint ventures with unaffiliated real estate developers, homebuilders, land bankers and other real estate investors, or with other United Development Funding-sponsored programs, to originate or acquire, as the case may be, the same kind of secured loans or real estate investments the Trust may originate or acquire directly.
 
UMTH General Services, L.P. (“UMTH GS” or “Advisor”), a Delaware limited partnership, is the Trust’s advisor and is responsible for managing the Trust’s affairs on a day-to-day basis.  UMTH GS has engaged UMTH LD as the Trust’s asset manager.  The asset manager oversees the investing and financing activities of the affiliated programs managed and advised by the Advisor and UMTH LD as well as oversees and provides the Trust’s board of trustees recommendations regarding investments and finance transactions, management, policies and guidelines and reviews investment transaction structure and terms, investment underwriting, investment collateral, investment performance, investment risk management, and the Trust’s capital structure at both the entity and asset level.
 
The Trust has no employees and does not maintain any physical properties.  The Trust’s operations are conducted at the corporate offices of the Trust’s advisor at 1301 Municipal Way, Grapevine, Texas.
 
B. Summary of Significant Accounting Policies
 
A summary of our significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:
 
 
6

 
 
Basis of Presentation
 
The accompanying unaudited consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, with the instructions to Form 10-Q and with Regulation S-X.  They do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  However, except as disclosed herein, there has been no material change to the information disclosed in our 2010 Annual Report on Form 10-K (the “Annual Report”).  The interim unaudited consolidated financial statements should be read in conjunction with the financial statements filed in our Annual Report.  In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments, consisting solely of normal recurring adjustments, considered necessary to present fairly our financial position as of September 30, 2011 and December 31, 2010, operating results for the three and nine months ended September 30, 2011 and 2010, and cash flows for the nine months ended September 30, 2011 and 2010.  Operating results and cash flows for the nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of the Trust and certain wholly-owned subsidiaries and all significant intercompany accounts and transactions have been eliminated.
 
Loan Participation Interest – Related Parties
 
Loan participation interest – related parties represents the purchase of a financial interest in certain interim construction loan and finished lot loan facilities originated by our affiliates.  We participate in these loans by funding the lending obligations of our affiliates under these credit facilities up to a maximum amount for each participation.  Such participations entitle us to receive payments of principal and interest from the borrower up to the amounts funded by us.  The participation interests are typically collateralized by promissory notes, first or second lien deeds of trust on the homes financed under the construction loans or lots financed under the lot loan facilities, and other loan documents.  None of such loans are insured or guaranteed by a federally owned or guaranteed mortgage agency.  The participations have terms ranging from 9 to 27 months and bear interest at rates ranging from 13% to 15%.  The participation interests may be paid off prior to maturity; however, we intend to hold all participation interests for the life of the loans.
 
Notes Receivable and Notes Receivable – Related Parties
 
Notes receivable and notes receivable – related parties are recorded at the lower of cost or net realizable value.  The notes are collateralized by a first or second lien deed of trust on the underlying real estate collateral or a pledge of ownership interests in the borrower, as well as promissory notes, assignments of certain lot sales contracts and earnest money, and other loan documents. None of such notes are insured or guaranteed by a federally owned or guaranteed mortgage agency.  The notes have terms ranging from 2 to 47 months and bear interest at rates ranging from 13% to 15%.  The notes may be paid off prior to maturity; however, the Trust intends to hold all notes for the life of the notes.
 
Allowance for Loan Losses

The allowance for loan losses is our estimate of incurred losses in our portfolio of loan participation interest – related parties, notes receivable, and notes receivable – related parties.  We periodically perform a detailed review of our portfolio of mortgage notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses.  We charge additions to the allowance for loan losses to current period earnings through a provision for loan losses.  Amounts determined to be uncollectible are charged directly against (and decrease) the allowance for loan losses (“charged off”), while amounts recovered on previously charged off accounts increase the allowance for loan losses.

Organization and Offering Expenses

Organization costs will be expensed as incurred in accordance with Statement of Position 98-5, Reporting on the Costs of Start-up Activities, currently within the scope of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 720-15.  Offering costs related to raising capital from debt will be capitalized and amortized over the term of such debt.  Offering costs related to raising capital from equity reduce equity and are reflected as shares issuance costs in shareholders’ equity.  Certain offering costs are currently being paid by our Advisor. As discussed in Note O, these costs will be reimbursed to our Advisor by the Trust.
 
 
7

 
 
Revenue Recognition
 
Interest income on loan participation interest – related parties, notes receivable and notes receivable – related parties is recognized over the life of the participation agreement or note agreement and recorded on the accrual basis.  Income recognition is suspended at either the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed.  As of September 30, 2011 and December 31, 2010, we were accruing interest on all loan participation interest – related parties, notes receivable and notes receivable – related parties.
 
Commitment fee income and Commitment fee income – related parties represents non-refundable fees charged to borrowers for entering into an obligation that commits us to make or acquire a loan or to satisfy a financial obligation of the borrower when certain conditions are met within a specified time period.  When a commitment is considered an integral part of the resulting loan and we believe there is a reasonable expectation that the commitment will be called upon, the commitment fee is recognized as revenue over the life of the resulting loan.  As of September 30, 2011 and December 31, 2010, approximately $437,000 and $176,000, respectively, of unamortized commitment fees are included as an offset of notes receivable. Approximately $105,000 and $19,000 of unamortized commitment fees are included as an offset of notes receivable – related party as of September 30, 2011 and December 31, 2010, respectively. When we believe it is unlikely that the commitment will be called upon or that the fee is not an integral part of the return of a specific future lending arrangement, the commitment fee is recognized as income when it is earned, based on the specific terms of the commitment.  We make a determination of revenue recognition on a case-by-case basis, due to the unique and varying terms of each commitment.
 
Acquisition and Origination Fees
 
We incur acquisition and origination fees, payable to UMTH LD, our asset manager, equal to 3% of the net amount available for investment in secured loans and other real estate assets (“Placement Fees”); provided, however, that we will not incur Placement Fees with respect to any asset level indebtedness we incur.  The Placement Fees that we incur will be reduced by the amount of any acquisition and origination fees and expenses paid by borrowers or investment entities to our Advisor or affiliates of our Advisor with respect to our investment.  We will not incur any Placement Fees with respect to any participation agreement we enter into with our affiliates or any affiliates of our Advisor for which our Advisor or affiliates of our Advisor have previously received acquisition and origination fees and expenses from such affiliate with respect to the same secured loan or other real estate asset.  Placement Fees are amortized into expense on a straight line basis over 7 years.  As of September 30, 2011 and December 31, 2010, approximately $1.9 million and $1.5 million, respectively, of such unamortized Placement Fees are included in notes receivable. Approximately $519,000 and $150,000 of unamortized Placement Fees are included in notes receivable – related party as of September 30, 2011 and December 31, 2010, respectively. As of September 30, 2011 and December 31, 2010, approximately $264,000 and $398,000, respectively, of unamortized Placement Fees are included in loan participation interest – related parties.
 
Income Taxes
 
We made an election under Section 856(c) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), to be taxed as a REIT, beginning with the taxable year ended December 31, 2010.  As a REIT, we generally are not subject to federal income tax on income that we distribute to our shareholders.  If we later fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates and may not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied unless we are entitled to relief under certain statutory provisions.  Such an event could materially and adversely affect our net income.  However, we intend to continue to operate so as to remain qualified as a REIT for federal income tax purposes.
 
 
8

 
 
Fair Value of Financial Instruments
 
In accordance with the reporting requirements of FASB ASC 825-10, Financial Instruments-Fair Value, we calculate the fair value of our assets and liabilities which qualify as financial instruments under this statement and include this additional information in the notes to the financial statements when the fair value is different than the carrying value of those financial instruments.  The estimated fair value of restricted cash, accrued interest receivable, accrued receivable – related parties, accounts payable and accrued liabilities approximates the carrying amounts due to the relatively short maturity of these instruments.  The estimated fair value of notes receivable, notes receivable – related parties, loan participation interest – related parties, senior credit facility, lines of credit and notes payable approximates the carrying amount since they bear interest at the market rate.
 
Impact of Recently Issued Accounting Standards
 
In July 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  ASU 2010-20 requires enhanced disclosures regarding the nature of credit risk inherent in an entity’s portfolio of financing receivables, how that risk is analyzed, and the changes and reasons for those changes in the allowance for credit losses.  It requires an entity to provide a greater level of disaggregated information about the credit quality of its financing receivables and its allowance for credit losses.  ASU 2010-20 will only impact disclosures.  Disclosures related to information as of the end of a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010, and appropriate disclosures have been included within these notes to consolidated financial statements.
 
Guarantees
 
From time to time we enter into guarantees of debtor’s borrowings and provide credit enhancements for the benefit of senior lenders in connection with our debtors and investments (collectively referred to as “guarantees”), and we account for such guarantees in accordance with FASB ASC 460-10, Guarantees.
 
Reclassifications
 
Certain reclassifications have been made to prior period amounts in order to conform with the current year presentation.
 
C.  Registration Statement
 
On November 12, 2009, the Trust’s Registration Statement on Form S-11, covering an initial public offering (the “Offering”) of up to 25,000,000 common shares of beneficial interest to be offered (the “Primary Offering”) at a price of $20 per share, was declared effective under the Securities Act of 1933, as amended.  The Offering also covers up to 10,000,000 common shares of beneficial interest to be issued pursuant to our distribution reinvestment plan (the “DRIP”) for $20 per share.  We reserve the right to reallocate the common shares of beneficial interest registered in the Offering between the Primary Offering and the DRIP.  The shares are being offered to investors on a reasonable best efforts basis, which means the dealer manager will use its reasonable best efforts to sell the shares offered, but is not required to sell any specific number or dollar amount of shares and does not have a firm commitment or obligation to purchase any of the offered shares.
 
D. Loan and Allowance for Credit Losses

Our aggregate loan portfolio is comprised of loan participation interest – related parties, notes receivable, net and notes receivable – related parties and is recorded at the lower of cost or estimated net realizable value.

   
September 30, 2011
   
December 31, 2010
 
Loan participation interest – related parties
  $ 12,601,000     $ 6,190,000  
Notes receivable, net
    87,602,000       53,801,000  
Notes receivable – related parties
    14,558,000       5,627,000  
Total
  $ 114,761,000     $ 65,618,000  

 
9

 
 
Our loans are classified as follows:

   
September 30, 2011
   
December 31, 2010
 
Real Estate:
           
Construction, acquisition and land development
  $ 113,117,000     $ 63,950,000  
Allowance for loan losses
    (504,000 )     (162,000 )
Unamortized commitment fees and placement fees
    2,148,000       1,830,000  
Total
  $ 114,761,000     $ 65,618,000  

As of September 30, 2011, we had originated or purchased 44 loans, including 5 loans that have been repaid in full by the respective borrower.  As of December 31, 2010, we had originated or purchased 27 loans, including 2 loans that had been repaid in full by the respective borrower.  For the nine months ended September 30, 2011, we had not purchased any loans. Of the 39 loans outstanding as of September 30, 2011, the scheduled maturity dates are as follows as of September 30, 2011:

    
Related Party
   
Non-related party
   
Total
 
Maturity
Date
 
Amount
   
Loans
   
% of
Total
   
Amount
   
Loans
   
% of
Total
   
Amount
   
Loans
   
% of
Total
 
Matured
  $ -       -       -     $ 715,000       2       1 %   $ 715,000       2       1 %
4Q11
    5,558,000       4       21 %     13,751,000       3       16 %     19,309,000       7       17 %
2012
    12,572,000       5       47 %     20,214,000       10       24 %     32,786,000       15       29 %
2013
    2,122,000       2       8 %     44,499,000       8       51 %     46,621,000       10       41 %
2014
    -       -       -       7,457,000       4       8 %     7,457,000       4       6 %
2015
    6,229,000       1       24 %     -       -       -       6,229,000       1       6 %
                                                                         
Total
  $ 26,481,000       12       100 %   $ 86,636,000       27       100 %   $ 113,117,000       39       100 %

The allowance for loan losses is our estimate of incurred losses in our portfolio of loan participation interest – related parties, notes receivable and notes receivable – related parties.  We periodically perform a detailed review of our portfolio of notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses.  We charge additions to the allowance for loan losses to current period earnings through a provision for loan losses.  Amounts determined to be uncollectible are charged directly against (and decrease) the allowance for loan losses (“charged off”), while amounts recovered on previously charged off amounts increase the allowance for loan losses.  The following table summarizes the change in the reserve for loan losses during the nine months ended September 30, 2011 and the year ended December 31, 2010, which is offset against notes receivable:

   
September 30, 2011
   
December 31, 2010
 
Balance, beginning of year
  $ 162,000     $ -  
Provision for loan losses
    342,000       162,000  
Charge-offs
    -       -  
Balance, end of period
  $ 504,000     $ 162,000  
 
A loan is placed on non-accrual status when income recognition is suspended at either the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. As of September 30, 2011 and December 31, 2010, we were accruing interest on all loan participation interest – related parties, notes receivable and notes receivable – related parties.
 
Loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. As of September 30, 2011 and December 31, 2010, we have no loans that are classified as impaired.
 
 
10

 
 
We have adopted the provisions of ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  In accordance with ASU 2011-02, the restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. As of September 30, 2011 and December 31, 2010, we have no loan modifications that are classified as troubled debt restructurings.
 
E.  Shareholders’ Equity
 
On December 18, 2009, the Trust’s initial public subscribers were accepted as shareholders pursuant to the Offering and the subscription proceeds from such initial public subscribers were released to the Trust from escrow.
 
As of September 30, 2011, the Trust had issued an aggregate of 5,897,849 common shares of beneficial interest pursuant to the Primary Offering and DRIP, consisting of 5,758,304 common shares of beneficial interest pursuant to the Primary Offering in exchange for gross proceeds of approximately $115.2 million (approximately $100.2 million, net of costs associated with the Primary Offering) and 139,545 common shares of beneficial interest in accordance with our DRIP in exchange for gross proceeds of approximately $2.8 million.  As of September 30, 2011, the Trust had redeemed an aggregate of 24,940 common shares of beneficial interest at a cost of approximately $494,000.
 
As of December 31, 2010, the Trust had issued an aggregate of 2,681,454 common shares of beneficial interest pursuant to the Primary Offering and DRIP, consisting of 2,646,129 common shares of beneficial interest pursuant to the Primary Offering in exchange for gross proceeds of approximately $52.9 million (approximately $46.0 million, net of costs associated with the Primary Offering) and 35,325 common shares of beneficial interest in accordance with our DRIP in exchange for gross proceeds of approximately $707,000.  As of December 31, 2010, the Trust had redeemed an aggregate of 2,500 common shares of beneficial interest at a cost of $50,000.
 
We must distribute to our shareholders at least 90% of our taxable income each year in order to meet the requirements for being treated as a REIT under the Internal Revenue Code.  This requirement is described in greater detail in the “Federal Income Tax Considerations – Annual Distribution Requirements” section of the prospectus for the Offering.  In accordance with this requirement, we pay monthly distributions to our shareholders.  Our distribution rate is determined quarterly by our board of trustees and is dependent on a number of factors, including funds available for payment of distributions, our financial condition, loan funding commitments and annual distribution requirements needed to maintain our status as a REIT under the Internal Revenue Code.  In addition to the monthly distributions, in an effort to ensure we distribute at least 90% of our taxable income, our board of trustees will periodically authorize additional, special distributions.  Monthly distributions and special distributions are paid in cash and DRIP shares.
 
