AMERICAN RESIDENTIAL INVESTMENT TRUST INC, 424B1, 1997-10-29

AMERICAN RESIDENTIAL INVESTMENT TRUST INC
424B1, 1997-10-29
REAL ESTATE INVESTMENT TRUSTS

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<PAGE> 1
This filing is made pursuant
to Rule 424(b)(1)
6,500,000 SHARES under the Securities Act of
1933 in connection with
Registration No. 333-33679
LOGO
COMMON STOCK
------------------------

All of the shares of Common Stock offered hereby are being sold by American
Residential Investment Trust, Inc. ("AMREIT" or the "Company"), a real estate
investment trust organized in February 1997 to acquire adjustable-rate
residential Mortgage Securities and Mortgage Loans initially in the following
categories: small multifamily home, manufactured housing, mixed use, rural home,
mini-ranch home and condominium/resort. As of the closing of this Offering, $90
million, or 28% of the Company's net assets will be uncommitted. The Company
will be managed by a corporation which, together with its affiliates, will own
approximately 20% of the Common Stock of the Company after this Offering. Prior
to this Offering, there has been no public market for the Common Stock of the
Company. See "Underwriting" for information relating to the determination of the
initial public offering price.

The Common Stock has been approved for listing on the New York Stock
Exchange under the symbol "INV."

SEE "RISK FACTORS" STARTING ON PAGE 8 FOR MATERIAL RISKS THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS. THESE RISKS INCLUDE:

- - Sudden Interest Rate Fluctuations May Reduce Income From Operations
- - Increased Levels of Mortgage Loan Prepayments May Reduce Operating Income
- - Material Portion of Offering Proceeds Not Committed to Specific Mortgage
Assets; Inability to Acquire Mortgage Assets
- - Manager's Lack of Prior Experience in Managing a REIT Could Adversely Affect
the Company's Business, Financial Condition and Results of Operations; Limited
Operating History Does Not Necessarily Predict Future Performance of Company
- - Failure to Implement Company's Leverage Strategy May Adversely Affect Results
of Operations
- - Failure to Successfully Manage Interest Rate Risks May Adversely Affect
Results of Operations
- - The Company Has Significant Conflicts with, and Is Dependent on, an Affiliate
of the Executive Officers of the Company

------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------

<TABLE>
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------
Underwriting
Price to Discount and Proceeds to
Public Commissions(1) Company(2)
- ------------------------------------------------------------------------------------------------
Per Share................................. $15.000 $0.975 $14.025
- ------------------------------------------------------------------------------------------------
Total..................................... $97,500,000 $6,337,500 $91,162,500
- ------------------------------------------------------------------------------------------------
Total Assuming Full Exercise of
Over-allotment Option(3)................ $112,125,000 $7,288,125 $104,836,875
================================================================================================
</TABLE>

(1) See "Underwriting" for information regarding indemnification of the
Underwriters and other matters.

(2) Before deducting expenses estimated at $1,500,000, all of which are payable
by the Company. See "Underwriting."

(3) Assuming exercise in full of the 30-day option granted by the Company to the
Underwriters to purchase up to 975,000 additional shares, on the same terms,
solely to cover over-allotments. See "Underwriting."
------------------------

The shares of Common Stock are offered by the Underwriters, subject to
prior sale, when, as and if delivered to and accepted by the Underwriters, and
subject to their right to reject orders in whole or in part. It is expected that
delivery of the Common Stock will be made in New York City on or about November
3, 1997.

------------------------

PAINEWEBBER INCORPORATED
OPPENHEIMER & CO., INC.
EVEREN SECURITIES, INC.
SUTRO & CO. INCORPORATED
------------------------

THE DATE OF THIS PROSPECTUS IS OCTOBER 28, 1997.

<PAGE> 2

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING AND
MAY BID FOR AND PURCHASE SHARES OF THE COMMON STOCK IN THE OPEN MARKET. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."

The Company intends to furnish its stockholders with annual reports
containing financial statements audited by its independent auditors and
quarterly reports for the first three quarters of each fiscal year containing
unaudited financial information.

TABLE OF CONTENTS

<TABLE>
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PROSPECTUS SUMMARY............................. 1
The Company.................................. 1
Business..................................... 1
Recent Developments.......................... 2
Summary Risk Factors......................... 3
Management of the Company.................... 4
Benefits of Offering to Management........... 5
The Manager.................................. 5
Management and Termination Fees.............. 6
Conflicts of Interest........................ 6
Federal Income Tax Consequences.............. 6
Dividend Policy and Distributions............ 6
The Offering................................. 7
Purpose of the Offering...................... 7
Summary Financial Information................ 7
RISK FACTORS................................... 8
Sudden Interest Rate Fluctuations May Reduce
Income From Operations..................... 8
Increased Levels of Mortgage Loan Prepayments
May Reduce Operating Income................ 8
Material Portion of Offering Proceeds Not
Committed to Specific Mortgage Assets;
Inability to Acquire Mortgage Assets....... 9
Manager's Lack of Prior Experience in
Managing a REIT Could Adversely Affect the
Company's Business, Financial Condition and
Results of Operations; Limited Operating
History Does Not Necessarily Predict Future
Performance of Company..................... 10
Failure to Implement Company's Leverage
Strategy May Adversely Affect Results of
Operations................................. 10
Failure to Successfully Manage Interest Rate
Risks May Adversely Affect Results of
Operations................................. 11
The Company Has Significant Conflicts with,
and Is Dependent on, an Affiliate of the
Executive Officers of the Company.......... 11
Borrower Credit May Decrease Value of
Mortgage Loans............................. 12
Characteristics of Underlying Property May
Decrease Value of Mortgage Loans........... 12
Dependence on Key Personnel for Successful
Operations................................. 13
Failure to Manage Expansion May Adversely
Affect Results of Operations............... 13
Real Estate Market Conditions May Adversely
Affect Results of Operations............... 13
Investments in Mortgage Assets May Be
Illiquid................................... 13
Policies and Strategies May Be Revised at the
Discretion of the Board of Directors....... 13
The Manager and Certain Affiliates Will
Control Approximately 20% of Outstanding
Shares After Offering...................... 14
Failure to Maintain REIT Status May Subject
Company to Corporate Level Tax............. 14
Market for Common Stock May be Limited and
Market Price May Fluctuate Below Offering
Price...................................... 14

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<S> <C>
Failure to Qualify for Exemption Under
Investment Company Act Would Result in
Significant Regulatory Burden.............. 15
Future Offerings of Common Stock May Affect
Market Price of Common Stock............... 15
Ownership of Common Stock May Be
Restricted................................. 15
Default of Manager under Securities Purchase
Agreement; Restrictive Covenants........... 16
Limitations on Acquisition and Change in
Control.................................... 16
Shares Eligible for Future Sale.............. 17
Dilution to Stockholders Purchasing in
Offering................................... 17
THE COMPANY.................................... 18
USE OF PROCEEDS................................ 20
DIVIDEND POLICY AND DISTRIBUTIONS.............. 21
CAPITALIZATION................................. 22
DILUTION....................................... 23
SELECTED FINANCIAL DATA........................ 24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS................................... 25
Overview..................................... 25
Certain Accounting Policies and Procedures... 27
Results of Operations........................ 28
Liquidity and Capital Resources.............. 29
Recent Developments.......................... 29
BUSINESS....................................... 30
Residential Mortgage Industry................ 30
Investments.................................. 30
Recent Investment Status..................... 35
Funding...................................... 35
Capital Guidelines........................... 37
Risk Management.............................. 38
Competition.................................. 42
Employees.................................... 42
Facilities................................... 43
Legal Proceedings............................ 43
MANAGEMENT OF THE COMPANY...................... 44
Directors and Executive Officers of the
Company.................................... 44
Term of Office............................... 46
Board Committees............................. 47
Action by Independent Directors.............. 47
Compensation Committee Interlocks and Insider
Participation in Compensation Decisions.... 47
Director Compensation........................ 47
Limitation of Liability and
Indemnification............................ 48
Executive Compensation....................... 49
Option Grants................................ 50
1997 Stock Incentive Plan.................... 51
1997 Stock Option Plan....................... 51
1997 Employee Stock Purchase Plan............ 51
1997 Outside Directors Stock Option Plan..... 52
Employment Contracts and Termination of
Employment and Change of Control
Arrangements............................... 52
</TABLE>

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<TABLE>
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PAGE
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<S> <C>
Fiduciary Obligations........................ 53
BENEFITS OF OFFERING TO MANAGEMENT............. 53
THE MANAGER.................................... 54
Directors and Executive Officers of the
Manager.................................... 55
The Management Agreement..................... 55
Relationship between the Manager and the
Company.................................... 58
MANAGEMENT AND TERMINATION FEES................ 58
Management Fees.............................. 58
Termination Fees............................. 59
Expenses..................................... 60
Salary Reimbursements........................ 60
CERTAIN TRANSACTIONS........................... 61
Discussion of Securities Purchase
Agreement.................................. 61
Other Transactions........................... 62
CONFLICTS OF INTEREST.......................... 64
PRINCIPAL STOCKHOLDERS......................... 65
DESCRIPTION OF CAPITAL STOCK................... 66
General...................................... 66
Common Stock................................. 66
Additional Classes and Series of Stock....... 66
Registration Rights.......................... 66
Repurchase of Shares and Ownership
Limitations................................ 67
Transfer Agent and Registrar................. 69
SHARES ELIGIBLE FOR FUTURE SALE................ 69
FEDERAL INCOME TAX CONSEQUENCES................ 70
General...................................... 70
Opinion of Special Counsel................... 70
Requirements for Qualification as a REIT..... 71
PAGE
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Recordkeeping Requirements................... 74
Termination or Revocation of REIT Status..... 74
Taxation of the Company...................... 75
Taxable Subsidiaries......................... 75
Taxation of Stockholders..................... 76
Taxation of Tax-Exempt Entities.............. 77
State and Local Taxes........................ 77
Certain United States Federal Income Tax
Considerations Applicable to Foreign
Holders.................................... 77
ERISA CONSIDERATIONS........................... 79
UNDERWRITING................................... 80
CERTAIN PROVISIONS OF MARYLAND LAW AND THE
COMPANY'S CHARTER AND BYLAWS................. 83
Certain Anti-Takeover Provisions............. 83
Staggered Board of Directors................. 83
Number of Directors, Independent Directors,
Removal, Filling Vacancies................. 83
Advance Notice Provisions for Stockholder
Nominations and Stockholder Proposals...... 84
Relevant Factors to be Considered by the
Board of Directors......................... 84
Rights to Purchase Securities and Other
Property................................... 84
Business Combinations........................ 84
Control Share Acquisitions................... 85
LEGAL MATTERS.................................. 86
EXPERTS........................................ 86
ADDITIONAL INFORMATION......................... 86
GLOSSARY....................................... 87
INDEX TO FINANCIAL STATEMENTS.................. F-1
</TABLE>

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(THIS PAGE INTENTIONALLY LEFT BLANK)
<PAGE> 5

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information appearing in this Prospectus. Capitalized and other terms relating
to the mortgage industry used herein shall have the definitive meanings assigned
to them in the Glossary which begins on page 87. Unless otherwise indicated, the
information in this Prospectus (i) assumes that the Underwriters' over-allotment
option will not be exercised and (ii) has been adjusted to reflect the 0.8-for-1
reverse stock split effected prior to the closing of this Offering. See Note 8
of Notes to Financial Statements.

This Prospectus contains forward looking statements that inherently involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward looking statements as a result of
certain important factors. Investors should carefully consider the information
set forth under the heading "Risk Factors."

THE COMPANY

American Residential Investment Trust, Inc. ("AMREIT" or the "Company") is
a real estate investment trust that invests in residential adjustable-rate
Mortgage Assets. The Company finances its acquisitions of Mortgage Assets with
equity and secured borrowings. AMREIT expects generally to earn interest on the
portion of its portfolio of Mortgage Assets financed with equity and to earn a
net interest spread on the leveraged portion of its portfolio of Mortgage
Assets. The Company is structured as a real estate investment trust, thereby
generally eliminating federal taxes at the corporate level on income it
distributes to stockholders.

The Company has entered into an agreement with Home Asset Management Corp.
(the "Manager") to manage the day-to-day operations of the Company (the
"Management Agreement"). Accordingly, the Company's success will depend in
significant part on the Manager. Certain of the executive officers of the
Company will also be executive officers, employees and stockholders of the
Manager. Pursuant to the terms of the Management Agreement, the Manager will
advise the Company's Board of Directors with respect to the formulation of
investment criteria and preparation of policy guidelines, and will be
compensated based upon the principal amount and type of Mortgage Assets held by
the Company. See "The Manager," "Management and Termination Fees," and
"Conflicts of Interest."

BUSINESS

Investments

AMREIT's current investment portfolio is comprised solely of Mortgage
Securities issued or guaranteed by federal government sponsored agencies.
Following the closing of this Offering, the Company will begin investing in
other types of Mortgage Securities and in Mortgage Loans (collectively "Mortgage
Assets"). The Company's goal is to acquire nonconforming Mortgage Loans with
higher overall returns than similar Mortgage Loans originated by its
competitors. Accordingly, the Manager has developed tailored underwriting
guidelines for nonconforming Mortgage Loans that the Company intends to acquire
from third-party originators through its Direct Purchase Program. The Manager
has initially developed tailored underwriting guidelines for the following
segments of the residential Mortgage Loan market: small multifamily home loans,
manufactured housing loans (not including mobile homes), mixed use loans, rural
home loans, mini-ranch home loans, and condominium/resort loans. The Company
expects that additional opportunities in other market segments will become
available as the Mortgage Loan market continues to change. The Company has not
yet acquired any Mortgage Loans pursuant to the Direct Purchase Program and
there can be no assurance that the program will be successfully implemented or
that any Mortgage Assets acquired through the program will be higher yielding
than Mortgage Loans originated by the Company's competitors. The Company has not
specifically identified any Mortgage Assets in which to invest the net proceeds
of this Offering.

Funding

The Company generally expects to finance the acquisition of 8% to 12% of
its Mortgage Assets with equity and the balance with third-party borrowing
facilities. The Company will earn interest on the Mortgage Assets financed with
equity and a net interest spread on the Mortgage Assets financed with
borrowings. AMREIT generally borrows funds pursuant to reverse repurchase
agreements. In a reverse repurchase agreement transaction, the Company agrees to
sell a Mortgage Asset and simultaneously agrees to repurchase

1
<PAGE> 6

the same Mortgage Asset one to six months later at a higher price. The price
differential represents the Company's interest expense. From time to time the
Company also intends to securitize Mortgage Loans acquired through the Direct
Purchase Program as part of its overall financing strategy.

Capital Guidelines

The Company's capital management goal is to strike a balance between the
under-utilization of leverage, which reduces potential returns to stockholders,
and the over-utilization of leverage, which could reduce the Company's ability
to meet its obligations during adverse market conditions. For this purpose, the
Company has established a Capital Policy which establishes a minimum ratio of
the Company's equity capital to the total value of its Mortgage Assets. The
Board of Directors of the Company adjusts this ratio when it determines in its
discretion that the percentage of Mortgage Assets financed with debt is either
too low or too high. The Company expects that its aggregate minimum equity
capital requirement under the Capital Policy will generally range between 8% to
12% of the total market value of the Company's Mortgage Assets. It may fluctuate
out of the expected range from time to time as a result of market conditions,
performance of hedges, credit risk, prepayments, general economic conditions and
general availability of financing. There can be no assurance that the Company's
equity capital will be sufficient to protect the Company against adverse effects
from interest rate adjustments or the obligation to sell Mortgage Assets on
unfavorable terms or at a loss.

Risk Management

AMREIT will implement certain processes and will follow a hedging program
intended to protect the Company against significant unexpected changes in
prepayment rates and interest rates. The Company will seek to minimize the
effects on earnings caused by higher than anticipated prepayment rates by
purchasing Mortgage Assets with prepayment penalties or which are fully-indexed
and have previously experienced periods of rising or falling interest rates. The
Company will seek to manage its Mortgage Asset portfolio to offset the potential
adverse effects from (i) lifetime and periodic rate adjustment caps on its
Mortgage Assets, (ii) the differences between interest rate adjustment indices
applicable to its Mortgage Assets and related borrowings, and (iii) the
differences between interest rate adjustment periods applicable to its Mortgage
Assets and related borrowings.

In order to reduce the credit risks associated with acquisitions of
Mortgage Loans under the Direct Purchase Program, the Company (with the advice
of the Manager) will (i) employ a quality control program, (ii) acquire Mortgage
Loans that represent a broad range of moderate risks as opposed to a
concentrated risk, (iii) monitor the credit quality of newly acquired and
existing Mortgage Assets, and (iv) periodically adjust loan loss allowances. The
Company also expects to arrange for servicing of any Mortgage Loans acquired
pursuant to the Direct Purchase Program with servicing entities that have
expertise and experience in the types of Mortgage Loans being acquired. Although
the Company intends to manage risks associated with prepayment rates, interest
rates and credit quality, there can be no assurance that the Company will be
able to effectively manage such risks.

RECENT DEVELOPMENTS

For the quarter ended September 30, 1997, AMREIT generated net income of
approximately $519,000 and net income per share of $0.31. From the commencement
of operations on February 11, 1997 through September 30, 1997, the Company
generated net income of approximately $1.1 million and net income per share of
$0.66. At September 30, 1997, the Company held Mortgage Assets that had a
carrying value of approximately $229 million. All Mortgage Assets held at
September 30, 1997 were Agency Securities backed by adjustable-rate single
family residential Mortgage Loans.