Our board of trustees has authorized monthly distributions for our shareholders of record beginning as of the close of business for the period commencing on December 18, 2009 and ending on December 31, 2011.  For distributions declared for each record date in the December 2009 through June 2011 periods, our distribution rate was $0.0043836 per common share of beneficial interest, which is equal to an annualized distribution rate of 8.0%, assuming a purchase price of $20.00 per share.  For distributions declared for each record date in the July 2011 through December 2011 periods, our distribution rate is $0.0044932 per common share of beneficial interest, which is equal to an annualized distribution rate of 8.2%, assuming a purchase price of $20.00 per share.  These distributions are aggregated and paid monthly in arrears.  Distributions are paid on or about the 25th day of the respective month or, if the 25th day of the month falls on a weekend or bank holiday, on the next business day following the 25th day of the month.  Distributions for shareholders participating in our DRIP are reinvested into our shares on the payment date of each distribution.
 
 
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In addition to the distributions discussed above, the following table represents all special distributions authorized by our board of trustees through September 30, 2011:
 
Authorization Date (1)
 
Record Date (2)
 
Rate (3)
 
Pay Date (4)
September 8, 2010
 
September 15, 2010
  $ 0.05  
October 15, 2010
               
September 8, 2010
 
December 15, 2010
  $ 0.15  
February 1, 2011
               
March 10, 2011
 
April 30, 2011
  $ 0.10  
May 17, 2011
               
June 27, 2011
 
August 31, 2011
  $ 0.05  
September 13, 2011
 
 
(1)
Represents the date the distribution was authorized by our board of trustees.
 
 
(2)
All outstanding common shares of beneficial interest as of the record date receive the distribution.
 
 
(3)
Represents the distribution rate per common share of beneficial interest on the record date.
 
 
(4)
Represents the date the special distribution was paid in cash and DRIP shares.
 
As of September 30, 2011, we have made the following distributions to our shareholders in 2011:
 
Period Ended
 
Date Paid
 
Distribution
Amount
 
December 31, 2010
 
January 14, 2011
  $ 339,018  
December 31, 2010
 
February 1, 2011
    374,278  
January 31, 2011
 
February 23, 2011
    378,999  
February 28, 2011
 
March 23, 2011
    376,178  
March 31, 2011
 
April 21, 2011
    455,713  
April 30, 2011
 
May 17, 2011
    387,258  
April 30, 2011
 
May 24, 2011
    479,930  
May 31, 2011
 
June 24, 2011
    548,189  
June 30, 2011
 
July 22, 2011
    573,791  
July 31, 2011
 
August 24, 2011
    667,321  
August 31, 2011
 
September 13, 2011
    271,519  
August 31, 2011
 
September 23, 2011
    724,932  
        $ 5,577,126  
 
For the nine months ended September 30, 2011, we paid distributions of $5,577,126 ($3,492,736 in cash and $2,084,390 in our common shares of beneficial interest pursuant to our DRIP), as compared to cash flows provided by operations of $2,753,825.  From May 28, 2008 (Date of Inception) through September 30, 2011, we paid cumulative distributions of $7,463,169, as compared to cumulative funds from operations (“FFO”) of $7,695,353 (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Funds from Operations and Modified Funds from Operations” below for a discussion of FFO).  As of September 30, 2011, we had $472,938 of cash distributions declared that were paid subsequent to period end.
 
The distributions paid during the nine months ended September 30, 2011 and 2010, along with the amount of distributions reinvested pursuant to our DRIP and the sources of our distributions were as follows:

   
Nine Months Ended September 30,
 
   
2011
 
2010
 
Distributions paid in cash
  $ 3,492,736         $ 618,087      
Distributions reinvested
    2,084,390           381,944      
Total distributions
  $ 5,577,126         $ 1,000,031      
Source of distributions:
                       
Cash from operations
  $ 2,753,825     (49 )%   $ -     (0 )%
Borrowings under credit facilities
    2,823,301     (51 )%     1,000,031     (100 )%
Total sources
  $ 5,577,126     (100 )%   $ 1,000,031     (100 )%

 
12

 
 
In our initial quarters of operations, and from time to time thereafter, we did not generate enough cash flow to fully fund distributions declared.  Therefore, some or all of our distributions are paid from sources other than operating cash flow, such as borrowings (including borrowings secured by our assets) in anticipation of future operating cash flow. Distributions in excess of our operating cash flows have been funded via financing activities, specifically borrowings under our credit facilities, consistent with our intent to use our credit facilities to meet our investment and distribution cash requirements throughout our initial period of operations.
 
We utilize cash to fund operating expenses, make investments, service debt obligations and pay distributions.  We receive cash from operations (which includes interest payments) as well as cash from investing activities (which includes repayment of principal on loans we have made) and financing activities (which includes borrowing proceeds and additional capital from the sale of our shares).  We have secured a senior credit facility, notes payable, and lines of credit to manage the timing of our cash receipts and funding requirements.  Over the long term, as additional subscriptions for common shares are received and proceeds from such subscriptions are invested in revenue-generating real estate investments, we expect that substantially all of our distributions will be funded from operating cash flow.  Further, we believe operating income will improve in future periods as start-up costs and general and administrative expenses are borne over a larger investment portfolio.
 
F.  Share Redemption Program
 
We have adopted a share redemption program that enables our shareholders to sell their shares back to us in limited circumstances. Generally, this program permits shareholders to sell their shares back to us after they have held them for at least one year.  Except for redemptions upon the death of a shareholder (in which case we may waive the minimum holding periods), the purchase price for the redeemed shares, for the period beginning after a shareholder has held the shares for a period of one year, will be (1) 92% of the purchase price actually paid for any shares held less than two years, (2) 94% of the purchase price actually paid for any shares held for at least two years but less than three years, (3) 96% of the purchase price actually paid for any shares held at least three years but less than four years, (4) 98% of the purchase price actually paid for any shares held at least four years but less than five years and (5) for any shares held at least five years, the lesser of the purchase price actually paid or the then-current fair market value of the shares as determined by the most recent annual valuation of our shares.  The purchase price for shares redeemed upon the death of a shareholder will be the lesser of (1) the purchase price the shareholder actually paid for the shares or (2) $20.00 per share.
 
We reserve the right in our sole discretion at any time and from time to time to (1) waive the one-year holding period in the event of the death or bankruptcy of a shareholder or other exigent circumstances, (2) reject any request for redemption, (3) change the purchase price for redemptions, or (4) terminate, suspend and/or reestablish our share redemption program.   In respect of shares redeemed upon the death of a shareholder, we will not redeem in excess of 1% of the weighted average number of shares outstanding during the twelve-month period immediately prior to the date of redemption, and the total number of shares we may redeem at any time will not exceed 5% of the weighted average number of shares outstanding during the trailing twelve-month period prior to the redemption date. Our board of trustees will determine from time to time whether we have sufficient excess cash from operations to repurchase shares. Generally, the cash available for redemption will be limited to 1% of the operating cash flow from the previous fiscal year, plus any net proceeds from our DRIP.
 
The Trust complies with the Distinguishing Liabilities from Equity topic of the FASB Accounting Standards Codification, which requires, among other things, that financial instruments that represent a mandatory obligation of the Trust to repurchase shares be classified as liabilities and reported at settlement value.  We believe that shares tendered for redemption by the shareholder under the Trust’s share redemption program do not represent a mandatory obligation until such redemptions are approved at our discretion.  At such time, we will reclassify such obligations from equity to an accrued liability based upon their respective settlement values.  As of September 30, 2011, we did not have any approved redemption requests included in our liabilities.
 
 
13

 
 
The following table summarizes the redemption activity for the nine months ended September 30, 2011 and the year ended December 31, 2010. The amounts presented are in total shares:

   
September 30, 2011
   
December 31, 2010
 
Balance, beginning of year
    -       -  
Redemption requests received
    22,440       2,500  
Shares redeemed
    (22,440 )     (2,500 )
Balance, end of period
    -       -  
 
Shares redeemed are included in treasury stock in the consolidated balance sheet.
 
G.  Organizational and Offering Compensation
 
Various parties will receive compensation as a result of the Offering, including the Advisor, affiliates of the Advisor, the dealer manager and soliciting dealers. The Advisor or an affiliate of the Advisor funds organization and offering costs on the Trust’s behalf and our Advisor will be paid by the Trust for such costs in an amount equal to 3% of the gross offering proceeds raised by the Trust in the Offering (the “O&O reimbursement”) less any offering costs paid by the Trust directly (except that no organization and offering expenses will be reimbursed with respect to sales under the DRIP). Payments to the dealer manager include selling commissions (6.5% of gross offering proceeds, except that no commissions will be paid with respect to sales under the DRIP) and dealer manager fees (up to 3.5% of gross offering proceeds, except that no dealer manager fees will be paid with respect to sales under the DRIP).
 
H.  Operational Compensation
 
The Advisor or its affiliates will receive Placement Fees as described in Note B.  Placement Fees will not be paid with respect to any asset level indebtedness the Trust incurs. Placement Fees incurred by the Trust will be reduced by the amount of any acquisition and origination fees and expenses paid by borrowers or investment entities to the Advisor or affiliates of the Advisor with respect to the investment.  The Trust will not incur any Placement Fees with respect to any participation agreement the Trust enters into with its affiliates or any affiliates of the Advisor for which the Advisor or affiliates of the Advisor previously has received acquisition and origination fees and expenses from such affiliate with respect to the same secured loan or other real estate asset.
 
The Advisor will receive advisory fees of 2% per annum of the average of invested assets (“Advisory Fees”), including secured loan assets; provided, however, that no Advisory Fees will be paid with respect to any asset level indebtedness the Trust incurs.  The fee will be payable monthly in an amount equal to one-twelfth of 2% of the Trust’s average invested assets, including secured loan assets, as of the last day of the immediately preceding month.
 
The Advisor will receive 1% of the amount made available to the Trust pursuant to the origination of any line of credit or other debt financing, provided that the Advisor has provided a substantial amount of services as determined by the Trust’s independent trustees and, on each anniversary date of the origination of any such line of credit or other debt financing, an additional fee of 0.25% of the primary loan amount (collectively, “Debt Financing Fees”) will be paid if such line of credit or other debt financing continues to be outstanding on such date, or a prorated portion of such additional fee will be paid for the portion of such year that the financing was outstanding.
 
The Trust will reimburse the expenses incurred by the Advisor in connection with its provision of services to the Trust (the “Advisor Expense Reimbursement”), including the Trust’s allocable share of the Advisor’s overhead, such as rent, personnel costs, utilities and IT costs. The Trust will not reimburse the Advisor for personnel costs in connection with services for which the Advisor or its affiliates receive other fees.
 
The Advisor will receive 15% of the amount by which the Trust’s net income for the immediately preceding year exceeds a 10% per annum return on aggregate capital contributions, as adjusted to reflect prior cash distributions to shareholders which constitute a return of capital. This fee will be paid annually and upon termination of the advisory agreement.
 
 
14

 
 
I.  Disposition/Liquidation Compensation
 
Upon successful sales by the Trust of securitized loan pool interests, the Advisor will be paid a securitized loan pool placement fee equal to 2% of the net proceeds realized by the Trust, provided the Advisor or an affiliate of the Advisor has provided a substantial amount of services as determined by the Trust’s independent trustees.
 
For substantial assistance in connection with the sale of properties, the Trust will pay the Advisor or its affiliates disposition fees of the lesser of one-half of the reasonable and customary real estate or brokerage commission or 2% of the contract sales price of each property sold; provided, however, in no event may the disposition fees paid to the Advisor, its affiliates and unaffiliated third parties exceed 6% of the contract sales price. The Trust’s independent trustees will determine whether the Advisor or its affiliate has provided substantial assistance to the Trust in connection with the sale of a property. Substantial assistance in connection with the sale of a property includes the Advisor’s preparation of an investment package for the property (including a new investment analysis, rent rolls, tenant information regarding credit, a property title report, an environmental report, a structural report and exhibits) or such other substantial services performed by the Advisor in connection with a sale.
 
Upon listing the Trust’s common shares of beneficial interest on a national securities exchange, the Advisor will be entitled to a fee equal to 15% of the amount, if any, by which (1) the market value of the Trust’s outstanding shares plus distributions paid by the Trust prior to listing, exceeds (2) the sum of the total amount of capital raised from investors and the amount of cash flow necessary to generate a 10% annual cumulative, non-compounded return to investors.
 
J.  Senior Credit Facility
 
On May 19, 2010, UDF IV HF entered into a $6 million revolving line of credit (the “UDF IV HF CTB LOC”) with Community Trust Bank (“CTB”).  The UDF IV HF CTB LOC bears interest at prime plus 1%, subject to a floor of 5.5% (5.5% at September 30, 2011), and requires monthly interest payments.  Advances under the line may be made from time to time through May 2013.  Proceeds from the line of credit will be used to fund our obligations under our interim home construction loan agreements.  Advances are subject to a borrowing base and are secured by the pledge of a first lien security interest in the residential real estate being financed.  Principal and all unpaid interest will be due at maturity, which is February 2014.  The UDF IV HF CTB LOC is guaranteed by us and by United Development Funding III, L.P. (“UDF III”), an affiliated Delaware limited partnership.
 
In connection with this line of credit, UDF IV HF agreed to pay a Debt Financing Fee of $60,000 to UMTH GS and an origination fee of $60,000 to CTB.  On the anniversary date of this line of credit, in May 2011, we agreed to pay an additional Debt Financing Fee of $15,000 to UMTH GS.  In consideration of UDF III guaranteeing the line of credit, UDF IV HF agreed to pay UDF III an annual credit enhancement fee equal to 1% of the line of credit amount.
 
The outstanding balance on the line of credit was approximately $2.8 million and $1.9 million as of September 30, 2011 and December 31, 2010, respectively.
 
K.  Notes Payable
 
Credit Facility
 
On February 5, 2010, we obtained a revolving credit facility in the maximum principal amount of $8 million (the “Credit Facility”) from Raley Holdings, LLC, an unaffiliated company (the “Lender”).  The interest rate on the Credit Facility is equal to 8.5% per annum.  Accrued interest on the outstanding principal amount of the Credit Facility is payable monthly.  The Credit Facility’s original maturity date was February 5, 2011.  Effective August 10, 2010, the Credit Facility was amended to increase the maximum principal amount to $20 million, pursuant to a First Amendment to Secured Line of Credit Promissory Note between us and the Lender.  On February 8, 2011, we executed an extension agreement that extended the maturity date of the Credit Facility to February 5, 2012.  The Credit Facility is secured by a first priority collateral assignment and lien on certain of our assets.
 
 
15

 
 
The Lender may, in its discretion, decide to advance additional principal to us under the Credit Facility.  The Lender may require us to provide additional collateral as a condition of funding additional advances of principal under the Credit Facility.  From time to time, we may request the Lender to release collateral, and the Lender may require a release price to be paid as a condition of granting its release of collateral.
 
If a default occurs under the Credit Facility, the Lender may declare the Credit Facility to be due and payable immediately, after giving effect to any notice and cure periods provided for in the loan documents.  A default may occur under the Credit Facility in various circumstances including, without limitation, if (i) we fail to pay amounts due to the Lender when due, (ii) we fail to comply with our representations, warranties, covenants and agreements with the Lender, (iii) a bankruptcy action is filed with respect to us, (iv) we are liquidated or wind up our affairs, (v) the sale or liquidation of all or substantially all of our assets occurs without the Lender’s prior written consent, or (vi) any loan document becomes invalid, nonbinding or unenforceable for any reason other than its release by the Lender.  In such event, the Lender may exercise any rights or remedies it may have, including, without limitation, increasing the interest rate to 10.5% per annum, or a foreclosure of the collateral.  A foreclosure of collateral may materially impair our ability to conduct our business.
 
In connection with this Credit Facility, we agreed to pay Debt Financing Fees totaling $144,500 to UMTH GS.  On the anniversary date of this Credit Facility, in February 2011, we agreed to pay additional Debt Financing Fees of approximately $32,000 to UMTH GS.
 
As of September 30, 2011 and December 31, 2010, $8.8 million and $14.3 million, respectively, in principal was outstanding under the Credit Facility.
 
F&M Note
 
On December 14, 2010, UDF IV FII obtained a revolving credit facility from F&M Bank and Trust Company (“F&M”) in the maximum principal amount of $5 million (the “F&M Note”) pursuant to a Loan Agreement (the “F&M Loan Agreement”).  Pursuant to the First Amendment to Loan Agreement, F&M increased its commitment to $7.5 million, effective September 1, 2011.  The interest rate on the F&M Note is equal to the greater of prime plus 1.5% or 5.0% per annum (5.0% at September 30, 2011).  Accrued interest on the outstanding principal amount of the F&M Note is payable monthly.  The F&M Note matures and becomes due and payable in full on December 14, 2012.  The F&M Note is secured by a first priority collateral assignment and lien on certain mortgage notes and construction loans originated by UDF IV FII.  The F&M Note is guaranteed by us and by UDF III.
 
UDF IV FII’s eligibility to borrow up to $7.5 million under the F&M Note is determined pursuant to a defined borrowing base.  The F&M Note requires UDF IV FII and the guarantors to make various representations to the bank and to comply with various covenants and agreements, including but not limited to, minimum net worth requirements and defined leverage ratios.
 
If a default occurs under the F&M Note, F&M may declare the note to be due and payable immediately.  A default may occur under the F&M note in various circumstances including, without limitation, the failure to pay principal or interest under the note or to pay other debt when due, the failure to comply with covenants and agreements, the breach of representations or warranties, the bankruptcy of UDF IV FII or the guarantors, a material adverse change in the financial condition of UDF IV FII or the guarantors, or the sale of UDF IV FII’s assets outside of the ordinary course of business.  In such event, F&M may exercise any rights or remedies it may have, including, without limitation, prohibiting distributions from UDF IV FII to us, or foreclosure of UDF IV FII’s assets.  Any such event may materially impair UDF IV FII’s ability to conduct its business, which could cause F&M to invoke our guarantee of repayment of the F&M Note and could thus materially impair our ability to conduct our business.
 
In connection with the F&M Note, UDF IV FII agreed to pay a Debt Financing Fee of $50,000 to UMTH GS and an origination fee of $50,000 to F&M.  Pursuant to the amendment to the F&M Loan Agreement entered into in September 2011, UDF IV FII agreed to pay an additional Debt Financing Fee of $25,000 to UMTH GS and an additional origination fee of $25,000 to F&M.   In consideration of UDF III guaranteeing the F&M Note, UDF IV FII agreed to pay UDF III a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance of the F&M Note at the end of each month.
 
As of September 30, 2011 and December 31, 2010, approximately $5.2 million and $3.8 million, respectively, in principal was outstanding under the F&M Note.
 
 
16

 
 
L.  Lines of Credit
 
CTB Revolver
 
Effective August 19, 2010, UDF IV AC obtained a three-year revolving credit facility in the maximum principal amount of $8 million (the “CTB Revolver”) from CTB pursuant to a Revolving Loan Agreement (the “Revolver Loan Agreement”). The interest rate on the CTB Revolver is equal to the greater of prime plus 1% or 5.5% per annum (5.5% at September 30, 2011).  Accrued interest on the outstanding principal amount of the CTB Revolver is payable monthly.  The CTB Revolver matures and becomes due and payable in full on August 19, 2013.  The CTB Revolver is secured by a first priority collateral assignment and lien on the loans purchased by UDF IV AC using funding from the bank, and by a first lien security interest in all of UDF IV AC’s assets.  The CTB Revolver is guaranteed by us and by UDF III.
 
UDF IV AC’s eligibility to borrow up to $8 million under the CTB Revolver is determined pursuant to a defined borrowing base.  The CTB Revolver requires UDF IV AC and the guarantors to make various representations to the bank and to comply with various covenants and agreements, including but not limited to, minimum net worth requirements and defined leverage ratios.
 
If a default occurs under the CTB Revolver, CTB may declare the CTB Revolver to be due and payable immediately.  A default may occur under the CTB Revolver in various circumstances including, without limitation, the failure to pay principal or interest under the CTB Revolver or to pay other debt when due, the failure to comply with covenants and agreements, the breach of representations or warranties, the bankruptcy of UDF IV AC or the guarantors, a material adverse change in the financial condition of UDF IV AC or the guarantors, or the sale of UDF IV AC’s assets outside of the ordinary course of business.  In such event, CTB may exercise any rights or remedies it may have, including, without limitation, prohibiting distributions from UDF IV AC to us, or foreclosure of UDF IV AC’s assets.  Any such event may materially impair UDF IV AC’s ability to conduct its business, which could cause CTB to invoke our guarantee of repayment of the CTB Revolver and could thus materially impair our ability to conduct our business.
 
In connection with the CTB Revolver, UDF IV AC agreed to pay a Debt Financing Fee of $80,000 to UMTH GS and an origination fee of $80,000 to CTB.  On the anniversary date of the CTB Revolver, in August 2011, we agreed to pay an additional Debt Financing Fee of $20,000 to UMTH GS.  In consideration of UDF III guaranteeing the CTB Revolver, UDF IV AC agreed to pay UDF III a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance of the CTB Revolver at the end of each month.
 
As of September 30, 2011 and December 31, 2010, approximately $4.3 million and $3.9 million in principal, respectively, was outstanding under the CTB Revolver.
 
UTB Revolver
 
Effective September 29, 2010, UDF IV FI entered into a $3.4 million revolving line of credit (the “UTB Revolver”) with United Texas Bank (“UTB”).  Pursuant to the First Loan Modification and Extension Agreement, effective August 18, 2011, UTB increased its commitment under the UTB Revolver to $4.0 million and the maturity date, which was originally September 29, 2011, was extended to September 29, 2012.  The UTB Revolver bears interest at prime plus 1%, subject to a floor of 5.5% (5.5% at September 30, 2011), and requires monthly interest payments.  Advances under the line may be made from time to time through September 1, 2012.  Proceeds from the UTB Revolver will be used to fund our obligations under our finished lot loan agreements.  Advances are subject to a borrowing base and are secured by the pledge of a first lien security interest in the residential real estate being financed.  Principal and all unpaid interest will be due at maturity and is guaranteed by us.
 
If a default occurs under the UTB Revolver, UTB may declare the UTB Revolver to be due and payable immediately.  A default may occur under the UTB Revolver in various circumstances including, without limitation, the failure to pay principal or interest under the UTB Revolver or to pay other debt when due, the failure to comply with covenants and agreements, the breach of representations or warranties, the bankruptcy of UDF IV FI or the guarantors, a material adverse change in the financial condition of UDF IV FI or the guarantors, or the sale of UDF IV FI’s assets outside of the ordinary course of business.  In such event, the bank may exercise any rights or remedies it may have, including, without limitation, prohibiting distributions from UDF IV FI to us, or foreclosure of UDF IV FI’s assets.  Any such event may materially impair UDF IV FI’s ability to conduct its business, which could cause the bank to invoke our guarantee of repayment of the UTB Revolver and could thus materially impair our ability to conduct our business.
 
 
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In connection with the UTB Revolver, UDF IV FI agreed to pay a Debt Financing Fee of $34,000 to UMTH GS and an origination fee of $34,000 to UTB.  Pursuant to First Loan Modification and Extension Agreement entered into in August 2011, UDF IV FI agreed to pay an additional Debt Financing Fee of $6,000 to UMTH GS and an additional origination fee of $23,000 to UTB.    On the anniversary date of the UTB Revolver, in September 2011, we agreed to pay an additional Debt Financing Fee of $10,000 to UMTH GS.
 
As of September 30, 2011 and December 31, 2010, $4.0 million and $177,000, respectively, in principal was outstanding under the UTB Revolver.
 
M.  Commitments and Contingencies
 
Litigation
 
In the ordinary course of business, the Trust may become subject to litigation or claims.  There are no material pending or threatened legal proceedings known to be contemplated against the Trust.
 
Off-Balance Sheet Arrangements
 
In connection with the funding of some of the Trust’s organization costs, on June 26, 2009, UMTH LD entered into a $6.3 million line of credit from CTB.  As a condition to such line of credit, the Trust has provided a limited guaranty to CTB for UMTH LD’s obligations to the bank under the line of credit in an amount equal to the amount of the Trust’s organization costs funded by UMTH LD.  UMTH LD has a receivable from our Advisor for such costs and is repaid by our Advisor as our Advisor receives the O&O Reimbursement discussed in Note G.  UMTH LD has assigned this receivable to the bank as security for the loan.  However, the amount of the Trust’s guaranty is reduced to the extent that our Advisor reimburses UMTH LD for any of the Trust’s organization costs it has funded, provided that no event of default has occurred and UDF IV has informed the bank in writing of the reimbursed costs.  The guaranty is subject to the overall limit on the Trust’s reimbursement of organization and offering expenses, which is set at 3% of the gross offering proceeds.  Notwithstanding the above, the Trust’s liability under this guaranty agreement is limited to approximately $3.1 million, plus any accrued and unpaid interest on this amount.  As of September 30, 2011, our outstanding repayment guaranty remained approximately $3.1 million.  As of September 30, 2011 and December 31, 2010, the outstanding balance on the line of credit was $4.9 million and $5.8 million, respectively.
 
From time to time, we enter into guarantees of debtor’s borrowings and provide credit enhancements for the benefit of senior lenders in connection with our debtors and investments.  Such credit enhancements may take the form of guarantees, pledges of assets, letters of credit, and inter-creditor agreements.   As of September 30, 2011, we had one outstanding repayment guaranty with total credit risk to us of approximately $219,000, all of which had been borrowed against by the debtor.  We had no outstanding credit enhancements to third parties as of December 31, 2010.
 
N.  Economic Dependency
 
Under various agreements, the Trust has engaged or will engage the Advisor and its affiliates to provide certain services that are essential to the Trust, including asset management services, asset acquisition and disposition decisions, the sale of the Trust’s common shares of beneficial interest available for issue, as well as other administrative responsibilities for the Trust.  As a result of these relationships, the Trust is dependent upon the Advisor and its affiliates.  In the event that these entities were unable to provide the Trust with the respective services, the Trust would be required to find alternative providers of these services.
 
O.  Related Party Transactions
 
Our Advisor and certain of its affiliates receive fees in connection with the Offering and in connection with the acquisition and management of the assets and reimbursement of costs of the Trust.
 
 
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O&O Reimbursement
 
We pay our Advisor an O&O Reimbursement (as discussed in Note G) for reimbursement of organization and offering expenses funded by our Advisor or its affiliates. From inception through September 30, 2011, the Trust had reimbursed our Advisor approximately $3.4 million in accordance with the O&O Reimbursement. The Trust has an accrued liability – related parties payable to our Advisor of approximately $8.0 million and $7.0 million as of September 30, 2011 and December 31, 2010, respectively, for organization and offering costs paid by our Advisor or affiliates related to the Offering. 
 
Advisory Fees
 
We incur monthly Advisory Fees, payable to our Advisor, equal to 2% per annum of our average invested assets (as discussed in Note H).  From inception through September 30, 2011, the Trust has incurred total Advisory Fees of approximately $1.9 million.  The Trust has an accrued liability – related parties payable to our Advisor of approximately $185,000 and $75,000 as of September 30, 2011 and December 31, 2010, respectively, for Advisory Fees.
 
Placement Fees
 
We incur Placement Fees equal to 3% of the net amount available for investment in secured loans and other real estate assets (as discussed in Note B and Note H); provided, however, that no such fees will be paid with respect to any asset level indebtedness we incur.  The fees are further reduced by the amount of any acquisition and origination expenses paid by borrowers or investment entities to our Advisor or affiliates of our Advisor with respect to our investment.  Such costs are amortized into expense on a straight line basis and are payable to UMTH LD, our asset manager.  From inception through September 30, 2011, the Trust has incurred total Placement Fees payable to UMTH LD of approximately $3.1 million.  The Trust has an accrued liability – related parties payable to UMTH LD of approximately $96,000 and $773,000 as of September 30, 2011 and December 31, 2010, respectively, for Placement Fees.
 
Debt Financing Fees
 
Pursuant to the origination of any line of credit or other debt financing, we pay our Advisor Debt Financing Fees, as discussed in Note H. These Debt Financing Fees are expensed on a straight line basis over the life of the financing arrangement. From inception through September 30, 2011, the Trust has incurred total Debt Financing Fees payable to our Advisor of approximately $477,000.
 
In connection with the UDF IV HF CTB LOC discussed in Note J, UDF IV HF has agreed to pay total Debt Financing Fees of $75,000 to our Advisor.
 
In connection with the Credit Facility discussed in Note K, we agreed to pay total Debt Financing Fees of approximately $177,000 to our Advisor.
 
In connection with the F&M Note discussed in Note K, UDF IV FII has agreed to pay total Debt Financing Fees of $75,000 to our Advisor.
 
In connection with the CTB Revolver discussed in Note L, UDF IV AC has agreed to pay total Debt Financing Fees of $100,000 to our Advisor.
 
In connection with the UTB Revolver discussed in Note L, UDF IV FI has agreed to pay total Debt Financing Fees of $50,000 to our Advisor.
 
As of September 30, 2011 and December 31, 2010, no amount is included in accrued liabilities - related parties associated with unpaid Debt Financing Fees.
 
Credit Enhancement Fees
 
The Trust and its wholly-owned subsidiaries will occasionally enter into financing arrangements that require guarantees from entities affiliated with the Trust.  These guarantees require us to pay fees (“Credit Enhancement Fees”) to our affiliated entities as consideration for their guarantees.  These Credit Enhancement Fees are either expensed as incurred or prepaid and amortized, based on the terms of the guarantee agreements.  From inception through September 30, 2011, the Trust has incurred total Credit Enhancement Fees payable to our affiliates of approximately $207,000.  The Trust has an accrued liability – related parties payable to our affiliates of approximately $15,000 and $16,000 as of September 30, 2011 and December 31, 2010, respectively, for Credit Enhancement Fees.  As of September 30, 2011, we have 3 existing arrangements that require us to pay Credit Enhancement Fees to affiliated entities.
 
 
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In consideration of UDF III guaranteeing the UDF IV HF CTB LOC entered into in May 2010 and discussed in Note J, UDF IV HF agreed to pay UDF III an annual credit enhancement fee equal to 1% of the line of credit amount.  The Trust’s asset manager also serves as the asset manager of UDF III.  UDF III has received an opinion from Jackson Claborn, Inc., an independent advisor, that this credit enhancement is fair and at least as reasonable as a credit enhancement with an unaffiliated entity in similar circumstances.  As of September 30, 2011, UDF IV HF has agreed to pay total Credit Enhancement Fees of $120,000 to UDF III in consideration for this guarantee.
 
In consideration of UDF III guaranteeing the CTB Revolver entered into in August 2010 and discussed in Note L, UDF IV AC agreed to pay UDF III a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance of the CTB Revolver at the end of each month.  The Trust’s asset manager also serves as the asset manager of UDF III.  UDF III has received an opinion from Jackson Claborn, Inc., an independent advisor, that this credit enhancement is fair and at least as reasonable as a credit enhancement with an unaffiliated entity in similar circumstances.  As of September 30, 2011, UDF IV AC has agreed to pay total Credit Enhancement Fees of approximately $49,000 to UDF III in consideration for this guarantee.
 