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SUMMARY RISK FACTORS

Each prospective purchaser of the shares of Common Stock (the "Shares")
offered hereby should review "Risk Factors" beginning on page 8 for a discussion
of certain factors that should be considered before acquiring the Shares,
including the following:

- - Sudden Interest Rate Fluctuations May Reduce Income From Operations. To the
extent the Company's cost of borrowings rises more rapidly than the earnings
on its Mortgage Assets, the Company's income from operations may be reduced.

- - Increased Levels of Mortgage Loan Prepayments May Reduce Operating Income. In
the event that prepayments on the Company's Mortgage Assets exceed
expectations, the Company may (i) have lost the opportunity to receive
interest at the fully indexed rate, (ii) need to write-off capitalized premium
amounts, and (iii) be unable to acquire new Mortgage Assets to replace the
prepaid Mortgage Assets. The Company experienced higher than expected levels
of prepayments in the quarter ended June 30, 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations."

- - Material Portion of Offering Proceeds Not Committed to Specific Mortgage
Assets; Inability to Acquire Mortgage Assets. At the closing of this Offering,
approximately $90 million, or 28%, of the Company's assets will not be
committed to Mortgage Assets. The Company's net interest income will depend on
the Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. To the extent the
Company is unable to acquire a sufficient number of Mortgage Assets meeting
its investment criteria, the Company's results of operations may be adversely
affected.

- - Manager's Lack of Prior Experience in Managing a REIT Could Adversely Affect
the Company's Business, Financial Condition and Results of Operations; Limited
Operating History Does Not Necessarily Predict Future Performance of
Company. The Manager has no prior experience in managing a real estate
investment trust. The Company began operations in February 1997, and the
Company's financial results to date may not be indicative of future results.

- - Failure to Implement Company's Leverage Strategy May Adversely Affect Results
of Operations. The Company relies on short-term borrowings to fund
acquisitions of Mortgage Assets. Any failure to obtain or renew adequate
funding on favorable terms could have a material adverse effect on the
Company's operations. In such event, the Company could be required to sell
Mortgage Assets under adverse market conditions and incur losses as a result.
There are no restrictions on the Company's ability to incur debt.

- - Failure to Successfully Manage Interest Rate Risks May Adversely Affect
Results of Operations. Developing an effective interest rate risk management
strategy is complex and no strategy can completely insulate the Company from
risks associated with unexpected interest rate changes. Further, the cost of
hedging transactions and the federal tax laws applicable to real estate
investment trusts may limit the Company's ability to fully hedge its interest
rate risks. In addition, a provider of interest rate derivatives may become
financially unsound or insolvent, thereby rendering the Company unprotected
against interest rate risks.

- - The Company Has Significant Conflicts with, and Is Dependent on, an Affiliate
of the Executive Officers of the Company. The executive officers of the
Company will also be executive officers, employees and stockholders of the
Manager, and will therefore be affiliated with the Manager. Emphasis by the
executive officers on maximizing income in order to achieve higher incentive
fees for the Manager could result in increased risk to the value of the
Company's Mortgage Asset portfolio.

- - Borrower Credit May Decrease Value of Mortgage Loans. In the event of a
default on any Mortgage Loan held by the Company, the Company will bear the
risk of loss of principal and the Mortgage Loan will cease to be eligible
collateral for borrowings.

- - Characteristics of Underlying Property May Decrease Value of Mortgage
Loans. Mortgage Loans acquired pursuant to the Direct Purchase Program will
have certain distinct risk characteristics and will result in increased credit
risk to the Company.

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- - Dependence on Key Personnel for Successful Operations. The Company's
operations depend in significant part upon the skills and experience of John
Robbins, Jay Fuller and other key personnel. The loss of any key person could
have a material adverse effect on the Company's business.

- - Failure to Manage Expansion May Adversely Affect Results of Operations. The
Company's expansion as a result of its investment of the net proceeds of this
Offering may cause a significant strain on the Company's and the Manager's
financial, management and other resources. If the Company and the Manager are
unable to manage growth effectively, the Company's business, financial
condition and results of operations may be adversely affected.

- - Real Estate Market Conditions May Adversely Affect Results of Operations. The
Company's business may be adversely affected by periods of economic slowdown
or recession which may be accompanied by declining real estate values.

- - Investments in Mortgage Assets May Be Illiquid. Certain of the Company's
investments may lack a regular trading market and may be illiquid. The
Company's inability to liquidate Mortgage Assets could render it insolvent.

- - Policies and Strategies May Be Revised at the Discretion of the Board of
Directors. The Board of Directors has established, and generally can waive and
modify, the investment, and operating policies and strategies of the Company.
These policies and strategies do not limit the amount of capital which may be
invested in any one type of Mortgage Asset.

- - The Manager and Certain Affiliates Will Control approximately 20% of
Outstanding Shares After Offering. Upon the closing of this Offering, the
Company's directors and officers, the Manager and certain of their affiliates
will beneficially own or have a right to control approximately 20% of the
outstanding shares of Common Stock of the Company. As stockholders, they could
exert significant influence over corporate actions requiring stockholder
approval.

- - Failure to Maintain REIT Status May Subject Company to Corporate Level Tax. If
the Company fails to qualify as a real estate investment trust in any taxable
year, the Company may be subject to federal income tax as a regular, domestic
corporation, thereby significantly reducing or eliminating the amount of cash
available for distribution to its stockholders. Failure to qualify for real
estate investment trust status may reduce or eliminate the Company's advantage
over non-real estate investment trust companies.

MANAGEMENT OF THE COMPANY

The Company has entered into an agreement with the Manager to provide
management services to the Company. Although the Manager has had no prior
experience managing a real estate investment trust, each of the executive
officers of the Manager and the Company has between 10 and 24 years, and
collectively, they have an average of 19 years, of experience in the mortgage
origination business and extensive experience in originating nonconforming
Mortgage Loans.

The Company is subject to conflicts of interest with the Manager and its
executive officers. The executive officers of the Company will also be executive
officers, employees and stockholders of the Manager. In evaluating Mortgage
Assets for investment and other strategies, the executive officers could
emphasize maximizing income at the expense of other criteria, in order to
achieve higher incentive compensation for the Manager, which could result in
increased risk to the value of the Company's portfolio of Mortgage Assets. In
addition, the Management Agreement does not limit or restrict the right of the
Manager to render services of any kind to any third party, except that the
Manager and its officers, directors or employees will not be permitted to
provide any such services to any real estate investment trust which invests in
residential Mortgage Assets, other than the Company. Moreover, in certain
circumstances termination of the Management Agreement could result in payment of
a significant termination fee by the Company. See "Management and Termination
Fees." Due to the nature of the relationship between the Company and the
Manager, the organization and operating structure of the Company and the
compensation arrangements between the Company and the Manager were not a result
of arm's-length negotiations. See "The Company."

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The Company's Bylaws require that a majority of the members of its Board of
Directors must be independent directors who are not officers or employees of the
Company. Upon the closing of this Offering, the Company will have seven members
serving on its Board of Directors, five of whom will be independent directors.
In addition to approval by the Board of Directors, the following actions require
approval by a majority of the independent directors:

- termination of the Management Agreement between the Company and the
Manager;

- revisions to the Company's investment policies; and

- an amendment to the Company's Bylaws.

The Board of Directors may amend the Company's investment policies without
further approval by the Company's stockholders.

BENEFITS OF OFFERING TO MANAGEMENT

Although no additional fees will be payable to the Manager solely as a
result of this Offering, investment of the net proceeds of this Offering will
result in an increase in the Company's Mortgage Assets and thus an increase in
the management fees to be paid to the Manager. At the discretion of the
Manager's board of directors, the Manager may elect to pay a portion of such
fees to its executive officers as a bonus. The executive officers may benefit in
a number of other ways from this Offering. First, upon the effectiveness of this
Offering, options to purchase an aggregate of 315,400 shares of Common Stock of
the Company were issued to the executive officers at an exercise price equal to
the initial public offering price. Second, upon the closing of this Offering,
certain executive officers will realize an immediate increase in the value of
certain options and shares of the Common Stock of the Company. Third, options
held by the executive officers to purchase an aggregate of 621,800 shares of the
Company's Common Stock will vest in full in the event the Company completes
additional public or private offerings which generate proceeds that, when
combined with the net proceeds of this Offering, exceed $150 million. See
"Management of the Company -- Option Grants."

THE MANAGER

Pursuant to a Management Agreement, AMREIT has engaged the Manager to
generate and manage the Company's Mortgage Assets and to oversee the day-to-day
operations of the Company, subject to direction by the Company's Board of
Directors. The Company believes that its use of an external manager has enabled
and will continue to enable the Company to avoid certain of the costs associated
with beginning its operations and establishing an infrastructure. In particular,
the Company believes that the Manager may incur significant up-front costs with
respect to the development of the Direct Purchase Program. Because the Company
pays management and incentive fees to the Manager based solely upon the
principal amounts of Mortgage Assets held by the Company and the Company's net
income, the Company's net income will not be directly affected by the employee
and other infrastructure expenses incurred by the Manager. Further, because the
Manager's incentive compensation is tied to return on equity, in periods of low
earnings, the Manager's incentive compensation will be reduced, thereby lowering
the Company's operating expenses. See "Management and Termination Fees."

The Manager funded AMREIT at its formation with a $20 million investment
through MDC REIT Holdings, LLC ("Holdings"), an intermediary entity. See "The
Manager -- Relationship between the Manager and the Company." Currently, the
Manager derives substantially all of its income from the Company, a majority of
which is from dividends and incentive fees. Accordingly, the success of the
Manager is substantially dependent upon the success of the Company. In addition,
the executive officers of the Company are also the executive officers of the
Manager and beneficially own an interest in the Manager. See "The Company," "The
Manager," "Certain Transactions," "Conflicts of Interest" and "Principal
Stockholders."

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MANAGEMENT AND TERMINATION FEES

In addition to reimbursing the Manager for certain expenses incurred on
behalf of the Company, the Company will pay to the Manager the base management
fees and incentive compensation, as follows:

- 1/8 of 1% per year, to be paid monthly, of the principal amount of Agency
Securities;

- 3/8 of 1% per year, to be paid monthly, of the principal amount of all
Mortgage Assets other than Agency Securities; and

- 25% of the amount by which the Company's net income (before deducting the
amount to be paid as incentive compensation) exceeds the annualized
return on equity equal to the average ten year U.S. Treasury Rate plus
2%.

Investment of the net proceeds of this Offering will result in an increase
in the Company's Mortgage Assets and, thus, an increase in the management fees
and incentive compensation to be paid to the Manager.

The Management Agreement has an initial term of two years with automatic
one-year renewals. It may be terminated by the Company without cause only upon
each renewal date and may be terminated for cause at any time by either party.
In the event that the Management Agreement is terminated by the Company without
cause, the Company is obligated to pay the Manager a termination fee pursuant to
a specified formula. See "Management and Termination Fees."
------------------------

The Company was incorporated in Maryland on February 6, 1997. The principal
executive offices of the Company and the Manager are located at 445 Marine View
Avenue, Suite 230, Del Mar, California 92014. The telephone number is (619)
350-5000.

CONFLICTS OF INTEREST

Certain of the executive officers of the Company are executive officers,
employees and stockholders of the Manager. The Manager's base management fee and
incentive compensation is determined based upon the principal amount and type of
assets held by the Company. Because the fees received by the Manager are greater
as the amount of non-Agency Securities held by the Company is increased, the
Manager may have an incentive to invest in Mortgage Assets with higher risks
than those associated with Agency Securities. Accordingly, the Company's
Mortgage Assets may be subject to greater risk of loss. See "Conflicts of
Interest."

FEDERAL INCOME TAX CONSEQUENCES

The Company intends to elect, with the filing of its first federal
corporate income tax return in 1998, to be treated as a real estate investment
trust ("REIT") for federal income tax purposes. A corporation qualifying as a
REIT may avoid corporate income taxation by distributing its taxable income to
its stockholders annually. Subject to the qualifications stated in the section
of the Prospectus entitled "Federal Income Tax Consequences," Jeffers, Wilson,
Shaff & Falk, LLP ("Special Tax Counsel") has given the Company an opinion that
the Company is organized in conformity with the requirements for qualification
and taxation as a REIT under the Internal Revenue Code of 1986, as amended (the
"Code"), and that its actual and proposed method of operation as described in
the Prospectus and as represented to Special Tax Counsel will enable it to meet
the requirements for qualification as a REIT. See "Federal Income Tax
Consequences -- Opinion of Special Counsel."

DIVIDEND POLICY AND DISTRIBUTIONS

The Company intends to distribute 95% or more of its net taxable income
(which does not necessarily equal net income as calculated in accordance with
GAAP) to its stockholders on a quarterly basis each year so as to comply with
the REIT provisions of the Code. Any taxable income remaining after the
distribution of the regular quarterly dividends will be distributed annually in
a special dividend on or prior to the date of the first regular quarterly
dividend payment date of the following taxable year. The dividend policy is
subject to revision in the discretion of the Board of Directors of the Company.

6
<PAGE> 11

THE OFFERING

<TABLE>
<S> <C>
Common Stock Offered by the Company (1)...... 6,500,000 Shares
Common Stock to be Outstanding after the
Offering (1)(2).............................. 8,114,000 Shares
Use of Proceeds.............................. To fund purchases of Mortgage Assets and for
general corporate purposes. See "Use of
Proceeds."
NYSE Symbol.................................. "INV"
</TABLE>

- ---------------

(1) Assumes that the Underwriters' option to purchase up to an additional
975,000 shares of Common Stock to cover over-allotments is not exercised.

(2) Excludes (i) 315,200 shares of Common Stock reserved for issuance pursuant
to options outstanding under the Company's 1997 Stock Incentive Plan (the
"Incentive Plan") and (ii) 337,800 shares of Common Stock reserved for
issuance pursuant to options issued under the Company's 1997 Stock Option
Plan (the "Option Plan") upon the effectiveness of this Offering. See
"Management of the Company" and "Shares Eligible for Future Sale."

PURPOSE OF THE OFFERING

Pursuant to its reverse repurchase agreements, the Company must provide
collateral which has a greater value than the amount it borrows. Accordingly,
the Company is not able to finance the entirety of its acquisitions of Mortgage
Assets with debt. In order to obtain the debt financing necessary to implement
its investment strategy, the Company must have an equity base. The net proceeds
of this Offering will substantially increase the Company's current equity base.
The Company generally intends to finance the acquisition of between 8% and 12%
of its Mortgage Assets with equity and the balance with borrowings. The net
proceeds of this Offering available for investment purposes, after deducting the
estimated expenses of this Offering ($1.5 million) and the underwriting
discounts and commissions ($6.3 million), and assuming no exercise of the
Underwriters' option to purchase shares of Common Stock to cover
over-allotments, will be approximately $89.7 million. Accordingly, the Company
anticipates that it will finance the acquisition of additional Mortgage Assets
with a value of approximately $750 million to $1.1 billion as a result of the
equity it is raising in this Offering and the additional borrowings it may
incur.

SUMMARY FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
FEBRUARY 11, 1997 QUARTER FEBRUARY 11, 1997
TO ENDED TO
JUNE 30, 1997 JUNE 30, 1997 MARCH 31, 1997
----------------- ------------- -----------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total interest income........................... $ 3,640 $ 3,334 $ 306
Net interest income............................. 724 568 156
Net income...................................... 584 438 146
Net income per share of Common Stock(1)......... $ 0.35 $ 0.26 $0.09
</TABLE>

<TABLE>
<CAPTION>
AS OF AS OF
JUNE 30, 1997 MARCH 31, 1997
------------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Mortgage Assets.................................................. $ 228,620 $152,883
Total assets..................................................... 231,518 161,302
Reverse repurchase agreements.................................... 209,539 141,068
Stockholders' equity............................................. 20,603 20,094
</TABLE>

- ---------------

(1) See Note 1 of Notes to Financial Statements for additional information.

7
<PAGE> 12

RISK FACTORS

This Prospectus contains forward looking statements that inherently involve
risks and uncertainties. Before investing in the Shares, prospective investors
should give special consideration to the information set forth below, in
addition to the information set forth elsewhere in this Prospectus. The
following risk factors are interrelated and, consequently, investors should
consider such risk factors as a whole.

SUDDEN INTEREST RATE FLUCTUATIONS MAY REDUCE INCOME FROM OPERATIONS

Substantially all of the Company's Mortgage Assets will have a repricing
frequency of one year or less, and substantially all of the Company's borrowings
will have maturities of six months or less. The interest rates on the Company's
borrowings may be based on interest rate indices which are different from, and
adjust more rapidly than, the interest rate indices of its related Mortgage
Assets. Consequently, changes in interest rates may significantly influence the
Company's net interest income. While increases in interest rates will generally
increase the yields on the Company's adjustable-rate Mortgage Assets, rising
rates will also increase the cost of borrowings by the Company. To the extent
such costs rise more rapidly than the yields on such Mortgage Assets, the
Company's net interest income will be reduced or a net interest loss may result.

Adjustable-rate Mortgage Assets are typically subject to periodic and
lifetime interest rate caps which limit the amount an adjustable-rate Mortgage
Asset interest rate can change during any given period. The Company's borrowings
will not be subject to similar restrictions. Hence, in a period of increasing
interest rates, the cost of the Company's borrowings could increase without
limitation by caps while the yields on the Company's Mortgage Assets could be
limited. Further, some adjustable-rate Mortgage Assets may be subject to
periodic payment caps that result in some portion of the interest being deferred
and added to the principal outstanding. This could result in receipt by the
Company of a lesser amount of cash income on its adjustable-rate Mortgage Assets
than is required to pay interest on the related borrowings, which will not have
such payment caps. These factors could lower the Company's net interest income
or cause a net interest loss during periods of rising interest rates, which
would negatively impact the Company's financial condition and results of
operations.