In consideration of UDF III guaranteeing the F&M Note entered into in December 2010 and discussed in Note K, UDF IV FII agreed to pay UDF III a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance of the F&M Note at the end of each month. The Trust’s asset manager also serves as the asset manager of UDF III.  UDF III has received an opinion from Jackson Claborn, Inc., an independent advisor, that this credit enhancement is fair and at least as reasonable as a credit enhancement with an unaffiliated entity in similar circumstances.  As of September 30, 2011, UDF IV FII has agreed to pay total Credit Enhancement Fees of approximately $38,000 to UDF III in consideration for this guarantee.
 
The chart below summarizes the approximate payments to related parties for the nine months ended September 30, 2011 and 2010:
 
       
For the Nine Months Ended September 30,
Payee
 
Purpose
 
2011
 
2010
UMTH GS
                       
   
O&O Reimbursement
  $ 1,858,000     38 %   $ 1,016,000     45 %
   
Advisory Fees
    1,175,000     24 %     219,000     10 %
   
Debt Financing Fees
    108,000     2 %     75,000     3 %
                                 
UMTH LD
                               
   
Placement Fees
    1,625,000     33 %     907,000     40 %
                                 
UDF III
                               
   
Credit Enhancement Fees
    128,000     3 %     64,000     2 %
                                 
Total Payments
      $ 4,894,000     100 %   $ 2,281,000     100 %

 
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The chart below summarizes the approximate expenses associated with related parties for the three months ended September 30, 2011 and 2010:
 
   
For the Three Months Ended September 30,
Purpose
 
2011
 
2010
                     
Advisory Fees
  $ 511,000     100 %   $ 212,000     100 %
                             
Total Advisory Fee – related party
   511,000      100    212,000      100
                             
                             
Amortization of Debt Financing Fees
  $ 40,000     22 %   $ 51,000     35 %
                             
                             
Amortization of Placement Fees
    104,000     57 %     58,000     39 %
                             
                             
Credit Enhancement Fees
    38,000     21 %     38,000     26 %
                             
Total General and administrative – related party
  182,000     100    147,000      100
 
The chart below summarizes the approximate expenses associated with related parties for the nine months ended September 30, 2011 and 2010:
 
   
For the Nine Months Ended September 30,
Purpose
 
2011
 
2010
                     
Advisory Fees
  $ 1,285,000     100 %   $ 375,000     100 %
                             
Total Advisory Fee – related party
  1,285,000       100   375,000     100
                             
                             
Amortization of Debt Financing Fees
  $ 123,000     24 %   $ 81,000     38 %
                             
                             
Amortization of Placement Fees
    283,000     54 %     92,000     44 %
                             
                             
Credit Enhancement Fees
    113,000     22 %     38,000     18 %
                             
Total General and administrative – related party
  519,000      100   211,000     100
 
Loan Participation Interest – Related Parties
 
Buffington Participation Agreements
 
On December 18, 2009, the Trust entered into two participation agreements (collectively, the “Buffington Participation Agreements”) with UMT Home Finance, LP, (“UMTHF”) an affiliated Delaware limited partnership, pursuant to which the Trust purchased a participation interest in UMTHF’s construction loans (the “Construction Loans”) to Buffington Texas Classic Homes, LLC (“Buffington Classic”), an affiliated Texas limited liability company, and Buffington Signature Homes, LLC (“Buffington Signature”), an affiliated Texas limited liability company (collectively, “Buff Homes”).  The Trust’s Advisor also serves as the advisor for United Mortgage Trust (“UMT”), a Maryland real estate investment trust, which owns 100% of the interests in UMTHF.
 
 
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The Construction Loans provide Buff Homes, which is a homebuilding group, with residential interim construction financing for the construction of new homes in the greater Austin, Texas area.  The Construction Loans are evidenced by promissory notes, are secured by first lien deeds of trust on the homes financed under the Construction Loans, and are guaranteed by the parent company and the principals of Buff Homes.
 
On April 9, 2010, we entered into an Agent – Participant Agreement with UMTHF (the “UMTHF Agent Agreement”).  In accordance with the UMTHF Agent Agreement, UMTHF will continue to manage and control the Construction Loans and each participant party has appointed UMTHF as its agent to act on its behalf with respect to all aspects of the Construction Loans, provided that, pursuant to the UMTHF Agent Agreement, we retain approval rights in connection with any material decisions pertaining to the administration and services of the loans and, with respect to any material modification to the loans and in the event that the loans become non-performing, we shall have effective control over the remedies relating to the enforcement of the loans, including ultimate control of the foreclosure process.
 
Pursuant to the Buffington Participation Agreements, the Trust will participate in the Construction Loans by funding the lending obligations of UMTHF under the Construction Loans up to a maximum amount of $3.5 million.  The Buffington Participation Agreements give the Trust the right to receive payment from UMTHF of principal and accrued interest relating to amounts funded by the Trust under the Buffington Participation Agreements.  The interest rate under the Construction Loans is the lower of 13% or the highest rate allowed by law.  The Trust’s participation interest is repaid as Buff Homes repays the Construction Loans.  For each loan originated to it, Buff Homes is required to pay interest monthly and to repay the principal advanced to it upon the sale of the home or in any event no later than 12 months following the origination of the loan.  The Buffington Participation Agreements mature on December 18, 2011.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the Buffington Participation Agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011 and December 31, 2010, approximately $442,000 and $1.4 million, respectively, is included in loan participation interest – related parties related to the Buffington Participation Agreements.  For the three and nine months ended September 30, 2011, we recognized approximately $93,000 and $270,000, respectively, of interest income related to this participation interest.  For the three and nine months ended September 30, 2010, we recognized approximately $139,000 and $395,000, respectively, of interest income related to this participation interest. Approximately $39,000 and $9,000 is included in accrued receivable – related parties as of September 30, 2011 and December 31, 2010, respectively, for interest associated with the Buffington Participation Agreements.
 
UDF III Participation Agreement
 
Effective January 8, 2010, we entered into a Loan Participation Agreement (the “UDF III Participation Agreement”) with UDF III pursuant to which we purchased a participation interest in a finished lot loan (the “BL Loan”) from UDF III, as the lender, to Buffington Land, Ltd., an unaffiliated Texas limited partnership, and Len-Buf Land Acquisitions of Texas, L.P., an unaffiliated Texas limited partnership, as co-borrowers (collectively, “Buffington”).  The Trust’s asset manager also serves as the asset manager of UDF III.  The BL Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 67 finished residential lots in the Bridges at Bear Creek residential subdivision in the City of Austin, Travis County, Texas, a promissory note, assignments of certain lot sale contracts and earnest money, and other loan documents.
 
On April 9, 2010, we entered into an Agent – Participant Agreement with UDF III (the “Agent Agreement”).  In accordance with the Agent Agreement, UDF III continued to manage and control the BL Loan and each participant party has appointed UDF III as its agent to act on its behalf with respect to all aspects of the BL Loan, provided that, pursuant to the Agent Agreement, we retained approval rights in connection with any material decisions pertaining to the administration and services of the loan and, with respect to any material modification to the loan and in the event that the loan became non-performing, we had effective control over the remedies relating to the enforcement of the loan, including ultimate control of the foreclosure process.
 
 
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The UDF III Participation Agreement gave the Trust the right to receive payment from UDF III of principal and accrued interest relating to amounts funded by the Trust under the UDF III Participation Agreement.  We had no obligations to advance funds to Buffington under the BL Loan or to increase our interest in the BL Loan.  The interest rate under the BL Loan was the lower of 14% or the highest rate allowed by law.  Buffington was required to pay interest monthly and to repay a portion of principal upon the sale of residential lots covered by the deed of trust.  The original maturity date of the BL Loan was June 30, 2011.  The BL Loan was fully repaid in October 2010.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the UDF III Participation Agreement as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
For the three and nine months ended September 30, 2010, we recognized approximately $121,000 and $344,000, respectively, of interest income related to the UDF III Participation Agreement.
 
Buffington Lot Participation Agreements
 
On March 24, 2010, we entered into two Participation Agreements (collectively, the “Buffington Lot Participation Agreements”) with UDF III pursuant to which we purchased a 100% participation interest in UDF III’s lot inventory line of credit loan facilities with Buffington Signature (the “Buffington Signature Line”) and Buffington Classic (the “Buffington Classic Line”) (collectively, the “Lot Inventory Loans”).  The Trust’s asset manager also serves as the asset manager of UDF III.  The Lot Inventory Loans are evidenced by promissory notes, are secured by first lien deeds of trust on the lots financed under the Lot Inventory Loans, and are guaranteed by Buff Homes’ parent company and an affiliate company of Buff Homes.  The Lot Inventory Loans provide Buff Homes with financing for the acquisition of residential lots which are held as inventory to facilitate Buff Homes’ new home construction business in the greater Austin, Texas area.  When a lot is slated for residential construction, Buff Homes obtains an interim construction loan and the principal advanced for the acquisition of the lot is repaid under the Lot Inventory Loans.
 
On April 9, 2010, we entered into the Agent Agreement.  In accordance with the Agent Agreement, UDF III will continue to manage and control the Lot Inventory Loans and each participant party has appointed UDF III as its agent to act on its behalf with respect to all aspects of the Lot Inventory Loans, provided that, pursuant to the Agent Agreement, we retain approval rights in connection with any material decisions pertaining to the administration and services of the loans and, with respect to any material modification to the loans and in the event that the loans become non-performing, we shall have effective control over the remedies relating to the enforcement of the loans, including ultimate control of the foreclosure process.
 
Pursuant to the Buffington Lot Participation Agreements, we will participate in the Lot Inventory Loans by funding UDF III’s lending obligations under the Lot Inventory Loans up to a maximum amount of $2.5 million under the Buffington Signature Line and $2.0 million under the Buffington Classic Line.  The Buffington Lot Participation Agreements give us the right to receive repayment of all principal and accrued interest relating to amounts funded by us under the Buffington Lot Participation Agreements.  The interest rate for the Lot Inventory Loans is the lower of 14% or the highest rate allowed by law.  Our participation interest is repaid as Buff Homes repays the Lot Inventory Loans.  For each loan originated, Buff Homes is required to pay interest monthly and to repay the principal advanced no later than 12 months following the origination of the loan.  The Buffington Signature Line matured in August 2011, at which time there was no outstanding balance, and was not renewed, and the Buffington Classic Line matures in August 2012.
 
UDF III is required to purchase back from us the participation interest in the Lot Inventory Loans (i) upon a foreclosure of UDF III’s assets by its lenders, (ii) upon the maturity of the Lot Inventory Loans, or (iii) at any time upon 30 days prior written notice from us.  In such event, the purchase price paid to us will be equal to the outstanding principal amount of the Lot Inventory Loans on the date of termination, together with all accrued interest due thereon, plus any other amounts due to us under the Buffington Lot Participation Agreements.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the Buffington Lot Participation Agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
 
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As of September 30, 2011 and December 31, 2010, approximately $246,000 and $216,000, respectively, is included in loan participation interest – related parties related to the participation in the Buffington Classic Line.  For the three and nine months ended September 30, 2011, we recognized approximately $9,000 and $24,000, respectively, of interest income related to the participation in the Buffington Classic Line.  For the three and nine months ended September 30, 2010, we recognized approximately $8,000 and $11,000, respectively, of interest income related to participations in the Lot Inventory Loans. Approximately $9,000 and $15,000 is included in accrued receivable – related parties as of September 30, 2011 and December 31, 2010, respectively, for interest associated with the Buffington Classic Line.
 
TR Finished Lot Participation
 
On June 30, 2010, we purchased a participation interest (the “TR Finished Lot Participation”) in a finished lot loan (the “Travis Ranch II Finished Lot Loan”) made by UDF III to CTMGT Travis Ranch II, LLC.  The Trust’s asset manager also serves as the asset manager of UDF III.  The Travis Ranch II Finished Lot Loan is secured by a subordinate, second lien deed of trust recorded against finished residential lots in the Travis Ranch residential subdivision located in Kaufman County, Texas.  The Travis Ranch II Finished Lot Loan is guaranteed by the limited liability company owners of the borrower and by the principal of the borrower.
 
In accordance with the TR Finished Lot Participation, we are entitled to receive repayment of our participation in the outstanding principal amount of the Travis Ranch II Finished Lot Loan, plus accrued interest thereon, over time as the borrower repays the loan.  We have no obligation to increase our participation interest in the Travis Ranch II Finished Lot Loan.  The interest rate under the Travis Ranch II Finished Lot Loan is the lower of 15% or the highest rate allowed by law.  The borrower has obtained a senior loan secured by a first lien deed of trust on the finished lots.  For so long as the senior loan is outstanding, proceeds from the sale of the residential lots securing the Travis Ranch II Finished Lot Loan will be paid to the senior lender and will be applied to reduce the outstanding balance of the senior loan.  After the senior lien is paid in full, the proceeds from the sale of the residential lots securing the Travis Ranch II Finished Lot Loan are required to be used to repay the Travis Ranch II Finished Lot Loan.  The Travis Ranch II Finished Lot Loan is due and payable in full on August 28, 2012.  The maximum combined loan-to-value ratio of the first lien senior loan and the second lien Travis Ranch II Finished Lot Loan is 85%.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the Participation Agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011 and December 31, 2010, approximately $2.5 million and $2.0 million, respectively, is included in loan participation interest – related parties related to the TR Finished Lot Participation.  For the three and nine months ended September 30, 2011, we recognized approximately $85,000 and $238,000, respectively, of interest income related to this participation interest.  For the three and nine months ended September 30, 2010, we recognized approximately $74,000 and $79,000, respectively, of interest income related to this participation interest.  Approximately $30,000 and $101,000 is included in accrued receivable – related parties as of September 30, 2011 and December 31, 2010, respectively, for interest associated with the TR Finished Lot Participation.
 
TR Paper Lot Participation
 
On June 30, 2010, we purchased a participation interest (the “TR Paper Lot Participation”) in a “paper” lot loan (the “Travis Ranch Paper Lot Loan”) from UDF III to CTMGT Travis Ranch, LLC.  The Trust’s asset manager also serves as the asset manager of UDF III.  A “paper” lot is a residential lot shown on a plat that has been accepted by the city or county, but which is currently undeveloped or under development.  The borrower owns paper lots in the Travis Ranch residential subdivision of Kaufman County, Texas.  The Travis Ranch Paper Lot Loan was initially secured by a pledge of the equity interests in the borrower instead of a real property lien, effectively subordinating the Travis Ranch Paper Lot Loan to all real property liens.  The Travis Ranch Paper Lot Loan is guaranteed by the limited liability company owners of the borrower and by the principal of the borrower.
 
We are entitled to receive repayment of our participation in the outstanding principal amount of the Travis Ranch Paper Lot Loan, plus its proportionate share of accrued interest thereon, over time as the borrower repays the Travis Ranch Paper Lot Loan.  We have no obligation to increase our participation interest in the Travis Ranch Paper Lot Loan.  The interest rate under the Travis Ranch Paper Lot Loan is the lower of 15% or the highest rate allowed by law.  The borrower has obtained a senior loan secured by a first lien deed of trust on the paper lots.  For so long as the senior loan is outstanding, proceeds from the sale of the paper lots will be paid to the senior lender and will be applied to reduce the outstanding balance of the senior loan.  After the senior lien is paid in full, the proceeds from the sale of the paper lots are required to be used to repay the Travis Ranch Paper Lot Loan.  The Travis Ranch Paper Lot Loan is due and payable in full on September 24, 2012.  The maximum combined loan-to-value ratio of the first lien senior loan and Travis Ranch Paper Lot Loan is 85%.
 