INCREASED LEVELS OF MORTGAGE LOAN PREPAYMENTS MAY REDUCE OPERATING INCOME

Prepayments of Mortgage Assets could adversely affect the Company's results
of operations in several ways. The Company anticipates that a portion of the
adjustable-rate Mortgage Assets to be acquired by the Company may bear initial
"teaser" interest rates which are lower than their "fully-indexed" rates (the
applicable index plus a margin). In the event that such an adjustable-rate
Mortgage Asset is prepaid prior to or soon after the time of adjustment to a
fully-indexed rate, the Company will have held the Mortgage Asset during its
least profitable period and lost the opportunity to receive interest at the
fully-indexed rate over the expected life of the adjustable-rate Mortgage Asset.
In addition, the prepayment of any Mortgage Asset that had been purchased with a
premium by the Company would result in the immediate write-off of any remaining
capitalized premium amount and consequent reduction of the Company's net
interest income by such amount. Finally, in the event that the Company is unable
to acquire new Mortgage Assets to replace the prepaid Mortgage Assets, the
Company's financial condition and results of operations could be materially
adversely affected.

Mortgage Asset prepayment rates generally increase when new Mortgage Loan
interest rates fall below the interest rates on the adjustable-rate Mortgage
Assets. Prepayment experience also may be affected by the geographic location of
the property securing the adjustable-rate Mortgage Assets, the assumability of
the adjustable-rate Mortgage Assets, the ability of the borrower to obtain or
convert to a fixed-rate Mortgage Loan, conditions in the housing and financial
markets and general economic conditions. The level of prepayments is also
subject to the same seasonal influences as the residential real estate industry
with prepayment rates generally being highest in the summer months and lowest in
the winter months. The Company experienced higher than expected levels of
prepayments in the quarter ended June 30, 1997. Although the Company does not
expect prepayment rates to continue at such levels, there can be no assurance
that the Company will be able to achieve or maintain lower prepayment rates.
Accordingly, the Company's

8
<PAGE> 13

financial condition and results of operations could be materially adversely
affected. See "Business -- Risk Management -- Interest Rate Risk Management."

It is expected that Mortgage Loans acquired by the Company may contain
provisions restricting prepayments of such Mortgage Loans and require a charge
in connection with the prepayment thereof. Such prepayment restrictions can, but
do not necessarily, provide a deterrent to prepayments. Prepayment charges may
be in an amount which is less than the figure which would fully compensate the
Company for a lower yield upon reinvestment of the prepayment proceeds.

MATERIAL PORTION OF OFFERING PROCEEDS NOT COMMITTED TO SPECIFIC MORTGAGE ASSETS;
INABILITY TO ACQUIRE MORTGAGE ASSETS

The Company has not specifically identified any Mortgage Assets in which to
invest the net proceeds of this Offering. The Company may acquire Mortgage
Assets with geographic, issuer, industry and other types of concentrations.
Accordingly, a significant portion of the Company's Mortgage Assets may be
subject to the risks associated with a single type of occurrence. In the event
of such an occurrence, the adverse effects on the Company's results of
operations will be significantly greater than if the Company's Mortgage Assets
were diversified with respect to such factors.

Further, although the Company does not currently intend to acquire residual
interests issued by REMICs, subordinate interests in Mortgage Securities,
interest-only Mortgage Securities or sub-prime Mortgage Loans, it is not
prohibited from doing so under the terms of its Capital Policy. Investments in
these types of Mortgage Assets are highly speculative, and, accordingly, the
risk of loss associated with investments in these types of Mortgage Assets is
substantially greater than the risk of loss associated with the Mortgage Assets
which the Company currently intends to invest in, as described in this
Prospectus. Any investment in such high risk Mortgage Assets could materially
adversely affect the Company's financial condition and results of operations.
See "Business -- Investments."

The Company's net interest income will depend, in large part, on the
Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. As a result of this
Offering, the Company will seek to acquire approximately $750 million to $1.1
billion or more of additional Mortgage Assets. However, the Company has not
specifically identified any Mortgage Assets in which to invest the net proceeds
of this Offering. As of the closing of this Offering, approximately $90 million,
or 28%, of the Company's net assets will not be committed to specific Mortgage
Assets. There can be no assurance that the Company will be able to acquire
sufficient Mortgage Assets at spreads above the Company's cost of funds. In
acquiring Mortgage Assets, the Company will compete with numerous investment
banking firms, savings and loan associations, banks, mortgage bankers, insurance
companies, mutual funds, other lenders, federal government sponsored agencies
such as FHLMC, FNMA and GNMA, and other entities purchasing Mortgage Assets,
many of which have greater financial resources than the Company. In addition,
there are several REITs similar to the Company and others may be organized in
the future. The effect of the existence of additional REITs may be to increase
competition for the available supply of Mortgage Assets suitable for purchase by
the Company. As it relates to the Direct Purchase Program, the Company competes
on the basis of product type. The Company will face competition from others
already established in these markets. There can be no assurance that the Company
will be able to successfully compete with its competition.

The availability of Mortgage Loans meeting the Company's criteria is
dependent upon, among other things, the size of and level of activity in the
residential real estate lending market and, in particular, the demand for
nonconforming Mortgage Loans. The size and level of activity in the residential
real estate lending market depends on various factors, including the level of
interest rates, regional and national economic conditions and inflation and
deflation in residential property values. To the extent that the Company is
unable to acquire a sufficient amount of Mortgage Loans meeting its criteria,
the Company's results of operations will be materially adversely affected.

9
<PAGE> 14

MANAGER'S LACK OF PRIOR EXPERIENCE IN MANAGING A REIT COULD ADVERSELY AFFECT THE
COMPANY'S BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS; LIMITED
OPERATING HISTORY DOES NOT NECESSARILY PREDICT FUTURE PERFORMANCE OF COMPANY

The Manager has no prior experience in managing a REIT or with certain
tailored Mortgage Loan products. Although the Company's and the Manager's
executive officers have expertise in the acquisition and management of Mortgage
Assets, mortgage finance, asset/liability management and the management of
corporations in the real estate lending business, there can be no assurance that
the past experience of the executive officers will be appropriate to the
business of the Company. The lack of prior experience of the Manager in managing
a REIT could have a material adverse affect on the business, financial condition
and results of operations of the Company. The Company has not yet begun
acquiring Mortgage Loans under the Direct Purchase Program.

The Company began operations in February 1997 and, accordingly, has not yet
developed an extensive financial history or experienced a wide variety of
interest rate fluctuations or market conditions. Consequently, the Company's
financial results to date may not be indicative of future results.

FAILURE TO IMPLEMENT COMPANY'S LEVERAGE STRATEGY MAY ADVERSELY AFFECT RESULTS OF
OPERATIONS

The Company relies on short term borrowings to fund acquisitions of
Mortgage Assets. Accordingly, the ability of the Company to achieve its
investment objectives depends on its ability (i) to borrow money in sufficient
amounts and on favorable terms, (ii) to renew or replace on a continuous basis
its maturing short term borrowings and (iii) to successfully leverage its
Mortgage Assets. In addition, the Company is dependent upon a few lenders to
provide the primary credit facilities for its purchases of Mortgage Assets. Any
failure to obtain or renew adequate funding under these facilities or other
financings on favorable terms, could reduce the Company's net interest income
and have a material adverse effect on the Company's operations. The Company has
no long term commitments with its lenders. The Company's current borrowing
facilities may be collateralized only by Mortgage Securities.

In the event the Company is not able to renew or replace maturing
borrowings, the Company could be required to sell Mortgage Assets under adverse
market conditions and could incur losses as a result. In addition, in such
event, the Company may be required to terminate hedge positions, which could
result in further costs to the Company. Any event or development, such as a
sharp rise in interest rates or increasing market concern about the value or
liquidity of a type or types of Mortgage Assets in which the Company's Mortgage
Asset portfolio is concentrated, will reduce the market value of the Mortgage
Assets, which would likely cause lenders to require additional collateral. A
number of such factors in combination may cause difficulties for the Company,
including a possible liquidation of a major portion of the Company's Mortgage
Assets at disadvantageous prices with consequent losses, which could have a
material adverse effect on the Company and could render it insolvent.

Lenders will have claims on the Company's assets superior to the claims of
the holders of the Shares and may require that the Company agree to covenants
that could restrict its flexibility in the future and limit the Company's
ability to pay dividends. In the event of the insolvency or bankruptcy of the
Company, any creditor under a reverse repurchase agreement may be allowed to
avoid the automatic stay provisions of the Bankruptcy Code and to foreclose on
the collateral agreements without delay. In the event of the insolvency or
bankruptcy of a lender during the term of a reverse repurchase agreement, the
lender may be permitted to repudiate the contract, and the Company's claim
against the lender for damages therefrom may be treated simply as one of the
unsecured creditors. Should this occur, the Company's claims would be subject to
significant delay and, if received, may be substantially less than the damages
actually suffered by the Company.

Due to the underlying loan to collateral values established by the
Company's lenders, the Company may be subject to calls for additional capital in
the event of adverse market conditions. Such conditions include (i) higher than
expected levels of prepayments on Mortgage Loans and (ii) sudden increases in
interest rates. To the extent that the Company is highly leveraged, it may not
be able to meet its loan to collateral value

10
<PAGE> 15

requirements, which may result in losses to the Company. There can be no
assurance that the Company will not face a call for additional capital. See
"Business -- Funding," and "-- Capital Guidelines."

The Company's Capital Policy, which is set by the Company's Board of
Directors, requires the Company to maintain a minimum equity capital of between
8% and 12%. However, the Company is not subject to additional statutory,
regulatory or third party limitations on incurring debt. Accordingly, there are
no restrictions on the Company's ability to incur debt and there can be no
assurance that the level of debt that the Company is authorized to incur
pursuant to its current Capital Policy will not be increased by the Board of
Directors following the closing of this Offering. See "-- Policies and
Strategies May Be Revised at the Discretion of the Board of Directors."

FAILURE TO SUCCESSFULLY MANAGE INTEREST RATE RISKS MAY ADVERSELY AFFECT RESULTS
OF OPERATIONS

The Company will follow a program intended to protect against interest rate
changes. However, developing an effective interest rate risk management strategy
is complex and no management strategy can completely insulate the Company from
risks associated with interest rate changes. In addition, hedging involves
transaction costs. In the event the Company hedges against interest rate risks,
the Company may substantially reduce its net income. Further, the federal tax
laws applicable to REITs may limit the Company's ability to fully hedge its
interest rate risks. Such federal tax laws may prevent the Company from
effectively implementing hedging strategies that, absent such restrictions,
would best insulate the Company from the risks associated with changing interest
rates. See "Business -- Risk Management -- Interest Rate Risk Management."

In the event that the Company purchases interest rate caps or other
interest rate derivatives to hedge against lifetime, periodic rate or payment
caps, and the provider of such caps on interest rate derivatives becomes
financially unsound or insolvent, the Company may be forced to unwind such caps
on its interest rate derivatives with such provider and may take a loss thereon.
Further, the Company could suffer the adverse consequences that the hedging
transaction was intended to protect against. Although the Company intends to
purchase interest rate caps and derivatives only from financially sound
institutions and to monitor the financial strength of such institutions on a
periodic basis, no assurance can be given that the Company can avoid such third
party risks.

Currently, the Company has entered into hedging transactions which seek to
protect only against the Mortgage Loans' lifetime rate caps and not against
periodic rate caps or unexpected payments. In addition, the Company's lifetime
cap hedges are for a two year period which does not begin until the second
quarter of 1998. Accordingly, the Company may not be adequately protected
against risks associated with interest rate changes and such changes could
adversely affect the Company's financial condition and results of operations.

THE COMPANY HAS SIGNIFICANT CONFLICTS WITH, AND IS DEPENDENT ON, AN AFFILIATE OF
THE EXECUTIVE OFFICERS OF THE COMPANY

The Company is subject to conflicts of interest with the Manager and its
executive officers. The executive officers of the Company generally will also be
executive officers, employees and stockholders of the Manager, and will
therefore be affiliated with the Manager. The Manager will manage the day-to-day
operations of the Company. Accordingly, the Company's success will depend in
significant part on the Manager. Under the Management Agreement, the Manager
will receive an annual base management fee payable monthly in arrears and the
Manager will have the opportunity to earn incentive compensation under the
Management Agreement based on the Company's annualized net income. The ability
of the Company to achieve the performance level required for the Manager to earn
the incentive compensation is dependent upon the level and volatility of
interest rates, the Company's ability to react to changes in interest rates and
to implement the operating strategies described herein, and other factors, many
of which are not within the Company's control. In evaluating Mortgage Assets for
investment and other strategies, an undue emphasis on maximizing income at the
expense of other criteria, such as preservation of capital, in order to achieve
higher incentive compensation for the Manager, could result in increased risk to
the value of the Company's Mortgage Asset portfolio. See "Management and
Termination Fees" and "Conflicts of Interest."

The Management Agreement does not limit or restrict the right of the
Manager or any of its officers, directors, employees or affiliates to engage in
any business or to render services of any kind to any other

11
<PAGE> 16

person, including purchasing, or rendering advice to others purchasing, Mortgage
Assets which meet the Company's policies and criteria, except that the Manager
and its officers, directors, or employees will not be permitted to provide any
such services to any REIT which invests primarily in residential Mortgage
Assets, other than the Company.

BORROWER CREDIT MAY DECREASE VALUE OF MORTGAGE LOANS

The Company expects that a portion of its Mortgage Assets will consist of
Mortgage Loans. Accordingly, during the time it holds Mortgage Loans, the
Company will be subject to increased credit risks, including risks of borrower
defaults and bankruptcies and special hazard losses that are not covered by
standard hazard insurance (such as those occurring from earthquakes or floods).
In the event of a default on any Mortgage Loan held by the Company, the Company
will bear the risk of loss of principal to the extent of any deficiency between
the value of the secured property, and the amount owing on the Mortgage Loan,
less any payments from an insurer or guarantor. Defaulted Mortgage Loans will
also cease to be eligible collateral for borrowings, and will have to be
financed by the Company out of other funds until ultimately liquidated. Although
the Company intends to establish an allowance for Mortgage Loan losses in
amounts adequate to cover these risks, in view of its limited operating history
and lack of experience with the Direct Purchase Program to date, there can be no
assurance that any allowance for Mortgage Loan losses which are established will
be sufficient to offset losses on Mortgage Loans in the future. See
"Business -- Investments -- Direct Purchase Program."

Even assuming that properties secured by the Mortgage Loans held by the
Company provide adequate security for such Mortgage Loans, substantial delays
could be encountered in connection with the foreclosure of defaulted Mortgage
Loans, with corresponding delays in the receipt of related proceeds by the
Company. State and local statutes and rules may delay or prevent the Company's
foreclosure on or sale of the mortgaged property and may prevent the Company
from receiving net proceeds sufficient to repay all amounts due on the related
Mortgage Loan. In addition, the Company's servicing agent may be entitled to
receive all expenses reasonably incurred in attempting to recover amounts due
and not yet repaid on liquidated Mortgage Loans, thereby reducing amounts
available to the Company. Some properties which will collateralize the Company's
Mortgage Loans may have unique characteristics or may be subject to seasonal
factors which could materially prolong the time period required to resell such
properties. See "-- Characteristics of Underlying Property May Decrease Value of
Mortgage Loans."

CHARACTERISTICS OF UNDERLYING PROPERTY MAY DECREASE VALUE OF MORTGAGE LOANS

Certain properties securing Mortgage Loans may be contaminated by hazardous
substances resulting in reduced property values. If the Company forecloses on a
defaulted Mortgage Loan collateralized by such property, the Company may be
subject to environmental liabilities regardless of whether the Company was
responsible for the contamination. The results of the Direct Purchase Program
may also be affected by various factors, many of which are beyond the control of
the Company, such as (i) local and other economic conditions affecting real
estate values, (ii) the ability of tenants to make lease payments, (iii) the
ability of a property to attract and retain tenants, (iv) interest rate levels
and the availability of credit to refinance such Mortgage Loans at or prior to
maturity, and (v) increased operating costs, including energy costs, real estate
taxes and costs of compliance with regulations.

12
<PAGE> 17

DEPENDENCE ON KEY PERSONNEL FOR SUCCESSFUL OPERATIONS

The Company's operations depend in significant part upon the skill and
experience of John Robbins and Jay Fuller. Although these executive officers
currently have employment agreements with the Manager, there can be no assurance
of the continued employment of such officers. The Company is also dependent on
other key personnel and on its ability to continue to attract, retain and
motivate qualified personnel. The loss of any key person could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Management of the Company -- Executive Compensation" and
"-- Employment Contracts and Termination of Employment and Change of Control
Arrangements."

FAILURE TO MANAGE EXPANSION MAY ADVERSELY AFFECT RESULTS OF OPERATIONS

The Company's expansion as a result of its investment of the net proceeds
of this Offering may cause a significant strain on the Company's and the
Manager's financial, management and other resources. To manage the Company's
growth effectively, the Company and the Manager must continue to improve and
expand their existing resources and management information systems and attract,
train and motivate qualified personnel. If the Company and the Manager are
unable to manage growth effectively, the Company's financial conditions and
results of operations may be adversely affected.

In order to further develop the Direct Purchase Program, the Manager must
significantly expand its level of operations. The Company's operating results
may be adversely affected if the Company is not able to acquire a significant
number of Mortgage Loans directly from Correspondents pursuant to the Direct
Purchase Program.

The Company may require up to twelve months to fully implement its
financing strategy and increase its investment in Mortgage Assets to the desired
level. Until such level is achieved, the net interest income on the Company's
Mortgage Asset portfolio is expected to be lower than would be the case if its
financing strategy were fully implemented. Further, the Company may acquire new
Mortgage Assets with coupons that are initially low relative to prevailing short
term interest rates. As a result, the Company's interest income may be lower
during periods of rapid growth in the Company's Mortgage Assets.