 
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A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the Participation Agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011 and December 31, 2010, approximately $7.2 million and $2.1 million, respectively, is included in loan participation interest – related parties related to the TR Paper Lot Participation.  For the three and nine months ended September 30, 2011, we recognized approximately $249,000 and $587,000, respectively, of interest income related to this participation interest.  For the three and nine months ended September 30, 2010, we recognized approximately $78,000 and $79,000, respectively, of interest income related to this participation interest.  There is no balance included in accrued receivable – related parties as of September 30, 2011 for interest associated with the TR Paper Lot Participation.  Approximately $80,000 is included in accrued receivable – related parties as of December 31, 2010 for interest associated with the TR Paper Lot Participation.
 
Carrollton Participation Agreement
 
On June 10, 2011, the Trust entered into a participation agreement (the “Carrollton Participation Agreement”) with UMT Home Finance III, LP (“UMTHFIII”), an affiliated Delaware limited partnership, pursuant to which the Trust purchased a participation interest in UMTHFIII’s finished lot loan (the “Carrollton Lot Loan”) to Carrollton TH, LP (“Carrollton TH”), an unaffiliated Texas limited partnership. The Trust’s Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFIII.  The Carrollton Lot Loan provides Carrollton TH with a finished lot loan totaling $3.4 million for townhome lots located in Carrollton, Texas.  The Carrollton Lot Loan is evidenced by a promissory note, is secured by first lien deeds of trust on the finished lots financed under the Carrollton Lot Loan, and is guaranteed by the borrower’s general partner and its principal.
 
The Carrollton Participation Agreement gives the Trust the right to receive payment from UMTHFIII of principal and accrued interest relating to amounts funded by the Trust under the Carrollton Participation Agreement.  We have no obligations to increase our participation in the Carrollton Lot Loan.  The interest rate under the Carrollton Lot Loan was the lower of 13% or the highest rate allowed by law.  Our interest will be repaid as Carrollton TH repays the Carrollton Lot Loan.  Carrollton TH is required to pay interest monthly and to repay a portion of principal upon the sale of lots covered by the deed of trust.  The original maturity date of the Carrollton Lot Loan is June 10, 2014.  The original maturity of the Carrollton Participation Agreement is March 10, 2012.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the Carrollton Participation Agreement as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011, approximately $1.9 million is included in loan participation interest – related parties related to the Carrollton Participation Agreement.  For the three and nine months ended September 30, 2011, we recognized approximately $63,000 and $82,000, respectively, of interest income related to the Carrollton Participation Agreement.  Approximately $12,000 is included in accrued receivable – related parties as of September 30, 2011 for interest associated with the Carrollton Participation Agreement.
 
Notes Receivable – Related Parties
 
HLL Indian Springs Loan
 
On January 18, 2010, we made a finished lot loan (the “HLL Indian Springs Loan”) of approximately $1.8 million to HLL Land Acquisitions of Texas, L.P., a Texas limited partnership (“HLL”).  HLL is a wholly owned subsidiary of United Development Funding, L.P. (“UDF I”), an affiliated Delaware limited partnership.  The Trust’s asset manager also serves as the asset manager of UDF I.  The HLL Indian Springs Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 71 finished residential lots in The Preserve at Indian Springs, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts and earnest money, and other loan documents.  The interest rate under the HLL Indian Springs Loan is the lower of 13% or the highest rate allowed by law.  The HLL Indian Springs Loan matures on July 18, 2013, pursuant to the First Modification Agreement dated July 18, 2011.  The HLL Indian Springs Loan provides HLL with an interest reserve of approximately $289,000 pursuant to which we will fund HLL’s monthly interest payments and add the payments to the outstanding principal balance of the HLL Indian Springs Loan.  In connection with the HLL Indian Springs Loan, HLL agreed to pay an origination fee of approximately $18,000 to UMTH LD, which was funded by us at the closing of the HLL Indian Springs Loan.
 
 
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A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the HLL Indian Springs Loan as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011 and December 31, 2010, approximately $716,000 and $1.0 million, respectively, is included in notes receivable – related parties related to the HLL Indian Springs Loan.  For the three and nine months ended September 30, 2011, we recognized approximately $27,000 and $83,000, respectively, of interest income related to this loan.  For the three and nine months ended September 30, 2010, we recognized approximately $24,000 and $84,000, respectively, of interest income related to this loan.  Approximately $3,000 and $26,000 is included in accrued receivable – related parties as of September 30, 2011 and December 31, 2010, respectively, for interest associated with the HLL Indian Springs Loan.
 
Buffington Loan Agreements
 
On April 30, 2010, we entered into two Construction Loan Agreements  with Buffington Signature (the “Buffington Signature CL”) and Buffington Classic (the “Buffington Classic CL”) (collectively, the “Buffington Loan Agreements”) through which we agreed to provide interim construction loan facilities (collectively, the “Buffington Loan Facilities”) to Buffington Signature and Buffington Classic.  Our asset manager owns an investment in Buffington Homebuilding Group, Ltd., which is the parent of Buff Homes.  Pursuant to the Second Modification To Construction Loan Agreement entered into in September 2011, the Buffington Signature CL provides Buffington Signature with up to $1.0 million in residential interim construction financing for the construction of new homes in the greater Austin, Texas area and other Texas counties approved by us.  Pursuant to the Second Modification To Construction Loan Agreement entered into in September 2011, the Buffington Classic CL provides Buffington Classic with up to $6.5 million in residential interim construction financing for the construction of new homes in the greater Austin, Texas area and other Texas counties approved by us.  The Buffington Loan Facilities are evidenced and secured by the Buffington Loan Agreements, promissory notes, first lien deeds of trust on the homes financed under the Buffington Loan Facilities and various other loan documents.  They are guaranteed by the parent company and certain principals of Buff Homes.  The interest rate under the Buffington Loan Facilities is the lower of 13% per annum, or the highest rate allowed by law.  Interest is payable monthly.  Each loan financed under the Buffington Loan Facilities matures and becomes due and payable in full upon the earlier of (i) the sale of the home financed under the loan, or (ii) nine months after the loan was originated; provided, that the maturity of the loan may be extended up to 90 days following the original maturity date.  At the closing of each loan, Buff Homes will pay a 0.5% origination fee to our asset manager.  As of September 30, 2011, there were no matured loans associated with the Buffington Loan Facilities.  Our obligation to fund loans under the Buffington Loan Facilities terminated on October 28, 2011, at which time there were no amounts outstanding and payable to us associated with the Buffington Signature CL.  We are in the process of extending the Buffington Classic CL for an additional year.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the Buffington Loan Facilities as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011 and December 31, 2010, approximately $5.1 million and $3.1 million, respectively, is included in notes receivable – related parties related to the Buffington Loan Facilities.  For the three and nine months ended September 30, 2011, we recognized approximately $148,000 and $399,000, respectively, of interest income related to the Buffington Loan Facilities.  For the three and nine months ended September 30, 2010, we recognized approximately $65,000 and $80,000, respectively, of interest income related to the Buffington Loan Facilities.  Approximately $22,000 and $42,000 is included in accrued receivable – related parties as of September 30, 2011 and December 31, 2010, respectively, for interest associated with the Buffington Loan Facilities.
 
 
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HLL II Highland Farms Loan
 
Effective December 22, 2010, we made a finished lot loan (the “HLL II Highland Farms Loan”) of approximately $1.9 million to HLL II Land Acquisitions of Texas, L.P., a Texas limited partnership (“HLL II”).  HLL II is a wholly owned subsidiary of UDF I.  The Trust’s asset manager also serves as the asset manager of UDF I.  The HLL II Highland Farms Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 68 finished residential lots and 148 undeveloped lots in Highland Farms, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts and earnest money, and other loan documents.  The interest rate under the HLL II Highland Farms Loan is the lower of 13% or the highest rate allowed by law.  The HLL II Highland Farms Loan matures and becomes due and payable in full on March 22, 2013.  The HLL II Highland Farms Loan provides HLL II with an interest reserve of approximately $354,000 pursuant to which we will fund HLL II’s monthly interest payments and add the payments to the outstanding principal balance of the HLL II Highland Farms Loan.  In connection with the HLL II Highland Farms Loan, HLL II agreed to pay us an origination fee of approximately $19,000, which was funded at the closing of the loan.  For the three and nine months ended September 30, 2011, approximately $2,000 and $7,000, respectively, is included in commitment fee income – related parties related to this fee.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the HLL II Highland Farms Loan as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011 and December 31, 2010, approximately $1.4 million is included in notes receivable – related parties related to the HLL II Highland Farms Loan.  For the three and nine months ended September 30, 2011, we recognized approximately $49,000 and $147,000, respectively, of interest income related to this loan.  Approximately $21,000 and $4,000 is included in accrued receivable – related parties as of September 30, 2011 and December 31, 2010, respectively, for interest associated with the HLL II Highland Farms Loan.
 
HLL Hidden Meadows Loan
 
Effective February 17, 2011, we entered into a Loan Agreement providing for a maximum $9.9 million loan (the “HLL Hidden Meadows Loan”) to be made to HLL.  HLL is a wholly owned subsidiary of UDF I.  The Trust’s asset manager also serves as the asset manager of UDF I.  The HLL Hidden Meadows Loan was initially secured by (i) a first priority lien deed of trust to be recorded against 91 finished residential lots, 190 partially developed residential lots and residual undeveloped land located in the residential subdivision of Hidden Meadows, Harris County, Texas, (ii) the assignment of lot sale contracts providing for sales of finished residential lots to a builder, and (iii) the assignment of development reimbursements owing from a Municipal Utility District to HLL.  The interest rate under the HLL Hidden Meadows Loan is the lower of 13% or the highest rate allowed by law.  The HLL Hidden Meadows Loan matures and becomes due and payable in full on January 21, 2015.  The HLL Hidden Meadows Loan provides HLL with an interest reserve, pursuant to which we will fund HLL’s monthly interest payments and add the payments to the outstanding principal balance of the HLL Hidden Meadows Loan.  In connection with the HLL Hidden Meadows Loan, HLL agreed to pay a $99,000 origination fee to us, which was funded at the closing of the HLL Hidden Meadows Loan.  For the three and nine months ended September 30, 2011, approximately $6,000 and $17,000, respectively, is included in commitment fee income – related parties related to this fee.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the HLL Hidden Meadows Loan as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011, approximately $6.2 million is included in notes receivable – related parties related to the HLL Hidden Meadows Loan.  For the three and nine months ended September 30, 2011, we recognized approximately $200,000 and $430,000, respectively, of interest income related to this loan. Approximately $415,000 is included in accrued receivable – related parties as of September 30, 2011 for interest associated with the HLL Hidden Meadows Loan.
 
 
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Ash Creek Loan
 
Effective April 20, 2011, we entered into a $3 million loan agreement (the “Ash Creek Loan”) with UDF Ash Creek, LP (“UDF Ash Creek”), an affiliated Delaware limited partnership.  UDF Ash Creek is a wholly owned subsidiary of UDF I.  The Trust’s asset manager also serves as the asset manager of UDF I.  The Ash Creek Loan provides UDF Ash Creek with interim construction financing for the construction of 19 new townhomes in an existing townhome community in Dallas, Texas.  The Ash Creek Loan is evidenced and secured by a promissory note, first lien deeds of trust on the townhomes financed under the Ash Creek Loan and various other loan documents.  The interest rate under the Ash Creek Loan is the lower of 13% per annum, or the highest rate allowed by law.  UDF Ash Creek is required to pay interest monthly and to repay a portion of the principal upon the sale of the townhomes covered by the deed of trust.  The Ash Creek Loan matures and becomes due and payable in full on October 20, 2012.  In connection with the Ash Creek Loan, UDF Ash Creek agreed to pay a $15,000 origination fee to us, which was funded at the closing of the Ash Creek Loan.  For the three and nine months ended September 30, 2011, approximately $2,000 and $5,000, respectively, is included in commitment fee income – related parties related to this fee.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the Ash Creek Loan as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
As of September 30, 2011, approximately $677,000 is included in notes receivable – related parties related to the Ash Creek Loan.  For the three and nine months ended September 30, 2011, we recognized approximately $12,000 and $17,000, respectively, of interest income related to this loan.  Approximately $17,000 is included in accrued receivable – related parties as of September 30, 2011 for interest associated with the Ash Creek Loan.
 
P.  Concentration of Credit Risk
 
Financial instruments that potentially expose the Trust to concentrations of credit risk are primarily temporary cash equivalent and loan participation interest – related parties.  The Trust maintains deposits in financial institutions that may at times exceed amounts covered by insurance provided by the U.S. Federal Deposit Insurance Corporation (“FDIC”).  The Trust has not experienced any losses related to amounts in excess of FDIC limits.
 
At September 30, 2011, the Trust’s real estate investments were secured by property located in Texas and Colorado.
 
We may invest in multiple secured loans that share a common borrower.  The bankruptcy, insolvency or other inability of any borrower that is the subject of multiple loans to pay interest or repay principal on its loans would have adverse consequences on our income and reduce the amount of funds available for distribution to investors. The more concentrated our portfolio is with one or a few borrowers, the greater credit risk we face. The loss of any one of these borrowers would have a material adverse effect on our financial condition and results of operations.
 
Q.  Subsequent Events
 
UMTH FII LOC
 
In October 2011, the Trust originated a secured line of credit promissory note (the “UMTHFII LOC”) with UMT Home Finance II, LP (“UMTHFII”), an affiliated Delaware limited partnership. The Trust’s Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFII.  The UMTHFII LOC provides UMTHFII with a $5 million revolving line of credit it will use to fund interim residential construction loans originated or acquired by UMTHFII.  The UMTHFII LOC is secured by a subordinate security interest in the assets of UMTHFII, a pledge of the ownership interests in UMTHFII, and the guaranty of UMT.  The interest rate payable to the Trust under the UMTHFII LOC is 13%.  The maturity date of the UMTHFII LOC is October 26, 2012.
 
A majority of our trustees, including a majority of our independent trustees, who are not otherwise interested in this transaction, approved the UMTHFII LOC as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
 
 
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Legacy Revolver
 
In November 2011, UDF IV FIII entered into a $5 million revolving line of credit (the “Legacy Revolver”) with LegacyTexas Bank (“Legacy”).  The Legacy Revolver bears interest at 5.5% and requires monthly interest payments.  Advances are subject to a borrowing base and are secured by the collateral assignment of a first lien security interest in the residential real estate being pledged.  Principal and all unpaid interest will be due at maturity and is guaranteed by us.  The Legacy Revolver matures on the earlier of (i) October 12, 2012 or (ii) 30 days prior to the completion of our public offering.
 
In connection with the Legacy Revolver, UDF IV FIII agreed to pay a Debt Financing Fee of $50,000 to UMTH GS and an origination fee of $50,000 to Legacy.
 
Advisory Agreement
 
On November 11, 2011, we, along with the Advisor, executed a mutual consent to renew the advisory agreement by and between the Advisor and us. As a result of the renewal, the advisory agreement was extended through November 12, 2012.
 
 
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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 consolidated financial statements and the notes thereto:
 
Forward-Looking Statements
 
This section of the quarterly report contains forward-looking statements, including discussion and analysis of us, our financial condition, amounts of anticipated cash distributions to common shareholders 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 our 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 guaranties 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 you not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report.  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 this Form 10-Q include changes in general economic conditions, changes in real estate conditions, development costs that may exceed estimates, development delays, increases in interest rates, residential lot take down or purchase rates or inability to sell residential lots experienced by our borrowers, and the potential need to fund development costs not completed by the initial borrower or other capital expenditures out of operating cash flows.  The forward-looking statements should be read in light of the risk factors identified in the “Risk Factors” section of our 2010 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.
 