REAL ESTATE MARKET CONDITIONS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS

The Company's business may be adversely affected by periods of economic
slowdown or recession which may be accompanied by declining real estate values.
Any material decline in real estate values reduces the ability of borrowers to
use home equity to support borrowings and increases the loan-to-value ratios of
Mortgage Loans previously made, thereby weakening collateral coverage and
increasing the possibility of a loss in the event of default. In addition,
delinquencies, foreclosures and losses generally increase during economic
slowdowns and recessions.

INVESTMENTS IN MORTGAGE ASSETS MAY BE ILLIQUID

Although the Company expects that a majority of the Company's investments
will be in Mortgage Assets for which a resale market exists, certain of the
Company's investments may lack a regular trading market and may be illiquid. In
addition, during turbulent market conditions, the liquidity of all of the
Company's Mortgage Assets may be adversely impacted. There is no limit to the
percentage of the Company's investments that may be invested in illiquid
Mortgage Assets. In the event the Company required additional cash as a result
of a margin call pursuant to its financing agreements or otherwise, the Company
may be required to liquidate Mortgage Assets on unfavorable terms. The Company's
inability to liquidate Mortgage Assets could render it insolvent.

POLICIES AND STRATEGIES MAY BE REVISED AT THE DISCRETION OF THE BOARD OF
DIRECTORS

The Board of Directors has established the investment policies, operating
policies and strategies of the Company set forth in this Prospectus. These
policies and strategies may be modified or waived by the Board of Directors
without stockholder consent. Further, the Board of Directors is not limited by
the Company's

13
<PAGE> 18

Articles of Amendment and Restatement ("the Charter") or Bylaws in determining
the Company's policies and strategies. Accordingly, investors are not able to
evaluate the credit or other risks which may be applicable to the Mortgage
Assets to be acquired by the Company. A change in the Company's policies and
strategies could adversely affect the Company's business, financial condition
and results of operations.

The Company does not currently intend to (i) issue senior securities, (ii)
make loans to other persons, (iii) invest in the securities of others for the
purpose of exercising control, (iv) underwrite securities of other issuers, (v)
offer securities in exchange for property or (vi) repurchase or otherwise
reacquire its shares or other securities.

THE MANAGER AND CERTAIN AFFILIATES WILL CONTROL APPROXIMATELY 20% OF OUTSTANDING
SHARES AFTER OFFERING

Immediately following the closing of this Offering, the Company's directors
and officers, the Manager and certain of their affiliates will beneficially own
or have the right to control approximately 20% of the Company's outstanding
shares of Common Stock. Accordingly, these stockholders may continue to exert
significant influence over the outcome of most corporate actions requiring
stockholder approval, including the election of directors and the approval of
transactions involving a change in control of the Company. See "Principal
Stockholders."

FAILURE TO MAINTAIN REIT STATUS MAY SUBJECT COMPANY TO CORPORATE LEVEL TAX

The Company intends at all times to operate so as to qualify as a REIT for
federal income tax purposes. To qualify as a REIT, the Company must satisfy
certain tests related to the nature of its assets and income and it must also
distribute substantially all of its income (as specially defined for these
purposes) to its stockholders. If the Company fails to qualify as a REIT in any
taxable year and certain relief provisions of the Code do not apply, the Company
would be subject to federal income tax as a regular, domestic corporation, and
its stockholders would be subject to tax in the same manner as stockholders of
such corporation. Distributions to stockholders in any years in which the
Company fails to qualify as a REIT would not be deductible by the Company in
computing its taxable income. As a result, the Company could be subject to
income tax liability, thereby significantly reducing or eliminating the amount
of cash available for distribution to its stockholders. Further, the Company
could also be disqualified from re-electing REIT status for the four taxable
years following the year during which it became disqualified.

No assurance can be given that future legislation, regulations,
administrative interpretations or court decisions will not significantly change
the tax laws with respect to the Company's qualification as a REIT or the
federal income tax consequences of such qualification, which changes may reduce
or eliminate the Company's advantage over other companies not organized as
REITs. See "Federal Income Tax Considerations."

MARKET FOR COMMON STOCK MAY BE LIMITED AND MARKET PRICE MAY FLUCTUATE BELOW
OFFERING PRICE

Prior to this Offering, there has not been a public market for the Common
Stock, and there can be no assurance that a regular trading market for the
Shares offered hereby will develop or, if developed, that any such market will
be sustained. In the absence of a public trading market, an investor may be
unable to liquidate his investment in the Company. The initial public offering
price has been determined by the Company and representatives of the
Underwriters. There can be no assurance that the price at which the Shares sell
in the public market after the closing of this Offering will not be lower than
the price at which they are sold by the Underwriters. See "Underwriting."

In the event that a public market for the Shares develops, it is likely
that the market price of the Shares will be influenced by any variations between
the net yield on the Company's Mortgage Assets and prevailing market interest
rates. The Company's net income will be derived primarily from any positive
spread between the yield on the Company's Mortgage Assets and the cost of the
Company's borrowings. Such positive spread will not necessarily be greater in
high interest rate environments than in low interest rate environments. However,
in periods of high interest rates, the net income of the Company, and therefore
the dividend yield on the Shares, may be less attractive compared with
alternative investments, which could negatively impact the price of the Shares.
If the dividend yield on the Company's Shares declines, or if prevailing market
interest

14
<PAGE> 19

rates rise, the market price of the Shares may be adversely affected.
Accordingly, fluctuations in interest rates could have a material adverse affect
on the trading market for the Shares. See "-- Sudden Interest Rate Fluctuations
May Reduce Income From Operations -- Material Portion of Offering Proceeds Not
Committed to Specific Mortgage Assets; Inability to Acquire Mortgage
Assets -- Failure to Successfully Manage Interest Rate Risks May Adversely
Affect Results of Operations."

FAILURE TO QUALIFY FOR EXEMPTION UNDER INVESTMENT COMPANY ACT WOULD RESULT IN
SIGNIFICANT REGULATORY BURDEN

The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act.
Accordingly, the Company does not expect to be subject to the restrictive
provisions of the Investment Company Act. However, if the Company fails to
qualify for exemption from registration as an investment company, its ability to
use leverage would be substantially reduced, and it would be unable to conduct
its business as described herein. Any such failure to qualify for such exemption
could have a material adverse effect on the Company.

The Investment Company Act exempts entities that are "primarily engaged in
the business of purchasing or otherwise acquiring mortgages and other liens on
and interests in real estate." Under the current interpretation of the staff of
the Securities and Exchange Commission, in order to qualify for this exemption,
the Company must maintain at least 55% of its assets directly in Mortgage Loans,
qualifying Mortgage Securities and certain other qualifying interests in real
estate. In addition, unless certain Mortgage Securities represent all the
certificates issued with respect to an underlying pool of Mortgage Loans, such
Mortgage Securities may be treated as securities separate from the underlying
Mortgage Loans and, thus, may not qualify for purposes of the 55% requirement.
As of August 31, approximately 30% of the Company's Mortgage Securities were
partial-pool Mortgage Securities which may be treated as securities separate
from the underlying Mortgage Loans. Therefore, the Company's ownership of
certain Mortgage Assets may be limited by the provisions of the Investment
Company Act.

FUTURE OFFERINGS OF COMMON STOCK MAY AFFECT MARKET PRICE OF COMMON STOCK

The Company may in the future increase its capital resources by making
additional offerings of equity and debt securities, including classes of
preferred stock, Common Stock, commercial paper, medium-term notes, CMOs and
senior or subordinated notes. All debt securities and classes of preferred stock
will be senior to the Common Stock in a liquidation of the Company. The effect
of additional equity offerings may be the dilution of the equity of stockholders
of the Company or the reduction of the price of the Company's Common Stock, or
both. The Company is unable to estimate the amount, timing or nature of
additional offerings as they will depend upon market conditions and other
factors. There can be no assurance that the Company will be able to raise the
capital it will require through such offerings on favorable terms or at all. The
inability of the Company to obtain needed sources of capital on favorable terms
could have a material adverse affect on the Company. See "Business -- Funding."

OWNERSHIP OF COMMON STOCK MAY BE RESTRICTED

In order that the Company may meet the requirements for qualification as a
REIT at all times, the Company's Charter prohibits any person from acquiring or
holding, directly or indirectly, shares of Common Stock in excess of 9.9% in
value of the aggregate of the outstanding shares of Common Stock of the Company.
The Company's Charter further prohibits (i) any person from beneficially or
constructively owning shares of Common Stock that would result in the Company
being "closely held" under Section 856(h) of the Internal Revenue Code of 1986,
as amended (the "Code") or otherwise cause the Company to fail to qualify as a
REIT, and (ii) any person from transferring shares of Common Stock if such
transfer would result in shares of Common Stock being owned by fewer than 100
persons. If any transfer of shares of Common Stock occurs which, if effective,
would result in any transfer or ownership limitations, then that number of
shares of Common Stock the beneficial or constructive ownership of which
otherwise would cause such person to violate such limitations (rounded to the
nearest whole shares) shall be automatically transferred to a trustee as trustee
of a trust for the exclusive benefit of one or more charitable beneficiaries,
and the intended transferee shall not acquire any rights in such shares. Subject
to certain limitations, the Board of Directors may increase

15
<PAGE> 20

or decrease the ownership limitations or waive the limitations for individual
investors. See "Description of Capital Stock -- Repurchase of Shares and
Restriction on Transfer."

Every owner of more than 5% (or such lower percentage as required by the
Code or the regulations promulgated thereunder) of the Company's Common Stock,
within 30 days after the end of each taxable year, is required to give written
notice to the Company stating the name and address of such owner, the number of
shares of Common Stock of the Company beneficially owned and a description of
the manner in which such shares are held. Each such owner shall provide to the
Company such additional information as the Company may request in order to
determine the effect, if any, of such beneficial ownership on the Company's
status as a REIT and to ensure compliance with the ownership limitations.

These provisions may inhibit market activity and the resulting opportunity
for the holders of the Company's Common Stock to receive a premium for their
stock that might otherwise exist in the absence of such provisions. Such
provisions also may make the Company an unsuitable investment vehicle for any
person seeking to obtain ownership of more than 9.9% of the Company's Common
Stock. Further, a violation of the ownership limitations of the Common Stock of
the Company could result in the Company's loss of its REIT status. A loss of its
REIT status could have a material adverse affect on the Company. See "-- Failure
to Maintain REIT Status May Subject Company to Corporate Level Tax."

DEFAULT OF MANAGER UNDER SECURITIES PURCHASE AGREEMENT; RESTRICTIVE COVENANTS

In connection with the private financing of the Manager and the Company,
the Company, the Manager and Holdings entered into a Securities Purchase
Agreement dated as of February 11, 1997 (the "Securities Purchase Agreement")
with the institutional investors therein (the "Investors") providing for, among
other things, the purchase by the Investors of senior secured notes of the
Manager due February 11, 2002 (the "Notes"). Pursuant to the Securities Purchase
Agreement, the Company must comply with various covenants, including covenants
restricting the Company's investment, hedging and leverage policies, leverage
ratio and indebtedness levels, and business and tax status. These restrictions
may limit the Company's ability to adequately respond to changing market
conditions, even when such changes may be in the best interest of the Company,
which could have a material adverse effect on the Company's financial condition
and results of operations. See "Certain Transactions -- Discussion of Securities
Purchase Agreement."

If the Manager defaults on its obligations with respect to the Notes, such
default may result in a default and termination of the Management Agreement, in
which case the operations of the Company could be materially and adversely
affected pending either the engagement of a new manager or the development
internally of the resources necessary to manage the operation of the Company. In
addition, Holdings has pledged 1,600,000 shares of its Common Stock of the
Company to secure the Manager's obligations under the Securities Purchase
Agreement. Upon a default under the Securities Purchase Agreement, the pledged
shares will be transferred to the holders of the Notes, who will then have
certain demand registration rights. See "-- Shares Eligible for Future Sale."

LIMITATIONS ON ACQUISITION AND CHANGE IN CONTROL

The Charter and Bylaws of the Company contain a number of provisions, and
the Board of Directors has taken certain actions, that could impede a change in
control of the Company. See "Certain Provisions of Maryland Law and the
Company's Charter and Bylaws -- Certain Anti-Takeover Provisions." These
provisions include the following:

Staggered Board of Directors. The Board of Directors of the Company has
three classes of directors. The staggered terms for directors may adversely
affect the stockholders' ability to cause a change in control of the Company,
even if a change in control were in the interest of some, or a majority, of the
stockholders.

Capital Stock. The Charter authorizes the Board of Directors to create new
classes and series of securities and to establish the preferences and rights of
any such classes and series. The issuance of securities by the Board of
Directors pursuant to this Charter provision could have the effect of delaying
or preventing a

16
<PAGE> 21

change in control of the Company, even if a change in control were in the
interest of some, or a majority, of the stockholders. See "Description of
Capital Stock."

Statutory Provisions. Under the Maryland General Corporation Law (the
"MGCL"), unless exempted by action of the Board of Directors, certain "business
combinations" between a Maryland corporation and a stockholder holding 10% or
more of the corporation's voting securities (an "Interested Stockholder") are
subject to certain conditions, including approval by a super-majority vote of
all voting stock, excluding those held by the Interested Stockholder or any
affiliate thereof, and may not occur for a period of five years after the
stockholder becomes an Interested Stockholder. Accordingly, certain business
combinations may be impeded or prohibited, even if such a combination may be in
the interest of some, or a majority, of the Company's stockholders. The MGCL
also provides that "control shares" may be voted only upon approval of
two-thirds of the outstanding stock of the corporation, excluding the control
shares and shares held by affiliates of the corporation. Under certain
circumstances, the corporation also may redeem the control shares for cash and,
in the event that control shares are permitted to vote, the other stockholders
of the corporation are entitled to appraisal rights. See "Certain Provisions of
Maryland Law and the Company's Charter and Bylaws -- Business Combinations" and
"-- Control Share Acquisitions."

These provisions may inhibit market activity and the resulting opportunity
for stockholders of the Company to receive a premium for their Shares that might
otherwise exist if any person were to attempt to assemble a block of shares of
Common Stock in excess of the number of shares permitted under the Charter. Such
provisions also may make the Company an unsuitable investment vehicle for any
person seeking to obtain ownership of more than 9.9% of the outstanding shares
of Common Stock.

SHARES ELIGIBLE FOR FUTURE SALE

A substantial number of shares of Common Stock outstanding prior to this
Offering and issuable upon exercise of outstanding options will be eligible for
sale in the public market following the closing of this Offering, and such sales
could have an adverse effect on the price of the Company's Common Stock. On the
date of this Prospectus, the 6,500,000 Shares offered hereby (assuming no
exercise of the Underwriters' over-allotment option) will be immediately
eligible for sale in the public market. In addition, upon the expiration of
lock-up agreements 180 days after the date of this Prospectus, 1,614,000 shares
of Common Stock held by the current stockholders of the Company will become
eligible for sale in the public market, subject in some cases to the volume
restrictions of Rule 144 promulgated under the Securities Act of 1933, as
amended (the "Securities Act"). In addition, the holders of such shares of
Common Stock are entitled to certain rights with respect to the registration of
such shares under the Securities Act. An increase in the number of shares of
Common Stock of the Company sold in the public market could have an adverse
effect on the market price of the Company's Common Stock. See "Shares Eligible
for Future Sale."

DILUTION TO STOCKHOLDERS PURCHASING IN OFFERING

The initial offering price is higher than the book value per share of
Common Stock. Investors purchasing shares of Common Stock in this Offering will,
therefore, incur immediate dilution of $1.41 per share. See "Dilution."

17
<PAGE> 22

THE COMPANY

AMREIT is a mortgage REIT which currently invests in residential
adjustable-rate Mortgage Securities. Following this Offering, AMREIT will also
invest in Mortgage Loans. The Manager has tailored underwriting guidelines for
Mortgage Loans to be acquired directly from mortgage originators. The Company
will then acquire Mortgage Loans directly from those Correspondents. The Company
finances its acquisitions of Mortgage Assets with equity and secured borrowings.
The Company expects generally to maintain an equity-to-assets ratio of
approximately 8% to 12% and to earn interest on the portion of its Mortgage
Asset portfolio financed with equity and to earn a net interest spread on the
leveraged portion of its Mortgage Asset portfolio. The Company is structured to
qualify as a REIT and, therefore, will generally not be subject to federal taxes
at the corporate level on the net income it distributes to its stockholders. The
Company is similar to a bank or savings and loan in its business purpose,
however, it does not collect deposits or incur the overhead costs related to
originating retail Mortgage Loans and it is not subject to a number of the
regulations governing banks and savings and loans. The Company believes its REIT
structure is the most efficient form in which to invest in adjustable-rate
Mortgage Assets.

The Company's day to day operations are managed by the Manager.
Accordingly, the Company's success will depend in significant part on the
Manager. Certain of the executive officers of the Company will also be executive
officers, employees and stockholders of the Manager. Pursuant to the terms of
the Management Agreement, the Manager will advise the Company's Board of
Directors with respect to the formulation of investment criteria and preparation
of policy guidelines, and will be compensated based upon the principal amount
and type of Mortgage Assets held by the Company. See "The Manager," "Management
and Termination Fees" and "Conflicts of Interest."

In addition to reimbursing the Manager for expenses incurred on behalf of
the Company, the Company will pay to the Manager: (i) 1/8 of 1% per year, to be
paid monthly, of the principal amount of Agency Securities; (ii) 3/8 of 1% per
year, to be paid monthly, of the principal amount of all Mortgage Assets other
than Agency Securities; and (iii) 25% of the amount by which the Company's net
income (before deducting the amount to be paid as incentive compensation)
exceeds the annualized return on equity equal to the average Ten Year U.S.
Treasury Rate plus 2%.

Investment of the net proceeds of this Offering will result in an increase
in the Company's Mortgage Assets and, thus, an increase in the base management
fee and incentive compensation to be paid to the Manager. See "The
Manager -- The Management Agreement," "Management and Termination Fees" and
"Conflicts of Interest."

AMREIT was incorporated in Maryland on February 6, 1997, and began
operations on February 11, 1997 as a result of a private equity funding from the
Manager. The Manager was created for the purpose of managing the day-to-day
operations of the Company, subject to direction by the Company's Board of
Directors. The Manager and the Company were financed by McCown De Leeuw & Co.,
TCW/Crescent Mezzanine, L.L.C., certain of their respective affiliates and
members of the management team of the Company. The Manager and its affiliates
own 1,614,000 shares of Common Stock of the Company which will constitute
approximately 20% of the outstanding shares of Common Stock of the Company
immediately after the closing of this Offering. In addition, David E. De Leeuw
and George E. McCown, the principals of McCown De Leeuw & Co., currently serve
on the Board of Directors of the Company. Mr. De Leeuw will continue as a
director after the closing of this Offering.

The Company's management team is lead by John Robbins and Jay Fuller,
former executive officers and founders of American Residential Mortgage
Corporation ("AMRES Mortgage"). Mr. Robbins, Mr. Fuller and other members of the
management team led AMRES Mortgage from a start-up company to one with
originations of approximately $9.7 billion and a servicing portfolio of
approximately $16.1 billion in 1993, its last full year of independent
operations. In 1994, AMRES Mortgage was sold to The Chase Manhattan Corporation
for approximately $330 million.

The principal executive offices of the Company and the Manager are located
at 445 Marine View Avenue, Suite 230, Del Mar, California 92014. The telephone
number is (619) 350-5000.

18
<PAGE> 23

The following chart summarizes the relationships among the Company, the
Manager, the Executive Officers and Directors of the Company and certain of
their affiliates.

SECURITY HOLDERS OF THE MANAGER AND HOLDINGS

o Entities affiliated with TCW/Crescent Mezzanine, L.L.C.
o Entities affiliated with McCown De Leeuw & Co.
o Certain executive officers of the Company and the Manager
o Manager individuals and entities

MANAGER
COMMON COMMON
DIRECTORS EXECUTIVE OFFICERS(4)
managing John Robbins John Robbings
member(1) Jay Fuller Jay Fuller
senior David De Leeuw Mark Conger
distribution John Dahl
preference(2) Rollie Lynn
HOLDINGS Lisa Faulk

dividends(3) 1.6 million shares(3)
(20%, post offering)

Management Agreement
AMREIT
fees services

</TABLE>
- ---------------

(1) The Manager is the managing member of Holdings pursuant to an operating
agreement. Accordingly, the Manager may be deemed to have voting control of
the shares of the Company's Common Stock held by Holdings with respect to
ordinary and usual matters. See "Risk Factors -- The Manager and Certain
Affiliates Will Control Approximately 20% of Outstanding Shares After
Offering," "The Manager" and "Principal Stockholders."

(2) The Manager contributed $20 million in 1997 to Holdings which used the funds
to acquire shares of the Company's Common Stock. In exchange for its
contribution to Holdings, the Manager received a senior right to receive
distributions equal to 5% per quarter of the capital contribution,
compounded quarterly to the extent unpaid. After payment of the preference
amount in full, the Manager has a right to receive approximately 50% of any
remaining distributions in repayment of its $20 million capital
contribution.

(3) Holdings' sole asset is its shares of the Company's Common Stock and its
sole source of income is dividends declared by the Company. The shares of
the Company's Common Stock held by Holdings have been pledged as collateral
to certain entities affiliated with TCW/Crescent Mezzanine, L.L.C. See "Risk
Factors -- Default of Manager under Securities Purchase Agreement;
Restrictive Covenants" and "Certain Transactions -- Discussion of Securities
Purchase Agreement."

(4) In evaluating Mortgage Assets for investment, the Manager's and the
Company's executive officers could emphasize maximizing income at the
expense of other criteria, in order to achieve higher compensation for the
Manager, which could result in increased risk to the value of the Company's
portfolio of Mortgage Assets. See "Risk Factors - The Company Has
Significant Conflicts with, and Is Dependent on, an Affiliate of the
Executive Officers of the Company" and "Management and Termination Fees."

In connection with the private financings of the Manager and the Company in
February 1997, the Company, the Manager and Holdings entered into the Securities
Purchase Agreement with certain institutional investors affiliated with
TCW/Crescent Mezzanine, L.L.C. providing for, among other things, the issuance
by the Manager of the Notes to the Investors. Pursuant to the Securities
Purchase Agreement, as long as the Notes remain outstanding, the Company and the
Manager must comply with various covenants, including covenants restricting the
Company's hedging and leverage policies, leverage ratio and indebtedness levels,
and business and tax status. These restrictions may limit the Company's ability
to adequately respond to changing market conditions, even when such changes may
be in the best interest of the Company, which could

19
<PAGE> 24

have a material adverse effect on the Company. See "Certain
Transactions -- Discussion of Securities Purchase Agreement."

USE OF PROCEEDS

The proceeds of this Offering are estimated to be as follows:

<TABLE>
<CAPTION>
6.5 MILLION 7.5 MILLION
SHARES SHARES(1)
----------- -----------
(IN MILLIONS)
<S> <C> <C>
Total proceeds......................................... $97.5 $ 112.1
Expenses............................................... 1.5 1.6
Underwriting discount and commissions.................. 6.3 7.3
----- -----
Net proceeds available for investment........ $89.7 $ 103.2
</TABLE>

- ---------------

(1) Assumes exercise by the Underwriters of an option to purchase shares to
cover over-allotments. See "Underwriting."

The net proceeds of this Offering, together with borrowings, will be used
primarily to purchase Mortgage Assets and otherwise for general corporate
purposes. The Company has not specifically identified any Mortgage Assets in
which to invest the net proceeds of this Offering. Pending the purchase of the
Mortgage Assets, the net proceeds of this Offering may be invested in short term
investments consistent with the applicable REIT provisions of the Code. The
Company intends to increase its investment in Mortgage Assets by borrowing
against existing Mortgage Assets and using the net proceeds from its borrowings
to acquire additional Mortgage Assets. The Company's borrowings generally will
be secured by the Mortgage Assets owned by the Company. The Company may, but
does not expect to, require up to twelve months to fully implement its financing
strategy and increase its investment in Mortgage Assets to the desired level.
Until the desired level is achieved, the net interest income on the Company's
Mortgage Asset portfolio is expected to be lower than would be the case if its
financing strategy were fully implemented.

The Company believes that cash flow from operations, the net proceeds of
this Offering and funds available pursuant to financing facilities and credit
arrangements will be sufficient to meet the Company's cash requirements for at
least one year following the closing of this Offering. Thereafter, if the
Company's cash resources are insufficient to satisfy the Company's liquidity
requirements, the Company may be required to sell additional equity or debt
securities. There is no assurance that additional financing will be available to
the Company on favorable terms, or at all. See "Risk Factors -- Future Offerings
of Common Stock May Affect Market Price of Common Stock" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

20
<PAGE> 25

DIVIDEND POLICY AND DISTRIBUTIONS

The Company intends to distribute substantially all of its taxable income
(which does not ordinarily equal net income as calculated in accordance with
GAAP) to its stockholders in each year so as to comply with the REIT provisions
of the Code. The Company intends to declare regular quarterly dividends. The
dividend policy is subject to revision at the discretion of the Board of
Directors. All distributions will be made by the Company at the discretion of
the Board of Directors and will depend on the taxable income of the Company, the
financial condition of the Company, maintenance of REIT status and such other
factors as the Board of Directors deems relevant. On October 21, 1997, July 17,
1997 and May 1, 1997, the Company declared dividends of $0.32, $0.27 and $0.09,
respectively, per share of Common Stock for the quarters ended September 30,
1997 and June 30, 1997 and the period ended March 31, 1997, respectively. There
can be no assurance that the Company will generate sufficient income in the
future to declare comparable levels of dividends, or to declare dividends at
all. See "Risk Factors -- Manager's Lack of Prior Experience in Managing a REIT
Could Adversely Affect the Company's Business, Financial Condition and Results
of Operations; Limited Operating History Does Not Necessarily Predict Future
Performance of Company," "-- Policies and Strategies May Be Revised at the
Discretion of the Board of Directors," "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Certain Accounting Policies and
Procedures" and "Federal Income Tax Consequences -- Requirements for
Qualification as a REIT -- Distribution Requirement."

Distributions to stockholders will generally be taxable as ordinary income,
although a portion of such distributions may be designated by the Company as
capital gain or may constitute a tax-free return of capital. The Company will
annually furnish to each of its stockholders a statement setting forth
distributions paid during the preceding year and their characterization as
ordinary income, capital gains, or return on capital. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Accounting Policies and Procedures" and "Federal Income
Tax Consequences -- Taxation of Stockholders."

21
<PAGE> 26

CAPITALIZATION

The capitalization of the Company, as of June 30, 1997, and as adjusted to
reflect the sale of the Shares offered hereby, is as follows:

<TABLE>
<CAPTION>
JUNE 30, 1997
---------------------------
AS
ACTUAL ADJUSTED(1)(2)
-------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Reverse repurchase agreements...................................... $209,539 $209,539
Stockholders' equity:
Preferred Stock, par value $.01 per share; 1,000,000 shares
authorized; no shares issued and outstanding(3)............... -- --
Common Stock, par value $.01 per share; 3,000,000 shares
authorized; 1,614,000 shares issued and outstanding, actual;
8,114,000 shares issued and outstanding as adjusted(3)........ 16 81
Additional paid-in capital....................................... 20,149 109,746
Cumulative dividends declared.................................... (146) (146)
Retained earnings................................................ 584 584
-------- --------
Total stockholders' equity............................... $ 20,603 $110,265
-------- --------
Total capitalization..................................... $230,142 $319,804
======== ========
</TABLE>

- ---------------

(1) After deducting offering expenses estimated to be $1,500,000 payable by the
Company, and assumes no exercise of the Underwriters' over-allotment option
to purchase up to an additional 975,000 shares of Common Stock. See
"Underwriting."

(2) Excludes 315,200 shares of Common Stock reserved for issuance pursuant to
options outstanding as of June 30, 1997 under the Incentive Plan.

(3) The Company's authorized Common Stock and Preferred Stock as of June 30,
1997, was 3,000,000 and 1,000,000 shares, respectively. The Company's
authorized Capital Stock was increased to 25,000,000 shares prior to the
closing of this Offering all of which have been initially designated Common
Stock. See "Description of Capital Stock" and Note 8 of Notes to Financial
Statements.

22
<PAGE> 27

DILUTION

The pro forma net tangible book value of the Company, as of June 30, 1997,
was approximately $20.6 million or $12.77 per share of Common Stock. Pro forma
net tangible book value per share of Common Stock is equal to the Company's
total tangible assets less its total liabilities, divided by the number of
outstanding shares of Common Stock. After giving effect to the sale of the
6,500,000 Shares offered by the Company hereby (after deducting the underwriting
discount and commissions and estimated offering expenses), the pro forma net
tangible book value of the Company at June 30, 1997 would have been
approximately $110.3 million or $13.59 per share of Common Stock. This
represents an immediate increase in such net tangible book value of $0.82 per
share of Common Stock to existing stockholders and an immediate dilution of
$1.41 per share of Common Stock to new investors purchasing Shares in this
Offering. The following table illustrates this per share dilution:

<TABLE>
<S> <C> <C>
Initial public offering price per share of Common Stock............ $15.00
Pro forma net tangible book value per share of Common Stock as of
June 30, 1997................................................. $12.77
Increase per share of Common Stock attributable to this
Offering...................................................... 0.82
-----
Pro forma net tangible book value per share of Common Stock
immediately after the closing of this Offering................... 13.59
------
Dilution per share of Common Stock to new investors................ $ 1.41
======
</TABLE>

The following table summarizes, on a pro forma basis, as of June 30, 1997,
the differences between the number of shares of Common Stock purchased from the
Company, the total consideration paid and the average price paid per share of
Common Stock by the existing holders of Common Stock and by the new investors:

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............ 1,614,000 19.9% $ 20,175,000 17.1% $ 12.50
New investors.................... 6,500,000 80.1 97,500,000 82.9 $ 15.00
--------- ----- ----------- -----
Total.................. 8,114,000 100.0% $117,675,000 100.0%
========= ===== =========== =====
</TABLE>

The foregoing tables exclude 315,200 shares of Common Stock reserved for
issuance pursuant to options outstanding as of June 30, 1997 under the Company's
Incentive Plan.

23
<PAGE> 28

SELECTED FINANCIAL DATA

The following selected statement of operations and balance sheet data for
the period from February 11, 1997 (inception) through June 30, 1997, and as of
June 30, 1997 have been derived from the Company's financial statements audited
by KPMG Peat Marwick LLP, independent auditors whose reports with respect
thereto appear elsewhere herein. Such selected financial data should be read in
conjunction with those financial statements and the notes thereto and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" also included elsewhere herein. The following selected financial
data for the period ended March 31 and the quarter ended June 30, 1997 have been
derived from the financial statements of the Company and include adjustments,
consisting only of normal recurring adjustments, which Management considers
necessary for a fair presentation of such financial information for those
periods. Results for the periods ended June 30, 1997 are not necessarily
indicative of results for the year ending December 31, 1997.

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
FEBRUARY 11, 1997 FEBRUARY 11, 1997
TO QUARTER ENDED TO
JUNE 30, 1997 JUNE 30, 1997 MARCH 31, 1997
----------------- ------------- -----------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Interest income.................................. $ 3,640 $ 3,334 $ 306
Interest expense................................. 2,916 2,766 150
------ ------ -----
Net interest income.............................. 724 568 156
------ ------ -----
General and administrative expenses.............. 140 130 10
------ ------ -----
Net income....................................... $ 584 $ 438 $ 146
====== ====== =====
Net income per share of Common Stock(1).......... $ 0.35 $ 0.26 $0.09
Dividends per share of Common Stock(2)........... $ 0.36 $ 0.27 $0.09
</TABLE>

<TABLE>
<CAPTION>
AS OF AS OF
JUNE 30, 1997 MARCH 31, 1997
------------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Mortgage Assets.................................................. $ 228,620 $152,883
Total assets..................................................... 231,518 161,302
Reverse repurchase agreements.................................... 209,539 141,068
Total liabilities................................................ 210,915 141,208
Stockholders' equity............................................. 20,603 20,094
</TABLE>

- ---------------

(1) See Note 1 of Notes to Financial Statements for information regarding the
calculation of this item.

(2) The level of quarterly dividends is determined by the Board of Directors
based upon its consideration of a number of factors and should not be deemed
indicative of taxable income for the quarter in which declared or future
quarters, or of income calculated in accordance with GAAP. See "Dividend
Policy and Distributions."

24
<PAGE> 29

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Prospectus contains forward looking statements that inherently involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward looking statements as a result of
certain factors, including those set forth in the following section and in "Risk
Factors." The following discussion should be read in conjunction with the
Financial Statements and Notes thereto appearing elsewhere in this Prospectus.

OVERVIEW

All of the Company's income to date has been interest income generated from
its Mortgage Assets and its cash balances ("earning assets"). The Company funds
its acquisitions of earning assets with both its equity capital and with
borrowings. For that portion of the Company's earning assets funded with equity
capital ("equity-funded lending"), net interest income is derived from the
average yield on earning assets. Due to the adjustable-rate nature of its
earning assets, the Company expects that income from this source will tend to
increase as interest rates rise and will tend to decrease as interest rates
fall.

For that portion of the Company's earning assets funded with borrowings
("spread lending"), resulting net interest income is a function of the volume of
spread lending and the difference between the Company's average yield on earning
assets and the cost of borrowed funds and interest rate hedging agreements.
Income from spread lending may initially decrease following an increase in
interest rates and then, after a lag period, be restored to its former level as
earning assets yields adjust to market conditions. Income from spread lending
may likewise increase following a fall in interest rates, but then decrease as
earning assets yields adjust to the new market conditions after a lag period.
See "Risk Factors -- Sudden Interest Rate Fluctuations May Reduce Income From
Operations" and "Business -- Funding."

The Company seeks to generate growth in net income in a variety of ways,
including through (i) issuing new Common Stock and increasing the size of the
earning assets when opportunities in the mortgage market are likely to allow
growth in net income per share of Common Stock, (ii) seeking to improve
productivity by increasing the size of the earning assets at a rate faster than
operating expenses increase, (iii) changing the mix of Mortgage Asset types
among the earning assets in an effort to improve returns, and (iv) increasing
the efficiency with which the Company uses its equity capital over time by
increasing the Company's use of debt when prudent and by issuing subordinated
debt, preferred stock or other forms of debt and equity. There can be no
assurance, however, that the Company's efforts will be successful or that the
Company will increase or maintain its income level. See "Risk
Factors -- Manager's Lack of Prior Experience in Managing a REIT Could Adversely
Affect the Company's Business, Financial Condition, and Results of Operations;
Limited Operating History Does Not Necessarily Predict Future Performance of
Company," and "-- Future Offerings of Common Stock May Affect Market Price of
Common Stock."

Interest Income and the Earning Asset Yield

On average, the Company had $196 million in earning assets during the
quarter ended June 30, 1997. The Company's sole source of income during fiscal
1997 for both equity-funded lending and spread lending was the interest income
earned from these earning assets. As a residential mortgage REIT, the Company
expects to continue to rely on interest income as its primary source of income
in the future. At June 30, 1997, the weighted average net coupon on the
Company's Mortgage Assets was 7.78% per annum based on the amortized cost of the
Mortgage Assets.