Overview
 
On November 12, 2009, the Trust’s Registration Statement on Form S-11, covering the Offering of up to 25,000,000 common shares of beneficial interest to be offered in the Primary Offering at a price of $20 per share, was declared effective under the Securities Act of 1933, as amended.  The Offering also covers up to 10,000,000 common shares of beneficial interest to be issued pursuant to our DRIP at a price of $20 per share.  We reserve the right to reallocate the common shares of beneficial interest registered in the Offering between the Primary Offering and the DRIP.
 
We use substantially all of the net proceeds from the Offering to originate, purchase, participate in and hold for investment secured loans made directly by us or indirectly through our affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots, and the construction of model and new single-family homes, including development of mixed-use master planned residential communities.  We also make direct investments in land for development into single-family lots, new and model homes and portfolios of finished lots and homes; provide credit enhancements to real estate developers, homebuilders, land bankers and other real estate investors; and purchase participations in, or finance for other real estate investors the purchase of, securitized real estate loan pools and discounted cash flows secured by state, county, municipal or other similar assessments levied on real property. We also may enter into joint ventures with unaffiliated real estate developers, homebuilders, land bankers and other real estate investors, or with other United Development Funding-sponsored programs, to originate or acquire, as the case may be, the same kind of secured loans or real estate investments we may originate or acquire directly.
 
Until required in connection with the funding of loans or other investments, substantially all of the net proceeds of the Offering and, thereafter, our working capital reserves, may be invested in short-term, highly-liquid investments including, but not limited to, government obligations, bank certificates of deposit, short-term debt obligations and interest-bearing accounts.
 
 
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We made an election under Section 856(c) of the Internal Revenue Code to be taxed as a REIT, beginning with the taxable year ended December 31, 2010, which was the first year in which we had material operations.  As a REIT, we generally are not subject to federal income tax on income that we distribute to our shareholders. If we later fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates and may not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied unless we are entitled to relief under certain statutory provisions. Such an event could materially and adversely affect our net income. However, we intend to continue to operate so as to remain qualified as a REIT for federal income tax purposes.
 
Our loan portfolio, consisting of notes receivable, notes receivable – related parties and loan participation interest – related parties, grew from approximately $66 million as of December 31, 2010 to approximately $115 million as of September 30, 2011.  With the increase in our loan portfolio, our revenues, the majority of which is from recognizing interest income associated with our loan portfolio, also increased.  Our expenses related to the portfolio also increased, including the provision for loan losses expense, which was approximately $136,000 and $342,000 for the three and nine months ended September 30, 2011, respectively, and approximately $57,000 and $87,000 for the three and nine months ended September 30, 2010, respectively.  The increase in the provision for loan losses expense primarily related to increased reserves associated with growth in our loan portfolio.
 
From time to time, as appropriate, we will enter into both fund level and asset level debt as a means of providing additional funds for the acquisition or origination of secured loans, acquisition of properties and the diversification of our portfolio.  Total debt associated with both fund level and asset level leverage was approximately $25 million and $24 million as of September 30, 2011 and December 31, 2010, respectively.   Our interest expense associated with this debt was approximately $407,000 and $1.3 million for the three and nine months ended September 30, 2011, respectively, compared to approximately $307,000 and $518,000 for the three and nine months ended September 30, 2010, respectively.
 
Net income was approximately $2.1 million and $4.9 million for the three and nine months ended September 30, 2011, respectively, and $591,000 and $812,000 for the three and nine months ended September 30, 2010, respectively.  Earnings per share of beneficial interest were $0.41 and $1.20 for the three and nine months ended September 30, 2011, respectively, and $0.36 and $0.79 for the three and nine months ended September 30, 2010, respectively.  Our earnings per share of beneficial interest is calculated based on net income divided by the weighted average shares of beneficial interest outstanding.  Such earnings per share of beneficial interest have fluctuated since the Offering began with the raise of gross proceeds and the deployment of funds available.
 
As of September 30, 2011, we had originated or acquired 44 loans, including 5 loans that have been repaid in full by the respective borrower, totaling approximately $204.4 million in loan commitments.  Of the 39 loans outstanding as of September 30, 2011, six of the loans, totaling approximately $24.1 million in loan  commitments, and six loans, totaling approximately $20.2 million in loan commitments, are included in notes receivable – related parties and loan participation interest – related parties, respectively, on our balance sheet.
 
Critical Accounting Policies and Estimates
 
Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP.  GAAP consists of a set of standards issued by the FASB and other authoritative bodies in the form of FASB Statements, Interpretations, FASB Staff Positions, Emerging Issues Task Force consensuses and American Institute of Certified Public Accountants Statements of Position, among others.  The FASB recognized the complexity of its standard-setting process and embarked on a revised process in 2004 that culminated in the release on July 1, 2009 of the ASC.  The ASC does not change how the Trust accounts for its transactions or the nature of related disclosures made.  Rather, the ASC results in changes to how the Trust references accounting standards within its reports.  This change was made effective by the FASB for periods ending on or after September 15, 2009.  The Trust has updated references to GAAP in this Quarterly Report on Form 10-Q to reflect the guidance in the ASC.  The preparation of these consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On a regular basis, we evaluate these estimates, including investment impairment.  These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates.
 
 
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Principles of Consolidation
 
The consolidated financial statements include the accounts of the Trust and certain wholly-owned subsidiaries and all significant intercompany accounts and transactions have been eliminated.
 
Loan Participation Interest – Related Parties
 
Loan participation interest – related parties represents the purchase of a financial interest in certain interim construction loan and finished lot loan facilities originated by our affiliates.  We participate in these loans by funding the lending obligations of our affiliates under these credit facilities up to a maximum amount for each participation.  Such participations entitle us to receive payments of principal and interest from the borrower up to the amounts funded by us.  The participation interests are typically collateralized by promissory notes, first or second lien deeds of trust on the homes financed under the construction loans or lots financed under the lot loan facilities, and other loan documents.  The participations have terms ranging from 9 to 27 months and bear interest at rates ranging from 13% to 15%.  The participation interests may be paid off prior to maturity; however, we intend to hold all participation interests for the life of the loans.
 
Notes Receivable and Notes Receivable – Related Parties
 
Notes receivable and notes receivable – related parties are recorded at the lower of cost or net realizable value.  The notes are collateralized by a first or second lien deed of trust on the underlying real estate collateral or a pledge of ownership interests in the borrower, as well as promissory notes, assignments of certain lot sales contracts and earnest money, and other loan documents.  The notes have terms ranging from 2 to 47 months and bear interest at rates ranging from 13% to 15%.  The notes may be paid off prior to maturity; however, we intend to hold all notes for the life of the notes.
 
Determination of the Allowance for Loan Losses
 
The allowance for loan losses is our estimate of incurred losses in our portfolio of loan participations, notes receivable, and notes receivable – related parties.  We periodically perform a detailed review of our portfolio of mortgage notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses.  We charge additions to the allowance for loan losses to current period earnings through a provision for loan losses.  Amounts determined to be uncollectible are charged directly against (and decrease) the allowance for loan losses (“charged off”), while amounts recovered on previously charged off accounts increase the allowance.  As of September 30, 2011 and December 31, 2010, the allowance for loan losses had a balance of $503,848 and $162,092, respectively, offset against notes receivable (see Note B to accompanying financial statements).
 
Organization and Offering Expenses
 
Organization costs will be expensed as incurred in accordance with Statement of Position 98-5, Reporting on the Costs of Start-up Activities, currently within the scope of FASB ASC 720-15.  Offering costs related to raising capital from debt will be capitalized and amortized over the term of such debt.  Offering costs related to raising capital from equity will be offset as a reduction of capital raised in shareholders’ equity.
 
Revenue Recognition
 
Interest income on loan participation interest – related parties, notes receivable and notes receivable – related parties is recognized over the life of the participation agreement or note agreement and recorded on the accrual basis.  Income recognition is suspended at either the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful.  Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed.  As of September 30, 2011 and December 31, 2010, we were accruing interest on all loan participation interest – related parties, notes receivable and notes receivable – related parties.
 
 
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Commitment fee income and Commitment fee income – related parties represents non-refundable fees charged to borrowers for entering into an obligation that commits us to make or acquire a loan or to satisfy a financial obligation of the borrower when certain conditions are met within a specified time period.  When a commitment is considered an integral part of the resulting loan and we believe there is a reasonable expectation that the commitment will be called upon, the commitment fee is recognized as revenue over the life of the resulting loan.  As of September 30, 2011 and December 31, 2010, approximately $437,000 and $176,000, respectively, of unamortized commitment fees are included as an offset of notes receivable. Approximately $105,000 and $19,000 of unamortized commitment fees are included as an offset of notes receivable – related parties as of September 30, 2011 and December 31, 2010, respectively. When we believe it is unlikely that the commitment will be called upon or that the fee is not an integral part of the return of a specific future lending arrangement, the commitment fee is recognized as income when it is earned, based on the specific terms of the commitment.  We make a determination of revenue recognition on a case-by-case basis, due to the unique and varying terms of each commitment.
 
Loan Portfolio
 
As of September 30, 2011, we had entered into 8 participation agreements with related parties (2 of which were repaid in full) with aggregate, maximum loan amounts of approximately $27.4 million (with an unfunded balance of approximately $1.5 million) and 6 related party note agreements with aggregate, maximum loan amounts totaling approximately $24.1 million (with an unfunded balance of $6.0 million).  Additionally, we had entered into 30 note agreements with third parties (3 of which were repaid in full) with aggregate, maximum loan amounts of approximately $152.9 million, of which $24.7 million has yet to be funded.
 
As of September 30, 2011, we had two loans to borrowers that, individually, accounted for over 10% of the outstanding balance of our portfolio.  These loans are to (i) CTMGT Land Holdings, LP, a Texas limited partnership unaffiliated with us (“Land Holdings”), which loan comprises approximately 11% of the outstanding balance of our portfolio, and (ii) FH 295, LLC, a Texas limited liability company unaffiliated with us (“FH 295”), which loan comprises approximately 13% of the outstanding balance of our portfolio.  FH 295 is an affiliate of Land Holdings.  Additionally, as of September 30, 2011, we had loans to certain affiliates of Land Holdings and FH 295 that comprised an additional 42% of the outstanding balance of our loan portfolio.
 
The participation agreements outstanding as of September 30, 2011 are made to developer entities which may hold ownership interests in projects in addition to the project funded by us, may be secured by multiple single-family residential communities, and certain participation agreements are secured by a personal guarantee of the developer in addition to a lien on the real property or the equity interests in the entity that holds the real property.  The outstanding aggregate principal amount of mortgage notes originated by us as of September 30, 2011 are secured by properties located in the Dallas, Fort Worth, Austin, Houston, and San Antonio metropolitan markets in Texas and Denver, Colorado.  Security for such loans takes the form of either a direct security interest represented by a first or second lien on the respective property and/or an indirect security interest represented by a pledge of the ownership interests of the entity which holds title to the property.
 
The interest rates payable range from 13% to 15% with respect to the outstanding participation agreements and notes receivable, including related parties, as of September 30, 2011.  The participation agreements have terms to maturity ranging from 9 to 27 months, while the notes receivable have terms ranging from 2 to 47 months.
 
Results of Operations
 
The three months ended September 30, 2011 as compared to the three months ended September 30, 2010
 
Revenues
 
Interest income (including related party interest income) for the three months ended September 30, 2011 and 2010 was approximately $3.4 million and $1.2 million, respectively.  The increase in interest income for the three months ended September 30, 2011 is primarily the result of our increased notes receivable portfolio (including related party transactions) and loan participation interest – related party portfolio of approximately $114.8 million as of September 30, 2011, compared to approximately $52.6 million as of September 30, 2010 as proceeds raised from our Offering continue to be invested in revenue-generating real estate investments.
 
Commitment fee income (including related party commitment fee income) for the three months ended September 30, 2011 and 2010 was approximately $139,000 and $163,000, respectively.  The decrease in commitment fee income for the three months ended September 30, 2011 is primarily the result of a fee recognized on a short-term loan that matured and was paid in full in the fourth quarter of 2010.
 
 
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We expect revenues to increase in the near future as we continue to raise proceeds from the Offering and invest such proceeds in revenue-generating real-estate investments.
 
Expenses
 
Interest expense related to our senior credit facility, notes payable, and lines of credit totaled approximately $407,000 and $307,000 for the three months ended September 30, 2011 and 2010, respectively.  The increase is due to the timing of leverage introduced to the fund during 2011 and 2010.
 
Advisory fee – related party expense represents the expense associated with the Advisory Fees discussed in note H and was approximately $511,000 and $212,000 for the three months ended September 30, 2011 and 2010, respectively.  The increase in advisory fee – related party expense is associated with the increase in our average invested assets as proceeds raised from our Offering continue to be invested in revenue-generating real estate investments.
 
General and administrative expense for the three months ended September 30, 2011 and 2010 was approximately $177,000 and $83,000, respectively.  General and administrative expense consists primarily of legal and accounting fees, transfer agent fees, insurance expense and amortization of deferred financing costs.  The increase in general and administrative expense is primarily associated with an increase in transfer agent fees and an increase in amortization of deferred financing costs commensurate with the increase in shareholders and the timing of leverage introduced to the fund over the same period.
 
General and administrative – related party expense for the three months ended September 30, 2011 and 2010 was approximately $182,000 and $147,000, respectively.  General and administrative – related party expense consists of amortization of Placement Fees, amortization of Debt Financing Fees and expense associated with Credit Enhancement Fees.  The increase in general and administrative – related party expense is primarily a result of an increase in amortization of Placement Fees commensurate with the increase in our investment portfolio over the same period.
 
       Comparison Charts
 
The chart below summarizes the approximate expenses associated with related parties for the three months ended September 30, 2011 and 2010:
 
   
For the Three Months Ended September 30,
Purpose
 
2011
 
2010
                     
Advisory Fees
  $ 511,000     100 %   $ 212,000     100 %
                             
Total Advisory Fee – related party
  $ 511,000     100 %   $ 212,000     100 %
                             
                             
Amortization of Debt Financing Fees
  $ 40,000     22 %   $ 51,000     35 %
                             
                             
Amortization of Placement Fees
    104,000     57 %     58,000     39 %
                             
                             
Credit Enhancement Fees
    38,000     21 %     38,000     26 %
                             
Total General and administrative – related party
  182,000     100   147,000      100
 
 
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The chart below summarizes the approximate payments to related parties for the three months ended September 30, 2011 and 2010:
 
       
For the Three Months Ended September 30,
Payee
 
Purpose
 
2011
 
2010
UMTH GS
                       
   
O&O Reimbursement
  $ 747,000     38 %   $ 276,000     39 %
   
Advisory Fees
    476,000     24 %     103,000     15 %
   
Debt Financing Fees
    61,000     3 %     -     - %
                                 
UMTH LD
                               
   
Placement Fees
    655,000     34 %     263,000     37 %
                                 
UDF III
                               
   
Credit Enhancement Fees
    15,000     1 %     64,000     9 %
                                 
Total Payments
      $ 1,953,000     100 %   $ 706,000     100 %
 
We intend to grow our portfolio in conjunction with the increase in proceeds raised in the Offering.  We intend to deploy such proceeds in a diversified manner to the borrowers and markets in which we have experience and as markets dictate in accordance with the economic factors conducive for a stable residential market.  We expect general and administrative and advisory fee – related party expenses to increase commensurate with the growth of our portfolio.
 
The nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010
 
Revenues
 
Interest income (including related party interest income) for the nine months ended September 30, 2011 and 2010 was approximately $8.6 million and $2.1 million, respectively.  The increase in interest income for the nine months ended September 30, 2011 is primarily the result of our increased notes receivable portfolio (including related party transactions) and loan participation interest – related parties portfolio of approximately $114.8 million as of September 30, 2011, compared to approximately $52.6 million as of September 30, 2010 as proceeds raised from our Offering continue to be invested in revenue-generating real estate investments.
 