The annualized mortgage principal repayment rate for the Company was 29% in
the quarter ended June 30, 1997. The Company adjusts its rate of premium
amortization monthly based on actual principal repayments received. As a result,
premium amortization accelerates as the rate of principal repayment increases.
This lowers the earning assets yields and reportable net income. See "Risk
Factors -- Increased Levels of Mortgage Loan Prepayments May Reduce Operating
Income."

25
<PAGE> 30

The Company may acquire new Mortgage Assets with coupons that are initially
low relative to prevailing short term interest rates. As a result, the overall
earning assets yields may be temporarily lower during periods of rapid growth in
the Company's Mortgage Assets.

Borrowings

To date, the Company's debt has consisted entirely of borrowings
collateralized by a pledge of the Company's Mortgage Assets. These borrowings
appear on the balance sheet as reverse repurchase agreements. Institutions with
high quality pledgable assets such as banks, savings and loans, brokerage firms,
federal agencies and the Federal Reserve Bank are the largest U.S. borrowers in
this market. The Company has established uncommitted borrowing facilities with
10 lenders in this market in amounts aggregating at least $500 million. The
Company also has in place a line of credit that it may use to fund certain cash
flow shortages. The Company intends to expand its uncommitted reverse repurchase
agreements following the closing of this Offering. There can be no assurance,
however, that the Company will be able to obtain debt financing in the future
under these facilities or otherwise. Further, the Company's current borrowing
facilities may be collateralized only by Mortgage Securities and may not be used
to finance acquisitions of Mortgage Loans pursuant to the Direct Purchase
Program. See "Risk Factors -- Failure to Implement Company's Leverage Strategy
May Adversely Affect Results of Operations" and "Business -- Funding."

With the Company's current asset/liability strategy, changes in the
Company's cost of funds are expected to be closely correlated with changes in
the two-month LIBOR interest rate, although the Company may choose to extend or
shorten the maturity of its liabilities at any time.

The term to maturity of the Company's borrowings has ranged from one day to
six months, with a weighted average term to maturity of 62 days at quarter
ending June 30, 1997. The weighted average cost of funds for all of the
Company's borrowings was 5.69% per annum as of June 30, 1997.

Net Interest Income from Equity-Funded Lending and Spread Lending

For the purpose of analyzing net interest income, the Company focuses on
the two component activities with respect to its earning assets: equity-funded
lending and spread lending. Each of these two components must be considered
separately when analyzing changes in interest rates, asset/liability strategy,
growth and other factors.

When analyzing the profitability of equity-funded lending and spread
lending, the Company does not assign specific Mortgage Assets to each type of
lending, but rather assumes that one portion of aggregate earning assets is
funded with equity and another portion of aggregate earning assets is funded
with borrowings.

The Company believes equity-funded lending has a large influence on the
Company's profitability relative to financial institutions which have (i) lower
equity-to-assets ratios, (ii) intangible capital, or (iii) significant amounts
of non-earning assets or net working capital on their books.

Liquidity of Mortgage Assets

Liquidity is the Company's ability to convert its Mortgage Assets to cash.
The liquidity of the Company's Mortgage Assets enables the Company to borrow
funds to purchase additional Mortgage Assets and allows the Company to pledge
additional Mortgage Assets to secure existing borrowings should the value of
pledged Mortgage Assets decline. The Company will typically pledge its least
liquid Mortgage Assets for secured borrowings so that the Company's pool of
unpledged Mortgage Assets is made up of its most liquid Mortgage Assets. Unused
borrowing capacity will vary over time as the market value of the Company's
Mortgage Assets varies and due to other factors.

The Company's Mortgage Assets generate liquidity on an ongoing basis
through mortgage principal repayments and net income held prior to payment as
dividends. Should the Company's needs ever exceed these ongoing sources of
liquidity, the Company believes that the Company's Mortgage Assets and interest
rate agreements could be sold in most circumstances to raise cash. There can be
no assurance, however, that such Mortgage Assets could be sold on terms
favorable to the Company, or at all. See "Risk Factors -- Investments in
Mortgage Assets May be Illiquid."

26
<PAGE> 31

Asset/Liability Management and Effect of Changes in Interest Rates

The Manager continually reviews the Company's asset/liability strategy with
respect to interest rate risk, mortgage prepayment risk, credit risk and the
related issues of capital adequacy and liquidity. The net effect of changes in
interest rates, relative changes in one- and six-month LIBOR rates, changes in
short term interest rates relative to long term interest rates, changes in
mortgage principal repayment rates, changes in the market value of Mortgage
Assets and interest rate agreements and other factors cannot be determined in
advance. The Company seeks attractive stockholder returns while seeking to
maintain a strong balance sheet and pattern of net income which is stable and
growing over time.

Inflation

The Company believes that interest rates and other factors influence the
Company's performance to a greater extent than inflation. Changes in interest
rates do not necessarily correlate with inflation rates or changes in inflation
rates. The Company's financial statements are prepared in accordance with GAAP
and the Company's dividends are determined by the Company's net income as
calculated for tax purposes.

Seasonality

The level of prepayments of the Company's Mortgage Assets is subject to the
same seasonal influences as the residential real estate industry with
prepayments generally being higher in the summer months and lower in the winter
months. Likewise, the Company anticipates that any originations under the Direct
Purchase Program would parallel these seasonal trends.

CERTAIN ACCOUNTING POLICIES AND PROCEDURES

Mortgage Security Accounting Treatment

Because the Company's Mortgage Securities are classified for accounting
purposes as "available for sale" accounting treatment, unrealized fluctuations
in the market value of the Mortgage Securities does not impact GAAP or taxable
income, but rather is reflected on the balance sheet by changing the carrying
value of the Mortgage Assets and reflecting the change in stockholders' equity
under "Net Unrealized Gains or Losses on Assets Available for Sale." As a result
of this mark-to-market accounting treatment, the book value and book value per
share of the Company are likely to fluctuate far more than if the Company used
historical amortized cost accounting. As a result, comparisons with companies
that use historical cost accounting for some or all of their balance sheet may
be misleading.

Unrealized changes in the estimated net market value of Mortgage Assets
have one direct effect on the Company's potential net income and dividends:
positive mark-to-market changes will increase the Company's equity base and
allow the Company to increase its spread lending activities while negative
changes will tend to limit spread lending growth under the Company's Capital
Policy. A very large negative change in the net market value of Mortgage Assets
and interest rate cap agreements might impair the Company's liquidity position,
requiring the Company to sell Mortgage Assets with the likely result of realized
losses upon sale. See "Risk Factors -- Failure to Implement Company's Leverage
Strategy May Adversely Affect Results of Operations."

Taxable Income and GAAP Income

Income as calculated for tax purposes ("taxable income") differs from
income as calculated according to generally accepted accounting principles
("GAAP income") for various reasons. Interest income differs due to different
methods of calculating the rate of amortization of the premium or discount when
Mortgage Assets are acquired at a price above or below the stated principal
amount of the Mortgage Loans. Credit losses differ between tax and GAAP methods
of accounting because the Company takes credit provisions in order to build a
credit allowance for GAAP whereas only actual credit losses are deducted in
calculating taxable income. General and administrative expenses differ due to
differing treatment of leasehold amortization and other items. The Company's
largest expense is the cost of borrowed funds. Interest expense is calculated in
the same manner for GAAP and tax purposes.

27
<PAGE> 32

These distinctions are important to the Company's stockholders as dividends
are based on taxable income. The Company generally will not pay federal taxes so
long as it meets the REIT provisions of the Code and distributes dividends to
stockholders in an amount equal to its taxable income. See "Federal Income Tax
Consequences -- Requirements for Qualification as a REIT."

Taxable Income and Dividends

The Company intends to declare and pay dividends equal to its taxable
income over time. The Company's current practice is to declare quarterly
dividends per share immediately at the first regular meeting of the Board of
Directors following the end of a quarter. In general, the Company has endeavored
to declare a quarterly dividend per share of Common Stock which would result in
the distribution of most or all of the taxable income earned in that quarter.
See "Risk Factors -- Manager's Lack of Prior Experience in Managing a REIT Could
Adversely Affect the Company's Business, Financial Condition and Results of
Operations; Limited Operating History Does Not Necessarily Predict Future
Performance of Company" and "Dividend Policy and Distributions."

RESULTS OF OPERATIONS

For the quarter ended June 30, 1997, the Company generated net income of
approximately $438,000 and net income per share of Common Stock of $0.26. From
the commencement of operations on February 11, 1997 through June 30, 1997, the
Company generated net income of approximately $584,000 and net income per share
of Common Stock of $0.35. At June 30, 1997, the Company held Mortgage Assets
that had a carrying value of approximately $229 million. All Mortgage Assets
held at June 30, 1997, were Agency Securities backed by adjustable-rate single
family residential Mortgage Loans.

Net income for the Company increased 200% from approximately $146,000 for
the period ended March 31, 1997, to approximately $438,000 for the quarter ended
June 30, 1997. The growth in net income was directly attributable to an increase
in net interest income. Net interest income grew 264% between the period ended
March 31, 1997 and the quarter ended June 30, 1997, from approximately $156,000
to approximately $568,000, respectively. This increase in net interest income
was partially offset by an increase in general and administrative expenses. From
the period ended March 31, 1997 to the quarter ended June 30, 1997, general and
administrative expenses increased from approximately $10,000 to approximately
$130,000.

The growth in net interest income between the period ended March 31, 1997
and the quarter ended June 30, 1997 was due to the increase in the Company's
Mortgage Assets. The Company commenced operations on February 11, 1997, but did
not complete the initial purchase of Mortgage Assets until March 24, 1997.
Therefore, the Company did not earn interest income from Mortgage Assets nor
incur premium amortization or reverse repurchase agreement expense until late in
the period ended March 31. Similarly, the increase in general and administrative
expenses between the period ended March 31, 1997 and the quarter ended June 30,
1997 is the result of the Company not starting operations until the middle of
the period ended March 31.

The Company experienced higher than expected levels of prepayments in the
quarter ended June 30, 1997. The annualized mortgage principal repayment rate
for the Company was 29% in the quarter ending June 30, 1997. Although the
Company does not expect repayment rates to continue at such levels, there can be
no assurance that the Company will be able to achieve or maintain lower
repayment rates. Accordingly, the Company's financial condition and results of
operations could be materially adversely affected if prepayments continue at
higher than anticipated levels. See "Business -- Risk Management -- Interest
Rate Risk Management."

The Company was in the process of investing the net proceeds of its initial
sale of privately placed Common Stock through May 15, 1997. Accordingly, the
full impact of the Company's use of proceeds was not realized in operations
until the middle of the quarter ended June 30, 1997. See "Risk
Factors -- Manager's Lack of Prior Experience in Managing a REIT Could Adversely
Affect the Company's Business, Financial Condition and Results of Operations;
Limited Operating History Does Not Necessarily Predict Future Performance of
Company."

28
<PAGE> 33

LIQUIDITY AND CAPITAL RESOURCES

The Company's principal liquidity needs result from the long term
investment in Mortgage Assets. Generally, reverse repurchase agreement
borrowings and the issuance of Common Stock provide the Company funding for its
investment needs. To a lesser extent, the Company may use funds available under
its line of credit. Pursuant to the line of credit, the Company may borrow the
lesser of $25 million and the outstanding principal and interest receivable
balance with one counter party, for a period of up to 36 days, at an interest
rate equal to LIBOR plus 0.6%. The line of credit has no set expiration date.
See "Business -- Funding."

During the period from February 11, 1997 (commencement of operations)
through June 30, 1997, net cash provided by operating activities was $259,000.
Net cash provided by operating activities was negatively impacted by an increase
in accrued interest receivable. There were no Mortgage Assets held at February
11, 1997 and, therefore, the total accrued interest receivables at June 30, 1997
negatively affected cash. Net cash for the period was positively affected by an
increase in accrued interest payable.

Net cash used in investing activities for the period from February 11, 1997
through June 30, 1997 was $229.7 million. Net cash used for the period was
negatively affected by the purchase of Mortgage Assets and positively affected
by principal repayments.

For the period from February 11, 1997 through June 30, 1997, net cash
provided by financing activities was $229.6 million. Net cash provided was
primarily affected by borrowings under reverse repurchase agreements and net
proceeds received from the issuance of Common Stock in the Company's private
placement.

At June 30, 1997 the Company had uncommitted reverse repurchase agreement
facilities in place to provide over $500 million to finance investments in
Mortgage Assets. The Company believes that cash flow from operations, the
proceeds of this Offering and funds available pursuant to reverse repurchase
agreement facilities and other credit arrangements will be sufficient to meet
the Company's cash requirements for at least one year following the closing of
this Offering. Thereafter, if the Company's cash resources are insufficient to
satisfy the Company's liquidity requirements, the Company may be required to
sell additional equity or debt securities. There is no assurance that such
financing will be available to the Company on favorable terms, or at all. See
"Risk Factors -- Failure to Implement Company's Leverage Strategy May Adversely
Affect Results of Operations" and "-- Future Offerings of Common Stock May
Affect Market Price of Common Stock."

RECENT DEVELOPMENTS

For the quarter ended September 30, 1997, the Company generated net income
of approximately $519,000 and net income per share of Common Stock of $0.31.
From the commencement of operations on February 11, 1997 through September 30,
1997, the Company generated net income of approximately $1.1 million and net
income per share of Common Stock of $0.66. At September 30, 1997 the Company
held Mortgage Assets that had a carrying value of approximately $229 million,
including an $804,000 net unrealized gain recorded during the quarter. All
Mortgage Assets held at September 30, 1997 were Mortgage Securities issued or
guaranteed by federal government sponsored agencies backed by adjustable-rate
single family residential Mortgage Loans.

Net income for the Company increased 18% from approximately $438,000 for
the quarter ended June 30, 1997, to approximately $519,000 for the quarter ended
September 30, 1997. The growth in net income was directly attributable to an
increase in net interest income. Net interest income grew 21% between the
quarter ended June 30, 1997 and the quarter ended September 30, 1997, from
approximately $568,000 to approximately $689,000, respectively. This increase in
net interest income was partially offset by an increase in general and
administrative expenses. From the quarter ended June 30, 1997 to the quarter
ended September 30, 1997, general and administrative expenses increased from
approximately $130,000 to approximately $170,000.

29
<PAGE> 34

BUSINESS

RESIDENTIAL MORTGAGE INDUSTRY

The residential mortgage market has experienced considerable growth over
the past 15 years with total residential mortgage debt outstanding growing from
approximately $965 billion in 1980 to approximately $3.9 trillion in 1996
according to the Mortgage Market Statistical Annual for 1997. In addition, the
total residential mortgage debt securitized into Mortgage Securities has grown
from approximately $110 billion in 1980 to approximately $1.9 trillion in 1996.
The Company believes that the current size of the residential mortgage market
will provide the Company with opportunities with respect to the purchase of
Mortgage Assets.

INVESTMENTS

AMREIT currently acquires adjustable-rate residential Mortgage Securities
in the capital markets. While the Company expects that a substantial portion of
its Mortgage Assets will continue to be Mortgage Securities, it anticipates that
it will increasingly invest in adjustable-rate Mortgage Loans, including
Mortgage Loans acquired directly from originators through its Direct Purchase
Program. Under the Direct Purchase Program, the Company believes that it can
enhance the overall yield of its Mortgage Asset portfolio by acquiring
relatively higher yielding Mortgage Loans and avoiding the cost of using
intermediaries. While the Company does not currently intend to acquire residual
interests issued by REMICs, subordinate interests in Mortgage Securities,
interest-only Mortgage Securities or sub-prime Mortgage Loans, it is not
prohibited from doing so under the terms of its Capital Policy. The Company has
not yet specifically identified any Mortgage Assets in which to invest the
proceeds of this Offering. See "Risk Factors -- Material Portion of the Net
Proceeds of this Offering Not Committed to Specific Mortgage Assets; Inability
to Acquire Mortgage Assets" and "Use of Proceeds."

The Company will only acquire those Mortgage Assets which the Company
believes it has the expertise (with the advice of the Manager) to evaluate and
manage and which are consistent with the Company's balance sheet guidelines and
risk management objectives. The Company also considers (i) the amount and nature
of anticipated cash flows from the Mortgage Assets, (ii) the Company's ability
to pledge the Mortgage Assets to secure collateralized borrowings, (iii) the
increase in the Company's capital requirements resulting from the purchase and
financing of the Mortgage Assets, as determined pursuant to the Company's
capital policies, and (iv) the costs of financing, hedging, managing, servicing,
securitizing and reserving for the Mortgage Asset. Prior to the acquisition of
Mortgage Assets, potential returns on capital employed are assessed over the
life of the Mortgage Assets and in a variety of interest rate, yield spread,
financing cost, credit loss and prepayment scenarios. The Board of Directors of
the Company can revise the Company's investment policies in its sole discretion,
subject to approval by a majority of the Company's directors who are not
employees or officers of the Company. See "Risk Factors -- Policies and
Strategies May Be Revised at the Discretion of the Board of Directors."

The Company finances acquisitions of Mortgage Assets with short term
borrowings which generally mature in six months or less. Upon maturity, the
Company refinances the Mortgage Assets with new short term borrowings which then
bear interest at the applicable market rate. Accordingly, the Company's interest
expense changes rapidly with changes in the market interest rates. In order to
maintain a margin between the Company's interest expense and the interest income
generated by Mortgage Assets, the Company generally acquires Mortgage Assets
with interest rates that also adjust with changing market interest rates.
Accordingly, the Company expects that substantially all of the Mortgage Assets
acquired by it will be adjustable-rate rather then fixed-rate Mortgage Assets.

Capital Markets Program

The Company has purchased and will continue to purchase Mortgage Securities
in the capital markets. These Mortgage Securities generally have a higher level
of liquidity than the Mortgage Loans to be acquired under the Direct Purchase
Program and are expected to provide a relatively stable flow of interest income
with

30
<PAGE> 35

relatively low levels of credit risk compared to such Mortgage Loans. The
Mortgage Securities to be acquired by the Company will be backed by a pool of
adjustable-rate Mortgage Loans. These Mortgage Securities entitle the holder to
receive a pass-through of principal and interest payments on the underlying pool
of Mortgage Loans and will be guaranteed by federal government sponsored
agencies or issued by certain private institutions. Mortgage Securities issued
by private institutions are usually, but not always, rated by one of the major
rating services. The Company may from time to time invest in Mortgage Securities
that are not investment grade.

Direct Purchase Program

The Manager intends to leverage the expertise of its executive officers in
the residential Mortgage Loan industry to develop a program for the purchase of
Mortgage Loans by the Company directly from originators ("Correspondents").
Under the Direct Purchase Program, the Manager will (i) identify segments of the
residential Mortgage Loan market that meet its general criteria for potential
originations, (ii) develop tailored underwriting guidelines for Mortgage Loans
to be generated in each market segment, (iii) arrange for the acquisition by the
Company of Mortgage Loans originated by Correspondents directly from such
Correspondents, hence avoiding certain loan broker or other intermediary fees,
and (iv) arrange for the servicing of the Mortgage Loans by entities experienced
in servicing the particular types of Mortgage Loans involved.

The Company has not acquired any Mortgage Loans under the Direct Purchase
Program, and there can be no assurance that the Direct Purchase Program will be
successfully implemented or that the Mortgage Loans acquired through the program
will be higher yielding than Mortgage Securities. See "Risk Factors -- Material
Portion of Offering Proceeds Not Committed to Specific Mortgage Assets;
Inability to Acquire Mortgage Assets."

Tailored Mortgage Loan Products. Under the Direct Purchase Program, the
Manager will identify market segments of the residential Mortgage Loan market
that it believes have the potential for generating Mortgage Loans with higher
yields than other Mortgage Loans with generally comparable risks. These segments
generally are present where there is less competition among Mortgage Loan
originators and, hence, fewer resources available to borrowers. The Manager has
identified a number of such segments and expects that new opportunities in other
market segments will become available as the Mortgage Loan market continues to
change. These emerging market segments typically will include Mortgage Loans
that are not readily available from large, nationally-based Mortgage Loan
originators due to factors related to the Mortgage Loan underwriting process
itself (such as the need to value a complex, mixed use property) or a limited
secondary market for resale of such types of Mortgage Loans.

The Manager has identified the following market segments of the residential
Mortgage Loan market for the Company's initial tailored Mortgage Loan products:

- Small Multifamily Home Mortgage Loans. A small multifamily home Mortgage
Loan will be secured by a first lien on a 5-unit to 20-unit residential
property. The underwriting guidelines for small multifamily home Mortgage
Loans will place emphasis on the appraised value, the existence and terms
of underlying leases, a cash flow analysis, the condition of the
mortgaged property and favorable credit reports.

- Manufactured Housing Mortgage Loans. A manufactured housing Mortgage Loan
will be secured by a first lien on an owner occupied manufactured housing
unit (excluding mobile homes) permanently affixed to a foundation and the
underlying lot. The underwriting guidelines for manufactured housing
Mortgage Loans will place emphasis on appraised value (relying on
comparable sales), condition of the property, the quality of the
borrower's income and favorable credit reports.

- Mixed Use Mortgage Loans. A mixed use Mortgage Loan will be secured by a
first lien on a combined commercial and up-to-twelve-unit residential
property. The qualifying commercial uses of the properties will be
generally limited to retail, professional, light industrial or office
use. The underwriting guidelines for mixed use Mortgage Loans will place
emphasis on appraised value (relying

31
<PAGE> 36

on comparable sales), condition of the property (and environmental
compliance), cash flow analysis and credit reports (including credit
reports on commercial tenants).

- Rural Home Mortgage Loans. A rural home Mortgage Loan will be secured by
a first lien on a residential property in a rural area where agricultural
use is present but limited to noncommercial use. The underwriting
guidelines for rural home Mortgage Loans will place emphasis on appraised
value (relying on comparable sales), condition of the property, quality
of the borrower's income and favorable credit reports. Rural home
Mortgage Loan amounts will generally be higher with respect to the
appraised value of the residence, and the first five acres and lower with
respect to any additional acreage.

- Mini-Ranch Home Mortgage Loans. A mini-ranch home Mortgage Loan will be
secured by a first lien on a residential ranch property. The underwriting
guidelines for mini-ranch home Mortgage Loans will place emphasis on
appraised value (relying on comparable sales), condition of the property,
the quality of the borrower's income (primarily non-ranch income) and
favorable credit reports. Mini-ranch home Mortgage Loan amounts will
generally be higher with respect to the appraised value of the residence
and the first five acres, and lower with respect to any additional
acreage.

- Condominium/Resort Mortgage Loans. A condominium/resort Mortgage Loan
will be secured by a first lien on a vacation property, including those
located in ski, golf and other recreational resort areas. The
underwriting guidelines for condominium/resort Mortgage Loans will place
emphasis on appraised value (relying on comparable sales with same
complex comparables preferred), same complex rental history, the quality
of the borrower's income and favorable credit reports.

The Manager has created tailored underwriting guidelines for Mortgage Loans
in the Company's initial target market segments. Such Mortgage Loan underwriting
guidelines will set forth the various characteristics (such as combinations of
loan-to-value levels and credit ranking of borrowers) for Mortgage Loans that
the Company is prepared to purchase from Correspondents. These Mortgage Loans
generally will be nonconforming, primarily as a result of the property type,
and, to a lesser extent, the borrower's credit characteristics. See "Risk
Factors -- Borrower Credit May Decrease Value of Mortgage
Loans -- Characteristics of Underlying Property May Decrease Value of Mortgage
Loans."

The Manager intends to draw upon the experience of its executive officers
in the residential mortgage industry to build a network of Correspondents with
expertise in market segments targeted by the Company. The Manager will make
arrangements for the Company to acquire Mortgage Loans through the Manager's
relationships with these Correspondents. The Manager will identify and work with
a number of Correspondents to generate Mortgage Loans products for the Direct
Purchase Program, although the Company has not yet begun acquiring Mortgage
Loans through the Direct Purchase Program.

The Company anticipates that in the future a portion of its Mortgage Assets
will consist of Mortgage Loans acquired pursuant to the Direct Purchase Program.
These Mortgage Loans will have certain distinct risk characteristics and
generally lack standardized terms, which may complicate their structure. The
underlying properties themselves may be unique and more difficult to value than
typical residential real estate properties. Although the Company intends to seek
geographic diversification of the properties which are collateral for the
Company's Mortgage Loans, it does not intend to set specific diversification
requirements (whether by state, zip code or other geographic measure).
Concentration in any one area will increase exposure of the Company's Mortgage
Assets to the economic and natural hazard risks associated with that area.
Further, certain properties securing Mortgage Loans may be contaminated by
hazardous substances resulting in reduced property values. If the Company
forecloses on a defaulted Mortgage Loan collateralized by such property, the
Company may be subject to environmental liabilities regardless of whether the
Company was responsible for the contamination. The results of the Direct
Purchase Program may also be affected by various factors, many of which are
beyond the control of the Company, such as (i) local and other economic
conditions affecting real estate values, (ii) the ability of tenants to make
lease payments, (iii) the ability of a property to attract and retain tenants,
(iv) interest rate levels and the availability of credit to refinance such
Mortgage Loans at or prior to maturity, and (v) increased operating costs,
including energy costs, real estate taxes and costs of compliance with
regulations.

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Other Products. In addition to the tailored Mortgage Loan products
described above, the Company may also acquire conforming Mortgage Loans and
nonconforming jumbo Mortgage Loans from Correspondents, and purchase Mortgage
Loans on a bulk basis. Conforming Mortgage Loans meet underwriting guidelines
with respect to principal balance, loan repayment schedule and borrower credit
history, as defined by certain government-sponsored agencies. These Mortgage
Loans will consist of (i) conventional Mortgage Loans that comply with
requirements for inclusion in certain programs sponsored by the FHLMC or FNMA,
(ii) Mortgage Loans insured by the Federal Housing Administration ("FHA") and
(iii) Mortgage Loans partially guaranteed by the Department of Veterans Affairs
("VA"), that comply with requirements for inclusion in a pool of Mortgage Loans
guaranteed by the GNMA. The nonconforming Mortgage Loans will be conventional
Mortgage Loans that vary in one or more respects from the requirements for
participation in FHLMC or FNMA programs.

The Company expects that substantially all of the nonconforming Mortgage
Loans it purchases outside its target market segments will be nonconforming
primarily because they have original principal balances which exceed the
requirements for FHLMC or FNMA programs and, to a lesser extent, because they
vary in certain other respects from the requirements of such programs, including
the requirements relating to creditworthiness of the borrowers. The Company may
in the future invest in sub-prime Mortgage Loans. Sub-prime Mortgage Loans are
residential Mortgage Loans made to borrowers with credit ratings below the
conforming Mortgage Loan guidelines. Additionally, sub-prime Mortgage Loans
generally are subject to greater frequency of loss and delinquency than
conforming Mortgage Loans. Accordingly, lower credit grade Mortgage Loans
normally bear a higher rate of interest than conforming Mortgage Loans. See
"Risk Factors -- Borrower Credit May Decrease Value of Mortgage
Loans -- Characteristics of Underlying Property May Decrease Value of Mortgage
Loans." The Company may, when opportunities arise, acquire Mortgage Loans on a
bulk basis.

The Company does not expect to acquire or retain residual interests issued
by REMICs. Such residual interests, if acquired by a REIT, would generate excess
inclusion income. See "Federal Income Tax Consequences -- Taxation of
Stockholders."

Pricing. For Mortgage Loans to be acquired from Correspondents on a "flow"
basis (i.e., on a periodic basis shortly after the Mortgage Loans are funded),
the Company expects to review the prices at which it is purchasing such Mortgage
Loans daily with the Manager and to adjust the prices frequently. Mortgage Loans
acquired on a bulk basis will typically be priced on a negotiated basis with
Correspondents or pursuant to a bidding process. In each case, different prices
will be established for the various types of Mortgage Loans to be acquired based
on current market conditions, with price adjustments for any "buy-ups" or
"buy-downs" (i.e., where the gross margin is higher or lower than the standard
margin set forth in the Company's pricing specifications).

Underwriting. In developing the tailored underwriting guidelines for
Mortgage Loans to be acquired under the Direct Purchase Program, the Manager
will create a matrix of specific underwriting standards based on various
combinations of the underwriting characteristics described below. Each
Correspondent will generally be required to represent and warrant that all
Mortgage Loans originated by it and sold to the Company have been underwritten
in accordance with the Company's specific underwriting standards as well as
standards consistent with those used by mortgage lenders generally.

Underwriting standards are applied by or on behalf of a lender to evaluate
the borrower's credit standing and repayment ability, and the value and adequacy
of the related mortgaged property as collateral. In general, a prospective
borrower applying for a Mortgage Loan is required to fill out a detailed
application designed to provide to the underwriting officer pertinent credit
information. As part of the description of the borrower's financial condition,
the borrower generally is required to provide a current list of assets and
liabilities and a statement of income and expenses, as well as an authorization
to apply for a credit report which summarizes the borrower's credit history with
local merchants and lenders and any record of bankruptcy. In most cases, an
employment verification is obtained from an independent source (typically the
borrower's employer) which verification reports, among other things, the length
of employment with that organization, the current salary, and whether it is
expected that the borrower will continue such employment in the future. If a
prospective

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borrower is self-employed, the borrower may be required to submit copies of
signed tax returns. The borrower may also be required to authorize verification
of deposits at financial institutions where the borrower has demand or savings
accounts.

The Company may elect to have the borrower's credit report reviewed, and a
credit score produced, by an independent credit-scoring firm, such as Fair,
Issac and Company ("FICO"). The Company has not engaged FICO or discussed any
such engagement with FICO. Credit scores estimate, on a relative basis, which
borrowers are most likely to default on Mortgage Loans. Lower scores imply
higher default risks relative to higher scores. FICO scores are empirically
derived from historical credit bureau data and represent a numerical weighing of
a borrower's credit characteristics over a two year period. A FICO score is
generated through the statistical analysis of a number of credit-related
characteristics or variables. Common characteristics include the following: the
number of credit lines (trade lines), payment history, past delinquencies,
severity of delinquencies, current levels of indebtedness, types of credit and
length of credit history. Attributes are the specific values of each
characteristic. A scorecard (the model) is created with weights or points
assigned to each attribute. An individual loan applicant's credit score is
derived by summing together the attribute weights for that applicant.

In determining the adequacy of the mortgaged property as collateral, an
appraisal is made of each property considered for financing. The appraiser is
required to inspect the property and verify that it is in good condition and
that construction, if new, has been completed. The appraisal is based on the
market value of comparable homes, the estimated rental income (if considered
applicable by the appraiser) and the cost of replacing the home. The value of
the property being financed, as indicated by the appraisal, must be such that it
currently supports, and is anticipated to support in the future, the outstanding
Mortgage Loan balance.

Once all applicable employment, credit and property information is
received, a determination generally is made as to whether the prospective
borrower has sufficient monthly income available to meet (i) the borrower's
monthly obligations on the proposed Mortgage Loan (determined on the basis of
the monthly payments due in the year of origination) and other expenses related
to the mortgaged property (such as property taxes and hazard insurance), and
(ii) monthly housing expenses and other financial obligations and monthly living
expenses. The underwriting standards applied by the Correspondent may be
permitted to vary in appropriate cases where factors such as low loan-to-value
ratios or other favorable credit issues exist.

Because certain types of Mortgage Loans which will be acquired by the
Company under the Direct Purchase Program will be recently developed, they may
involve additional uncertainties not present in traditional types of Mortgage
Loans. The Company expects that these recently developed types of Mortgage Loans
may be underwritten primarily upon the basis of loan-to-value ratios or
favorable credit factors rather than on the borrower's credit standing or income
ratios. See "Risk Factors -- Borrower Credit May Decrease Value of Mortgage
Loans -- Characteristics of Underlying Property May Decrease Value of Mortgage
Loans."

Quality Control. The Manager has developed a quality control program to
monitor the quality of Mortgage Loan underwriting at the time of acquisition and
on an ongoing basis. All Mortgage Loans purchased by the Company will be subject
to this quality control program. A legal document review of each Mortgage Loan
acquired will be conducted to verify the accuracy and completeness of the
information contained in the Mortgage Loan documents, security instruments and
other pertinent documents in the file. A sample of Mortgage Loans originated
under the Direct Purchase Program will normally be submitted to a third party,
nationally recognized underwriting review firm for a compliance check of
underwriting and review of income, asset and appraisal information. For purposes
of this compliance check, Mortgage Loans will be selected by focusing on
Mortgage Loans with higher risk characteristics. In addition, the Manager
expects to conduct post-acquisition audits to monitor ongoing documentation and
servicing compliance.

Servicing. The Company expects to acquire certain of its Mortgage Loans on
a "servicing released" basis (i.e., the Company will acquire both the Mortgage
Loans and the rights to service them) and to act as the servicer of such
Mortgage Loans while they are in the Company's Mortgage Asset portfolio. The
Company believes this strategy will have the effect of increasing the yield to
the Company from the Mortgage Loans above what it would otherwise be. The
Company will contract with a subservicer for a fixed dollar fee per

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<PAGE> 39

Mortgage Loan per year or a percentage of the outstanding mortgage balance and
the right to hold escrow account balances and retain certain ancillary charges.
The Company expects to arrange for servicing of the Mortgage Loans originated
through the Direct Purchase Program with servicing entities that have particular
expertise and experience in the types of Mortgage Loans being acquired. The
Company does not expect to acquire Mortgage Loan servicing rights with respect
to Mortgage Loans beneficially owned by others.

RECENT INVESTMENT STATUS

From the commencement of operations on February 11, 1997 through August 31,
1997, the Company acquired Mortgage Securities that had a carrying value at
August 31, 1997 of approximately $228 million. All Mortgage Assets held by the
Company at August 31, 1997 were Agency Securities evidencing an interest in
adjustable-rate single family residential Mortgage Loans. Approximately 70% of
these Mortgage Securities were whole-pool Mortgage Securities which represent
all the certificates issued with respect to an underlying pool of Mortgage
Loans. None of the Mortgage Securities held by the Company include any sub-prime
Mortgage Loans, subordinate interests in Mortgage Securities, interest only
Mortgage Securities or REMICs. The securitized interests in pools of
adjustable-rate mortgages from the Federal Home Loan Mortgage Corporation and
the Federal National Mortgage Association are guaranteed as to principal and
interest. The original maturity of the majority of the Mortgage Assets is over a
period of thirty years; the actual maturity is subject to change based on the
prepayments of the underlying Mortgage Loans. The information provided in this
section is as of August 31, 1997. For information regarding the Company's
investments as of June 30, 1997, see Note 2 of Notes to Financial Statements.

FUNDING

The Company employs a debt financing strategy to increase its investment in
Mortgage Assets. By using the Company's Mortgage Assets as collateral to borrow
funds, the Company is able to purchase Mortgage Assets with significantly
greater value than its equity. The Company has a targeted ratio of
equity-to-assets of between 8% and 12%, which is generally greater than the
levels of many other companies that invest in Mortgage Assets, including many
commercial banks, savings and loans, FNMA and FHLMC. The Company has borrowing
arrangements with ten financial institutions consisting primarily of large
investment banking firms. At June 30, 1997, the Company had borrowed funds under
reverse repurchase agreements with five of these firms. The Company intends to
expand its uncommitted reverse repurchase agreements following the closing of
this Offering. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."