Commitment fee income (including related party commitment fee income) for the nine months ended September 30, 2011 and 2010 was approximately $228,000 and $163,000, respectively.  The increase in commitment fee income for the nine months ended September 30, 2011 is primarily the result of an increase in loan commitments as proceeds raised from our Offering continue to be invested in revenue-generating real estate investments.
 
We expect revenues to increase in the near future as we continue to raise proceeds from the Offering and invest such proceeds in revenue-generating real-estate investments.
 
Expenses
 
Interest expense related to our senior credit facility, notes payable, and lines of credit totaled approximately $1.3 million and $518,000 for the nine months ended September 30, 2011 and 2010, respectively.  The increase is due to the timing of leverage introduced to the fund during 2011 and 2010.
 
Advisory fee – related party expense represents the expense associated with the Advisory Fees discussed in Note H and was approximately $1.3 million and $375,000 for the nine months ended September 30, 2011 and 2010, respectively.  The increase in advisory fee – related party expense is associated with the increase in our average invested assets as proceeds raised from our Offering continue to be invested in revenue-generating real estate investments.
 
 
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General and administrative expense for the nine months ended September 30, 2011 and 2010 was approximately $452,000 and $287,000, respectively.  General and administrative expense consists primarily of legal and accounting fees, transfer agent fees, insurance expense and amortization of deferred financing costs.  The increase in general and administrative expense is primarily associated with an increase in amortization of deferred financing costs commensurate with the timing of leverage introduced to the fund over the same period.
 
General and administrative – related party expense for the nine months ended September 30, 2011 and 2010 was approximately $519,000 and $211,000, respectively.  General and administrative – related party expense consists of amortization of Placement Fees, amortization of Debt Financing Fees and expense associated with Credit Enhancement Fees.  The increase in general and administrative – related party expense is a result of an increase in each of these costs commensurate with the increase in our investment portfolio over the same period.
 
       Comparison Charts
 
The chart below summarizes the approximate expenses associated with related parties for the nine months ended September 30, 2011 and 2010:
 
   
For the Nine Months Ended September 30,
Purpose
 
2011
 
2010
                     
Advisory Fees
  $ 1,285,000     100 %   $ 375,000     100 %
                             
Total Advisory Fee – related party
  $ 1,285,000     100 %   $ 375,000     100 %
                             
                             
Amortization of Debt Financing Fees
  $ 123,000     24 %   $ 81,000     38 %
                             
                             
Amortization of Placement Fees
    283,000     54 %     92,000     44 %
                             
                             
Credit Enhancement Fees
    113,000     22 %     38,000     18 %
                             
Total General and administrative – related party
  $ 519,000     100 %   $ 211,000     100 %
 
The chart below summarizes the approximate payments to related parties for the nine months ended September 30, 2011 and 2010:
 
       
For the Nine Months Ended September 30,
Payee
 
Purpose
 
2011
 
2010
UMTH GS
                       
   
O&O Reimbursement
  $ 1,858,000     38 %   $ 1,016,000     45 %
   
Advisory Fees
    1,175,000     24 %     219,000     10 %
   
Debt Financing Fees
    108,000     2 %     75,000     3 %
                                 
UMTH LD
                               
   
Placement Fees
    1,625,000     33 %     907,000     40 %
                                 
UDF III
                               
   
Credit Enhancement Fees
    128,000     3 %     64,000     2 %
                                 
Total Payments
      $ 4,894,000     100 %   $ 2,281,000     100 %
 
 
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We intend to grow our portfolio in conjunction with the increase in proceeds raised in the Offering.  We intend to deploy such proceeds in a diversified manner to the borrowers and markets in which we have experience and as markets dictate in accordance with the economic factors conducive for a stable residential market.  We expect general and administrative and advisory fee – related party expenses to increase commensurate with the growth of our portfolio.

Cash Flow
 
Cash flows provided by operating activities for the nine months ended September 30, 2011 were approximately $2.8 million and were comprised primarily of net income offset slightly with accrued interest receivable and accrued receivable – related party.  Cash flows used in operating activities for the nine months ended September 30, 2010 were approximately $209,000 and were comprised primarily of net income offset with accrued receivable – related parties and other assets.
 
Cash flows used in investing activities for the nine months ended September 30, 2011 and 2010 were approximately $49.5 million and $51.3 million, respectively, resulting primarily from originations of notes receivable (including related party transactions) and loan participation interest – related parties, offset by receipts from mortgage notes receivable (including related party transactions) and loan participation interest – related parties.
 
Cash flows provided by financing activities for the nine months ended September 30, 2011 were approximately $50.9 million and were comprised primarily of funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, offset slightly by payments on notes payable, cash distributions to shareholders and payments of offering costs.   Cash flows provided by financing activities for the nine months ended September 30, 2010 were approximately $52.2 million and were comprised primarily of funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, cash distributions to shareholders and payments of offering costs.
 
Our cash and cash equivalents were approximately $6.7 million as of September 30, 2011, compared to approximately $1.2 million at September 30, 2010.
 
Funds from Operations and Modified Funds from Operations
 
Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts (“NAREIT”), an industry trade group, has promulgated a measure known as FFO which we believe to be an appropriate supplemental measure to reflect the operating performance of a REIT.  FFO is not equivalent to our net income or loss as determined under GAAP.
 
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the “White Paper”).  The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property but including asset impairment write-downs, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.  Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO.  Our FFO calculation complies with NAREIT’s policy described above.
 
However, changes in the accounting and reporting rules under GAAP that have been put into effect since the establishment of NAREIT’s definition of FFO have prompted an increase in the non-cash and non-operating items included in FFO.  Additionally, publicly registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation and therefore require additional adjustments to FFO in evaluating performance.  Due to these and other unique features of publicly registered, non-listed REITs, the Investment Program Association, or the IPA, an industry trade group, has standardized a measure known as modified funds from operations, or MFFO, which we believe to be another appropriate supplemental measure to reflect the operating performance of a REIT.  The use of MFFO is recommended by the IPA as a supplemental performance measure for publicly registered, non-listed REITs.  MFFO is a metric used by management to evaluate sustainable performance and dividend policy.  MFFO is not equivalent to our net income or loss as determined under GAAP.
 
 
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We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations (the “Practice Guideline”), issued by the IPA in November 2010.  The Practice Guideline defines MFFO as FFO further adjusted for the following items included in the determination of GAAP net income: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities; accretion of discounts and amortization of premiums on debt investments; nonrecurring impairments of real estate-related investments; mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis.  Our MFFO calculation complies with the IPA’s Practice Guideline described above.
 
In calculating MFFO, we adjust for acquisition related expenses and impairments of real estate assets.  Management believes excluding acquisition costs from MFFO provides investors with supplemental performance information that is consistent with the performance models used by management, and provides investors with a view of our portfolio over time, independent of direct costs associated with the timing of acquisition activity.  MFFO also allows for a comparison of our portfolio with other REITs that are not currently engaged in acquisition activity, as well as a comparison of our performance with that of other publicly registered, non-listed REITs, as MFFO, or an equivalent measure, is routinely reported by publicly registered, non-listed REITs, and we believe often used by analysts and investors for comparison purposes.  With respect to loan loss provisions, management does not include these expenses in our evaluation of the operating performance of our real estate loan portfolio, as we believe these costs will be reflected in our reported results from operations if and when we actually realize a loss on a real estate investment.  As many other publicly registered, non-listed REITs exclude impairments in reporting their MFFO, we believe that our calculation and reporting of MFFO will assist investors and analysts in comparing our performance versus other publicly registered, non-listed REITs.  The other adjustments included in the IPA’s Practice Guideline are not applicable to us for the three and nine month periods ended September 30, 2011 and 2010.
 
Presentation of this information is intended to assist the reader in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful.  Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income as an indication of our performance, as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our shareholders.  FFO and MFFO should be reviewed in conjunction with other measurements as an indication of our performance.  MFFO has limitations as a performance measure in an offering such as ours where the price of a common share of beneficial interest is a stated value and there is no net asset value determination during the Offering and for a period thereafter.  MFFO is useful in assisting management and investors in assessing the sustainability of operating performance and our current distribution policy in future operating periods, and in particular, after the Offering or the time when we cease to make investments on a frequent and regular basis and net asset value is disclosed.  MFFO is not a useful measure in evaluating net asset value because impairments are taken into account in determining net asset value but not in determining MFFO.  In addition, because MFFO excludes the effect of acquisition costs, which are an important component in an analysis of the historical performance of an asset, MFFO should not be construed as a historic performance measure.  Our FFO and MFFO reporting complies with NAREIT’s policy described above.
 
The following is a reconciliation of net income to FFO and MFFO for the three and nine months ended September 30, 2011 and 2010:
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
 
 
2011
   
2010
   
2011
   
2010
 
Funds From Operations                                
Net Income, as reported
  $ 2,138,271     $ 590,915     $ 4,939,902     $ 811,860  
Add:
                               
Amortization expense
    102,161       96,333       289,938       129,363  
FFO
    2,240,432       687,248       5,229,840       941,223  
Other Adjustments:
                               
Provision for loan losses
    135,634       56,836       341,756       87,022  
Acquisition costs
    104,222       58,375       282,523       92,170  
MFFO
  $ 2,480,288     $ 802,459     $ 5,854,119     $ 1,120,415  
 
 
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Net Operating Income
 
We are disclosing net operating income and intend to disclose net operating income in future filings, because we believe that net operating income provides an accurate measure of the operating performance of our operating assets because net operating income excludes certain items that are not directly associated with our investments.  Net operating income is a non-GAAP financial measure that is defined as net income, computed in accordance with GAAP, generated from properties before interest expense, general and administrative expenses, depreciation, amortization and interest and dividend income.  Additionally, we believe that net operating income is a widely accepted measure of comparative operating performance in the real estate community.  However, our use of the term net operating income may not be comparable to that of other real estate companies as they may have different methodologies for computing this amount.
 
To facilitate understanding of this financial measure, the following is a reconciliation of net income to net operating income for the three and nine months ended September 30, 2011 and 2010:
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
 
 
2011
   
2010
   
2011
   
2010
 
Net Operating Income                                
Net Income, as reported
  $ 2,138,271     $ 590,915     $ 4,939,902     $ 811,860  
Add:
                               
Interest expense
    406,907       306,913       1,293,222       518,450  
General and administrative expense (1)
    903,898       402,316       2,307,040       830,591  
Amortization expense
    102,161       96,333       289,938       129,363  
Less:
                               
Other interest and dividend income
    (14,537 )     (3,939 )     (27,910 )     (9,603 )
Net operating income
  $ 3,536,700     $ 1,392,538     $ 8,802,192     $ 2,280,661  
 
(1)
Includes advisory fee – related party expense, provision for loan losses expense, general and administrative expense, net of amortization expense and general and administrative – related party expense, net of amortization expense.
 
Liquidity and Capital Resources
 
Our liquidity requirements will be affected by (1) outstanding loan funding obligations, (2) our administrative expenses and (3) debt service on fund level and asset level indebtedness required to preserve our collateral position.  We expect that our liquidity will be provided by (1) loan interest, transaction fees and credit enhancement fee payments, (2) loan principal payments, (3) proceeds from the issuance of common shares of beneficial interest pursuant to the Offering, (4) proceeds from our DRIP, and (5) credit lines available to us.
 
There may be a delay between the sale of our shares and the making of real estate-related investments, which could result in a delay in our ability to make distributions to our shareholders.  However, we have not established any limit on the amount of proceeds from the Offering that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would (1) cause us to be unable to pay our debts as they become due in the usual course of business; (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences, if any; or (3) jeopardize our ability to qualify as a REIT.  In addition, to the extent our investments are in development projects or in other properties that have significant capital requirements and/or delays in their ability to generate income, our ability to make distributions may be negatively impacted, especially during our early periods of operation.
 
 
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We use debt as a means of providing additional funds for the acquisition or origination of secured loans, acquisition of properties and the diversification of our portfolio.  There is no limitation on the amount we may borrow for the purchase or origination of a single secured loan, the purchase of any individual property or other investment.  Under our declaration of trust, the maximum amount of our indebtedness shall not exceed 300% of our net assets as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent trustees and disclosed in our next quarterly report to shareholders, along with justification for such excess.  In addition to our declaration of trust limitation, our board of trustees has adopted a policy to generally limit our fund level borrowings to 50% of the aggregate fair market value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests.  We also use, when appropriate, leverage at the asset level.  Asset level leverage is determined by the anticipated term of the investment and the cash flow expected by the investment.  Asset level leverage is expected to range from 0% to 90% of the asset value.
 
Asset level indebtedness will be either interest only or be amortized over the expected life of the asset.  Typically, asset indebtedness will be from a senior commercial lender between 50% and 90% of the fair market value of the asset.  Further, entity-level indebtedness will typically be a revolving credit facility permitting us to borrow up to an agreed-upon outstanding principal amount.  Such entity-level indebtedness is secured by a first priority lien upon all of our existing and future acquired assets.
 
Our Advisor may, but is not required to, establish capital reserves from gross offering proceeds, out of cash flow generated from interest income from loans and income from other investments or out of non-liquidating net sale proceeds from the sale of our loans, properties and other investments.  Alternatively, a lender may require its own formula for escrow of capital reserves.
 
Potential future sources of capital include proceeds from secured or unsecured financings from banks or other lenders, proceeds from the repayment of loans, sale of assets and undistributed funds from operations.  If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures.
 
We believe that the resources stated above will be sufficient to satisfy our operating requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than the sources described above within the next 12 months.

Material Trends Affecting Our Business
 
We believe that the housing market has reached a bottom in its four-year decline and has begun to recover. This recovery likely will be regional in its early stages and will be led by those housing markets with balanced supply, affordable and stable home prices, minimal levels of foreclosures, strong economies, and strong demand fundamentals. Nationally, we expect the recovery will continue to experience headwinds from weak demand fundamentals, specifically consumer confidence and employment, as well as from the limited availability of bank financing, and a persisting oversupply of home inventory and high levels of foreclosures. The national consumer confidence index, which fell to record lows during the economic downturn, has recovered somewhat, but remains closer to levels historically associated with recession than to normalized conditions. Unemployment remains elevated and access to conventional real estate and commercial financing remains limited across most of the country. These factors pose obstacles to a robust recovery on a national scale, which, we believe, is contingent upon the reengagement of the consumer and the return of final demand. However, we expect the recovery will be stronger in markets such as Texas, where consumer confidence averaged approximately 16 points higher than the national index from September 2010 to September 2011; where the job growth rate over the past 12 months was more than double the national rate; and where approximately 15% of all homebuilding permits in the country were issued in 2010. Further, according to the Bureau of Labor Statistics, 37.8% of the total jobs created in the United States since the official end of the national recession were created in Texas (from June 2009 to September 2011). Currently, 98% of our portfolio relates to property located in the state of Texas, and we intend to invest in markets that demonstrate similarly sound economic and demand fundamentals – fundamentals that we believe will be the drivers of the recovery – and balanced supplies of homes and finished lots. We believe the fact that new single-family home permits, starts, and sales have all risen from their respective lows reflects a continued return of real demand for new homes. However, we anticipate the former bubble market states – principally California, Arizona, Nevada and Florida – will be slower to recover, as those markets have seen overbuilding and extensive price correction and are experiencing weakened economies and continued foreclosures.
 
 
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From a national perspective, ongoing credit constriction, a less robust economic recovery, continued high unemployment, and housing price correction have made potential new home purchasers and real estate lenders cautious. As a result of these factors, the national housing market has experienced a protracted decline, and the time necessary to correct the market likely means a corresponding slower recovery for the housing industry.
 
Nationally, capital constraints at the heart of the credit crisis have reduced the number of real estate lenders able or willing to finance development, construction or the purchase of homes and have increased the number of undercapitalized or failed builders and developers. In correlation, the number of new homes and finished lots developed has decreased, which may result in a shortage of new homes and developed lots in select real estate markets in 2011 and 2012. We believe this shortage will be most prominent in markets that did not participate in the housing bubble, avoiding overbuilding and maintaining balanced supplies and affordable and stable home prices. With lenders imposing stricter underwriting standards, mortgages to purchase homes have become more difficult to obtain in some markets. To support the secondary residential mortgage market and prevent further deterioration of mortgage lending, the Federal Reserve began an unprecedented program to purchase approximately $1.25 trillion of residential mortgage backed securities between January 5, 2009 and March 31, 2010. This program ended on March 31, 2010, as scheduled by the Federal Reserve. As of the date of this quarterly report, the 30-year fixed-rate single-family residential mortgage interest rate continues to remain below the rate that was available at the conclusion of the period of Federal Reserve purchases. We believe that such stability at low rates indicates that the secondary residential mortgage market is operating smoothly independent of the support previously provided by the Federal Reserve. Further, on September 21, 2011, the Federal Reserve announced that it would begin reinvesting the principal payments from its mortgage-backed securities holdings into additional purchases of agency mortgage-backed securities to help support conditions in mortgage markets. However, any limitations or restrictions on the availability of financing or on the liquidity provided in the secondary residential mortgage market by Government Sponsored Enterprises such as Fannie Mae and Freddie Mac could adversely affect interest rates and mortgage availability, which could cause the number of homebuyers to decrease, which could increase the likelihood of borrowers defaulting on our loans and, consequently, reduce our ability to pay distributions to our shareholders.
 
Nationally, new home sales rose slightly during the third quarter from the pace of sales in the second quarter of 2011, though levels continue to be depressed in the aftermath of the expiration of the federal homebuyer tax credit. However, national fundamentals that drive home sales continue to improve in most markets and home affordability remains near record-highs, so we expect the pace of home sales will continue to increase over 2011. The U.S. Census Bureau reports that the sales of new single-family residential homes in September 2011 were at a seasonally adjusted annual rate of 313,000 units. This number is up approximately 3.3% from the second quarter 2011 figure of 303,000, but down approximately 0.9% year-over-year from the September 2010 estimate of 316,000. However, seasonal and year-over-year comparisons are and will likely continue to be distorted by the effects of the federal homebuyer tax credit, which expired in June 2010, creating a hangover effect on home sales in the subsequent months and quarters.
 
Nationally, new single-family home inventory continued to improve in the third quarter of 2011 as it has done consistently since the second quarter of 2007. Through much of the downturn, homebuilders reduced their starts and focused on selling their existing new home inventory. The number of new homes for sale fell by approximately 39,000 units from September 2010 to September 2011 and by 3,000 units in the third quarter 2011. We believe that, with such reductions, the new home market has been restored to equilibrium in most markets, even at low levels of demand. The seasonally adjusted estimate of new homes for sale at the end of September 2011 was 163,000 – a balanced supply of 6.2 months at the September sales rate but the lowest number of homes available for sale since the U.S. Census Bureau began keeping records of this statistic in 1963. We believe that what is necessary now to regain prosperity in housing markets is the return of healthy levels of demand.
 
According to the U.S. Census Bureau, new single-family residential home permits and starts fell nationally from 2006 through early 2009, as a result and in anticipation of an elevated supply of and decreased demand for new single-family residential homes in that period. Since bottoming in early 2009, however, single-family permits and starts have improved significantly. Single-family homes authorized by building permits in September 2011 were at a seasonally adjusted annual rate of 417,000 units. This was a 3.5% increase year-over-year from the rate of 403,000 in September 2010, and is approximately 23.7% higher than the low of 337,000 set in January 2009. Single-family home starts for September 2011 stood at a seasonally adjusted annual rate of 425,000 units. This pace is down approximately 4.9% from the September 2010 estimate of 447,000 units – as homebuilders continue to adjust their start rate one year after the expiration of the homebuyer tax credit. Again, seasonal comparisons and year-over-year figures between September 2010 home starts and September 2011 home starts are likely distorted by the reduction in new home starts following the June 2010 expiration of the homebuyer tax credit as builders adjusted their inventory levels to match reduced demand. However, the September 2011 pace of home starts is still 20.4% higher than the low of 353,000 set in March 2009. Such increases suggest to us that new home inventories are generally in balance and the homebuilding industry now anticipates greater demand for new homes in coming months relative to the demand evident at the bottom of the new homebuilding cycle.
 
 
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The primary factors affecting new home sales are home price stability, home affordability, and housing demand. Housing supply may affect both new home prices and the demand for new homes. When the supply of new homes exceeds new home demand, new home prices may generally be expected to decline. Also, home foreclosures cause the inventory of existing homes to increase, which may add additional downward price pressure on home prices. Declining new home prices may result in diminished new home demand as people postpone a new home purchase until such time as they are comfortable that stable price levels have been reached.  The converse point is also true and equally important. When new home demand exceeds new home supply, new home prices may generally be expected to increase; and rising new home prices, particularly at or near the bottom of the housing cycle, may result in increased new home demand as people become confident in home prices and accelerate their timing of a new home purchase. Hence, we intend to concentrate our investments in housing markets with affordable and stable home prices, balanced supply, lower incidences of foreclosures, and strong demand fundamentals. These demand fundamentals are generally job growth, the relative strength of the economy and consumer confidence, household formations, and population growth – both immigration and in-migration.
 
The U.S. Census Bureau forecasts that California, Florida and Texas will account for nearly one-half of the total U.S. population growth between 2000 and 2030 and that the total population of Arizona and Nevada will double during that period. The U.S. Census Bureau projects that between 2000 and 2030 the total populations of Arizona and Nevada will grow from approximately 5 million to more than 10.7 million and from approximately 2 million to nearly 4.3 million, respectively; Florida’s population will grow nearly 80% between 2000 and 2030, from nearly 16 million to nearly 28.7 million; Texas’ population will increase 60% between 2000 and 2030, from nearly 21 million to approximately 33.3 million; and California’s population will grow 37% between 2000 and 2030, from approximately 34 million to nearly 46.5 million.
 
The Harvard Joint Center for Housing Studies forecasts that an average of between approximately 1.25 million and 1.48 million new households will be formed per year over the next ten years. Likewise, The Homeownership Alliance, a joint project undertaken by the chief economists of Fannie Mae, Freddie Mac, the Independent Community Bankers of America, the National Association of Home Builders, and the National Association of Realtors, has projected that 1.3 million new households will be formed per year over the next decade and approximately 1.8 million housing units per year should be started to meet such new demand, including approximately 1.3 million new single-family homes per year based on the estimation of the Homeownership Alliance that 72% of all housing units built will be single-family residences. The U.S. Census Bureau estimates that approximately 951,190 new households were formed in 2010.
 
While housing woes have beleaguered the national economy, Texas housing markets have held up as some of the healthiest in the country. Furthermore, Texas is the largest homebuilding market in the country based on the U.S. Census Bureau’s measurements of housing permits and starts. We have concentrated our initial investment portfolio in Texas as we believe Texas markets, though weakened from their highs in 2007, have remained fairly healthy due to strong demographics, economies and job growth, balanced housing inventories, stable home prices and high housing affordability ratios. Texas did not experience the dramatic price appreciation (and subsequent depreciation) that states such as California, Florida, Arizona, and Nevada experienced. The following graph, created with data from the second quarter 2011 Federal Housing Finance Agency’s (“FHFA”) Purchase Price Only Index, illustrates the declines in home prices nationally, as well as in California, Florida, Arizona, and Nevada over the past few years. Price declines have begun to moderate in those states in recent quarters, though. Further, the graph illustrates how Texas has maintained relative home price stability throughout the downturn. The Standard (Purchase-Only) Home Price Index indicates that Texas had a home price depreciation of -1.91% between the second quarter of 2010 and the second quarter of 2011. However, Texas’ home prices continued to demonstrate more stability than the national average of -5.93%. Further, the index also reports that over the past five years, Texas home prices have appreciated 5.94% compared to a national depreciation of -18.78% over the same time period.
 
 
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FHFA’s Purchase Price Only Index tracks average house price changes in repeat sales on the same single-family properties. The Purchase Price Only Index is based on more than 6 million repeat sales transactions and is based on data obtained from Fannie Mae and Freddie Mac for mortgages originated over the past 36 years. FHFA analyzes the combined mortgage records of Fannie Mae and Freddie Mac, which form the nation’s largest database of conventional, conforming mortgage transactions. The conforming loan limit for mortgages purchased since the beginning of 2006 has been $417,000. Loan limits for mortgages originated in the latter half of 2007 through December 31, 2008 were raised to as much as $729,750 in high-cost areas in the contiguous United States. Legislation generally extended those limits for 2009-originated mortgages. An appropriations act (PL111-88) further extended those limits for 2010 originations in places where the limits were higher than those that would have been calculated under pre-existing rules.
 
Median new home prices in the four major Texas markets have begun to rise. According to numbers publicly released by Metrostudy, a leading provider of primary and secondary market information, the median new home prices for the third quarter of 2011 in the metropolitan areas of Austin, Houston, Dallas, and San Antonio are $218,205, $216,966, $226,995 and $178,011, respectively.
 
Using the Department of Housing and Urban Development’s estimated 2011 median family income for the respective metropolitan areas of Austin, Houston, Dallas and San Antonio, the median income earner in those areas has 1.48 times, 1.31 times, 1.31 times, and 1.45 times the income required to qualify for a mortgage to purchase the median priced new home in the respective metropolitan area. These numbers illustrate the affordability of Texas homes, as each of these markets has higher affordability than the national average. Our measurement of housing affordability, as referenced above, is determined as the ratio of median family income to the income required to qualify for a 90 percent, 30-year fixed-rate mortgage to purchase the median-priced new home, based on the average interest rate over the third quarter of 2011 and assuming an annual mortgage insurance premium of 70 basis points for private mortgage insurance, plus a cost that includes estimated property taxes and insurance for the home. Using the Department of Housing and Urban Development’s 2011 income data to project an estimated median income for the United States of $64,200 and the September 2011 national median sales prices of new homes sold of $204,400, we conclude that the national median income earner has 1.36 times the income required to qualify for a mortgage loan to purchase the median-priced new home in the United States. This estimation reflects the increase in home affordability in housing markets outside of Texas over the past 48 months, as new home prices in housing markets outside of Texas generally have fallen. Recently, however, such price declines have begun to stabilize. We believe that such price stabilization indicates that new home affordability has been restored to the national housing market.
 
 
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Since the national recession’s official end, Texas employment markets have experienced strong job growth. According to the United States Department of Labor, Texas added approximately 248,500 jobs in the 12 months ended September 2011, which was the second largest year-over-year increase of any state in the country. Furthermore, Texas added an even greater amount of jobs in the private sector (281,400) over the past 12 months, which was the largest private sector job increase of any state over the past 12 months and is a growth rate of 3.3%. Since the national recession’s end in June 2009, Texas has added 318,300 net new jobs, which is approximately 37.8% of all net jobs added nationwide over that 27 month period. Further, Texas has added approximately 1.1 million new jobs over the past 10 years, 884,000 in the private sector, in contrast to a loss of approximately 184,000 total jobs and a loss of more than 1 million private sector jobs in the country as a whole. From September 2010 to September 2011, Austin added 17,500 jobs year-over-year. Dallas-Fort Worth added 79,600 jobs over that same time period, which was the greatest job gain of any city in the country over the past 12 months, just ahead of Houston, which enjoyed the second greatest job gain of any city in the country in that time. Houston added 68,200 jobs over that period and San Antonio added 9,200 jobs in that time.
 
Texas’ unemployment rate rose year-over-year to 8.5% in September 2011 from 8.2% in September 2010. The increase in the state unemployment rate is likely due to a growth in Texas’ labor force, as Texas has added an estimated 148,100 workers to its labor force over the past 12 months, which is an all-time high. The growth in Texas’ labor force stands in contrast with the national labor force, which has fallen by approximately 936,000 workers, as of September 2011, from its peak in October 2008 and fell by approximately 107,000 over the past 12 months. The national unemployment rate fell year-over-year from September 2010 (9.6%) to September 2011 (9.1%). In addition, all four major Texas labor markets have unemployment rates below the national unemployment rate.
 
We believe that Texas cities will continue to be among the first in the country to recover based on employment figures, consumer confidence, gross metropolitan product, and new home demand. According to the Texas Workforce Commission, Texas tends to enter into recessions after the national economy has entered a recession and usually leads among states in the economic recovery. The National Bureau of Economic Research has concluded that the U.S. economy entered into a recession in December 2007, ending an economic expansion that began in November 2001. We believe, based on transitions in the Texas Leading Index as prepared by the Federal Reserve Bank of Dallas, that Texas entered into recession in late Fall 2008, trailing the national recession by nearly a year and emerged from the recession in the late spring of 2009. We believe the Texas economy is now leading the national economic recovery. The Texas Leading Index has risen significantly since reaching a low of 100.5 in March 2009 and, as of August 2011, was 119.6, which is higher than at any period during 2009 or 2010. The Texas Leading Index, produced monthly by the Federal Reserve Bank of Dallas, combines eight measures that tend to anticipate changes in the Texas business cycle by approximately three to nine months. The index has either risen or remained constant for nine consecutive months.
 
Further, we believe Texas consumers are beginning to return to their normal consumption habits. The aggregate value of state sales tax receipts in Texas increased 11.8% year-over-year in September 2011 from September 2010 – the 18th consecutive month in which Texas has experienced year-over-year improvement in sales tax receipts.
 
The U.S. Census Bureau reported in its 2009 Estimate of Population Change for the period from July 1, 2008 to July 1, 2009 that Texas led the country in population growth during that period. The estimate concluded that Texas’ population grew by 478,012 people, or 2%, a number that was 1.25 times greater than the next closest state in terms of raw population growth, California, and more than 3.57 times the second closest state in terms of raw population growth, North Carolina. In the Census Bureau’s 2010 Estimate of Population Change, Texas’ population grew an additional 1.8%, adding approximately 442,794 new residents in 2010. For the decade, July 1, 2000 to July 1, 2010, Texas grew by nearly 4.3 million residents, averaging nearly 427,000 new residents per year. This population growth was 1.17 times greater in terms of raw population growth than the next closest state, California, and 2.63 times greater than the second closest state, Florida. The U.S. Census Bureau also reported that among the 15 counties that added the largest number of residents between July 1, 2008 and July 1, 2009, six were in Texas: Harris (Houston), Tarrant (Fort Worth), Bexar (San Antonio), Collin (North Dallas), Dallas (Dallas) and Travis (Austin). In March 2010, the U.S. Census Bureau reported that Texas’ four major metro areas – Austin, Houston, San Antonio, and Dallas-Fort Worth – were among the top 20 in the nation for population growth from 2008 to 2009. Dallas-Fort Worth-Arlington led the nation in numerical population growth with a combined estimated population increase of 146,530. Houston-Sugarland-Baytown was second in the nation with a population increase of 140,784 from July 1, 2008 to July 1, 2009. Austin-Round Rock had an estimated population growth of 50,975 and San Antonio had an estimated population growth of 41,437 over the same period. The percentage increase in population for each of these major Texas cities ranged from 2% to 3.1%.
 
 
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The national foreclosure tracking service, RealtyTrac, estimates that the Texas foreclosure rate continues to be significantly healthier than the national average. We do not expect the four major Texas housing markets to be materially adversely affected by foreclosures and anticipate that home foreclosures will continue to be mostly concentrated in the b