The Company's financing strategy is designed to maintain a cushion of
equity sufficient to provide required liquidity to respond to the effects under
its borrowing arrangements of interest rate movements and changes in the market
value of its Mortgage Assets. However, a major disruption of the reverse
repurchase or other markets relied on by the Company for short term borrowings
would have a material adverse effect on the Company unless the Company was able
to arrange alternative sources of financing on comparable terms. The Company
intends to finance its acquisition of Mortgage Assets primarily through reverse
repurchase agreements and, to a lesser extent, through lines of credit,
securitizations and other financings.

At June 30, 1997, total borrowings outstanding were $209.5 million, with
Mortgage Assets valued at $221.0 million pledged to secure such borrowings.
These borrowings are carried on the balance sheet at historical cost, which
approximates market value. All of the borrowings were undertaken pursuant to
reverse repurchase agreements. At June 30, 1997, the weighted average term to
maturity was 62 days and the weighted average borrowing rate was 5.69% per
annum. Under the reverse repurchase agreements outstanding at June 30, 1997, the
original aggregate "haircut," or the percentage by which the market value of the
pledged collateral must exceed the borrowing amount, was 4.4%. The Company
anticipates that, upon its repayment of each borrowing, the collateral will
immediately be used for a further borrowing pursuant to a new reverse repurchase
agreement. However, there can be no assurance that the Company would be able to
borrow additional funds. See "Risk Factors -- Failure to Implement Company's
Leverage Strategy May Adversely Affect Results of Operations."

The Company expects that all of its borrowing agreements will require the
Company to pledge cash or additional Mortgage Assets in the event the market
value of existing collateral declines. To the extent that

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<PAGE> 40

cash reserves are insufficient to cover such deficiencies in collateral, the
Company may be required to sell Mortgage Assets to reduce the borrowings. The
Company's current borrowing facilities may be collateralized only by Mortgage
Securities and may not be used to finance acquisitions of Mortgage Loans
pursuant to the Direct Purchase Program. See "Risk Factors -- Failure to
Implement Company's Leverage Strategy May Adversely Affect Results of
Operations."

Reverse Repurchase Agreements

The Company finances its portfolio of Mortgage Assets primarily through a
form of borrowing known as reverse repurchase agreements. In a reverse
repurchase agreement transaction, the Company agrees to sell a Mortgage Asset
and simultaneously agrees to repurchase the same Mortgage Asset one to six
months later at a higher price with the price differential representing the
interest expense. These transactions constitute collateralized borrowings for
the Company, based on the market value of the Company's Mortgage Assets. The
Company generally will retain beneficial ownership of the Mortgage Security,
including the right to distributions on the collateral and the right to vote.
Upon a payment default under any such reverse repurchase agreement, the lending
party may liquidate the collateral.

The Company intends to enter into reverse repurchase agreements primarily
with national broker/dealers, commercial banks and other lenders who typically
offer such financing. The Company does not intend at the present time to enter
into commitment agreements under which the lender would be required to enter
into new reverse repurchase agreements during a specified period of time. The
Manager and the Company will monitor the need for such commitment agreements and
may enter into such commitment agreements in the future if deemed favorable to
the Company. At June 30, 1997 the Company had uncommitted reverse repurchase
facilities to provide over $500 million to finance investments in Mortgage
Assets. See "Risk Factors -- Failure to Implement Company's Leverage Strategy
May Adversely Affect Results of Operations."

In the event of the insolvency or bankruptcy of the Company, the creditor
under reverse repurchase agreements may be allowed to avoid the automatic stay
provisions of the Bankruptcy Code and to foreclose on the collateral agreements
without delay. In the event of the insolvency or bankruptcy of a lender during
the term of a reverse repurchase agreement, the lender may be permitted to
repudiate the contract, and the Company's claim against the lender for damages
therefrom may be treated simply as one of the unsecured creditors. Should this
occur, the Company's claims would be subject to significant delay and, if
received, may be substantially less than the damages actually suffered by the
Company.

To reduce its exposure to the credit risk of reverse repurchase agreement
lenders, the Company intends to enter into such agreements with several
different parties and to follow credit exposure policies approved by the Board
of Directors, which include (i) conducting a financial review of each potential
lender, (ii) imposing minimum equity and credit rating (if rated) requirements
on such lenders, and (iii) limiting the percentage of Mortgage Assets that are
the subject of reverse repurchase agreements with a single lender to 45% of the
Company's total Mortgage Assets. Any exceptions to these policies must be
approved by both the Chief Executive Officer and the Chief Operating Officer of
the Company. The Company will monitor the financial condition of its reverse
repurchase agreement lenders on a regular basis. Notwithstanding these measures,
no assurance can be given that the Company will be able to avoid such counter
party risks.

Line of Credit

The Company has in place a line of credit facility that it may use to fund
portions of cash flow shortages which may result from prepayments on Mortgage
Loans underlying its Mortgage Securities. Generally, the Company's reverse
repurchase agreements, which are collateralized by the Company's Mortgage
Securities, demand immediate receipt of additional collateral to the extent that
the value of the Mortgage Securities is reduced as a result of prepayments.
However, the federal government agencies that issue the Mortgage Securities do
not deliver the proceeds from such prepayments for periods ranging from 15 to 36
days following the announcement of such prepayments. Accordingly, the Company
may be required to draw on its line of credit for the period between the date
the prepayments are announced and the Company is required to

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<PAGE> 41

surrender additional collateral and the date it receives the proceeds from the
prepayments. The line of credit is with one lender and is secured by the
proceeds of prepayments pursuant to collateral which secures the Company's
borrowings with that lender. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."

Securitizations

The Company intends to securitize from time to time Mortgage Loans acquired
through the Direct Purchase Program as part of its overall financing strategy.
Securitization is the process of pooling Mortgage Loans and issuing equity
securities, such as mortgage pass-through, or debt securities, such as
Collateralized Mortgage Obligations ("CMOs"). The Company intends to securitize
its Mortgage Loans primarily by issuing structured debt. Under this approach,
for accounting purposes, the Mortgage Loans so securitized remain on the balance
sheet as assets and the debt obligations (i.e., the CMOs) appear as liabilities.
A structured debt securitization is generally expected to result in substituting
one type of debt financing for another, as proceeds from the structured debt
issuance are applied against preexisting borrowings (i.e., advances under the
warehouse line of credit or borrowings under reverse repurchase agreements). The
structured debt securities issued will constitute non-recourse, long term
financing, the payments on which correspond to the payments on the Mortgage
Loans serving as collateral for the debt. Such financings are not subject to a
margin call if a rapid increase in rates would reduce the value of the
underlying Mortgage Loans and, hence, reduce the liquidity risk to the Company
for the Mortgage Loans so financed.

In addition to securitizing its Mortgage Loans, the Company also plans from
time to time to "re-securitize" portions of its Mortgage Securities portfolio.
In a re-securitization transaction, Mortgage Securities rather than Mortgage
Loans are used as collateral to create new Mortgage Securities. Only those
Mortgage Securities originally issued with (or subsequently downgraded to) a
rating below the two highest rating categories would benefit from
re-securitization. While the Company's investment strategy does not contemplate
purchasing such lower rated Mortgage Securities, the Company anticipates that it
may acquire such types of Mortgage Securities from time to time in connection
with securitizing its own Mortgage Loans as described above. A re-securitization
would typically be carried out when the Mortgage Loans underlying the Company's
Mortgage Securities improve in credit quality through seasoning, as values rise
on the underlying properties, or when the credit quality of a junior class of
Mortgage Security improves due to prepayment of more senior classes. Such
transactions can result in improved credit ratings, higher market values and
lowered borrowing costs. The Company has not engaged in any securitization or
re-securitization transactions to date and there can be no assurances that the
Company will be able to securitize or otherwise finance its Mortgage Loans
acquired pursuant to the Direct Purchase Program.

CAPITAL GUIDELINES

The Company's capital management goal is to strike a balance between the
under-utilization of leverage, which could reduce potential returns to
stockholders, and the over-utilization of leverage, which could reduce the
Company's ability to meet its obligations during periods of adverse market
conditions. For this purpose, the Company has established a "Capital Policy"
which limits the Company's ability to acquire additional Mortgage Assets during
times when the actual capital base of the Company is less than a required amount
defined in the Capital Policy. In this way, the Company believes the use of
balance sheet leverage can be better controlled. For purposes of the Capital
Policy, the actual capital base, is equal to the market value of total Mortgage
Assets, less the book value of total collateralized borrowings. In addition,
when the actual capital base falls below the Capital Policy requirement, the
Manager is required to submit to the Board of Directors of the Company a plan
for bringing the actual capital base into compliance with the Capital Policy. It
is anticipated that in most circumstances this goal will be achieved over time
without specific action by the Company or the Manager through the natural
process of mortgage principal repayments and increases in the market values of
Mortgage Assets as their coupon rates adjust upwards to market levels. The
Company anticipates that the actual capital base is likely to exceed the Capital
Policy requirement during periods following new equity offerings and during
periods of falling interest rates and that the actual capital base is likely to
fall below the Capital Policy requirement during periods of rising interest
rates. The Board of

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Directors has the discretion to modify or waive the Company's policies and
restrictions without stockholder consent. Aside from the Capital Policy set by
the Board of Directors, there are no restrictions on the Company's ability to
incur debt and there can be no assurance the level of debt that the Company is
authorized to incur will not be increased by the Board of Directors following
the closing of this Offering. See "Risk Factors -- Policies and Strategies May
Be Revised at the Discretion of the Board of Directors."

The Company, with the advice of the Manager, assigns to each Mortgage Asset
a specified amount of capital to be maintained against it by aggregating three
component requirements of the Capital Policy. The first component of the
Company's Capital Policy is the current aggregate over-collateralization amount
or "haircut" the lenders require the Company to hold as capital. The Company is
required to pledge as collateral Mortgage Assets with a market value that
exceeds the amount it borrows. The haircut for each Mortgage Asset is determined
by the lender based on the risk characteristics and liquidity of that Mortgage
Asset. For example, haircut levels on individual borrowings could range from 3%
for Agency Securities to 20% for certain Mortgage Loans acquired through the
Direct Purchase Program.

The second component of the Company's Capital Policy is the "liquidity
capital cushion." The Company expects that substantially all of its borrowing
agreements will require the Company to deposit additional collateral in the
event the market value of existing collateral declines. The liquidity capital
cushion is an additional amount of capital in excess of the haircut maintained
by the Company designed to assist the Company in meeting the demands of the
lenders for additional collateral should the market value of the Company's
Mortgage Assets decline. Alternatively, the Company might sell Mortgage Assets
to reduce the borrowings. See "Risk Factors -- Investments in Mortgage Assets
May Be Illiquid."

The third component of the Company's capital requirement is the "capital
cushion" assigned to each Mortgage Asset based on the Manager's assessment of
the Mortgage Asset's credit risk. This represents an assessment of the risk of
delinquency, default or loss on individual Mortgage Assets.

Finally, the Board of Directors establishes, subject to revision from time
to time, a minimum equity to total assets ratio for the Company pursuant to its
Capital Policy. The Board of Directors reviews on a periodic basis various
analyses prepared by the Manager of the risks inherent in the Company's balance
sheet, including an analysis of the effects of various scenarios on the
Company's net cash flow, net income, dividends, liquidity and net market value.
Should the Board of Directors determine, in its discretion, that the minimum
required capital base is either too low or too high, the Board of Directors will
raise or lower the capital requirement accordingly.

The Company expects that its aggregate minimum equity capital required
under the Capital Policy will range between 8% to 12% of the total market value
of the Company's Mortgage Assets. This percentage will fluctuate over time, and
may fluctuate out of the expected range, as the composition of the balance sheet
changes, haircut levels required by lenders change, the market value of the
Mortgage Assets change and as the capital cushion percentages set by the Board
of Directors are adjusted over time. The Company will actively monitor and
adjust, if necessary, its Capital Policy, both on an aggregate portfolio level
as well as on an individual pool or Mortgage Loan basis. In monitoring its
Capital Policy, the Company expects to take into consideration current market
conditions and a variety of interest rate scenarios, performance of hedges,
performance of Mortgage Assets, credit risk, prepayments of Mortgage Assets, the
restructuring of Mortgage Assets, general economic conditions, potential
issuance of additional equity, pending acquisitions or sales of Mortgage Assets,
Mortgage Loan securitizations and the general availability of financing. There
can be no assurance that the Company's capital will be sufficient to protect the
Company against adverse effects from interest rate adjustments or the obligation
to sell Mortgage Assets on unfavorable terms or at a loss. See "Risk
Factors -- Sudden Interest Rate Fluctuations May Reduce Income from Operations."

RISK MANAGEMENT

Prior to arranging the acquisition of Mortgage Assets by the Company, the
Manager gives consideration to balance sheet management and risk diversification
issues. A specific Mortgage Asset which is being evaluated for potential
acquisition is deemed more or less valuable to the Company to the extent it
serves to increase or decrease certain interest rate or prepayment risks which
may exist in the balance sheet, to diversify

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or concentrate credit risk, and to meet the cash flow and liquidity objectives
the Company may establish for its balance sheet from time to time. Accordingly,
an important part of the Mortgage Asset evaluation process is a simulation,
using the Manager's risk management model, of the addition of proposed Mortgage
Assets and its associated borrowings and hedgings to the balance sheet and an
assessment of the impact any proposed acquisition of Mortgage Assets would have
on the risks in, and returns generated by, the Company's balance sheet as a
whole over a variety of scenarios.

Interest Rate Risk Management

To the extent consistent with its election to qualify as a REIT, the
Company will implement certain processes and will follow a hedging program
intended to protect the Company against significant unexpected changes in
prepayment rates and interest rates.

Prepayment Risk Management Process. The Company will seek to minimize the
effects on earnings caused by faster than anticipated prepayment rates by
purchasing Mortgage Assets with prepayment penalties or which are fully-indexed
and have previously experienced periods of rising or falling interest rates. In
particular, the Company intends to include prepayment penalties in the
underwriting guidelines for the tailored Mortgage Loan products in the Direct
Purchase Program. See "Risk Factors -- Increased Levels of Mortgage Loan
Prepayments May Reduce Operating Income."

During the quarter ended June 30, 1997, the Company received $10.4 million
in principal payments on its Mortgage Assets. The annualized rate of principal
repayment the Company experienced was 29%. The amortized cost of the Company's
Mortgage Assets at June 30, 1997 was equal to 103.7% of the face value of the
Mortgage Assets. The smaller the level of net premium, the less risk there is
that fluctuations in prepayment rates will affect earnings in the long run. See
"Risk Factors -- Increased Levels of Mortgage Loan Prepayments May Reduce
Operating Income" and "Management Discussion and Analysis of Financial Condition
and Results of Operations -- Overview."

Other Processes. The Manager manages the Company's Mortgage Asset portfolio
to offset the potential adverse effects from (i) lifetime and periodic rate
adjustment caps on its Mortgage Assets, (ii) the differences between interest
rate adjustment indices of its Mortgage Assets and related borrowings, and (iii)
the differences between interest rate adjustment periods of its Mortgage Assets
and related borrowings. The Company generally purchases Mortgage Assets which
are fully indexed and have previously experienced periods of rising and falling
interest rates. The Manager also attempts to structure the Company's
acquisitions so that the Mortgage Assets purchased by the Company have interest
rate adjustment indices and adjustment periods that, on an aggregate basis,
correspond as closely as advisable by the Company to the interest rate
adjustment indices and adjustment periods of its anticipated borrowings. In
addition, the Manager structures the Company's short term borrowing agreements
to have a range of different maturities (although the majority will be six
months or less). As a result, the Company expects to be able to adjust the
average maturity of its borrowings on an ongoing basis by changing the mix of
maturities as borrowings come due and are renewed. In this way, the Company
intends to reduce the differences between adjustment periods of Mortgage Assets
and related borrowings.

At June 30, 1997, the Company's weighted average Mortgage Assets and
liabilities were matched within a two-month period in terms of adjustment
frequency and speed of adjustment to market conditions. All of the Company's
Mortgage Assets at June 30, 1997 had coupon rates that adjust to market levels
at least annually, with a weighted average term to reset of approximately four
months. All of the Company's borrowings at June 30, 1997 will either mature or
adjust to a market interest rate level within four months of such date. The
borrowings had a weighted average term to expiration of 62 days at June 30,
1997. Changes in coupon rates earned on Mortgage Assets highly correlated with
changes in LIBOR rates and CMT rates. The rates paid on borrowings generally
correlate with the changes in either LIBOR or FED fund rates (subject to the
effects of periodic and lifetime caps). There can be no assurance that the
Company's processes will protect the Company against interest rate fluctuations
which may adversely affect the Company's net interest income and results of
operations. See "Risk Factors -- Sudden Interest Rate Fluctuations May Reduce
Income From Operations."

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Hedging. The Company recognizes the need to hedge specific interest rate
risks associated with its Mortgage Asset portfolio and will seek the hedging
instrument most appropriate for the specific risk. Currently, all of the
Company's Mortgage Assets are subject to both lifetime interest rate caps and
periodic interest rate caps. The Company actively hedges the lifetime cap risks
associated with its Mortgage Assets. The Company has entered into hedging
transactions with respect to lifetime interest rate caps in order to reduce the
negative impact to the Company's earnings which might otherwise result from a
significant rise in interest rates. The Company may enter into additional types
of hedging transactions in the future if Management believes there exists a
significant risk to earnings. These types of hedging transactions may include
hedging against risks associated with (i) periodic interest rate adjustment
caps, and (ii) Mortgage Assets denominated in different interest rate indices,
such as U.S. Treasury bills and Eurodollars. The Manager intends to monitor and
evaluate the results of its hedging strategy and to adjust its hedging strategy
as it deems is in the best interest of the Company.

The cost of the interest rate cap agreements at June 30, 1997 was
approximately $502,000. Cap premiums are amortized from the purchase date
through the effective date of the cap on a straight-line basis. During the
quarter ended June 30, 1997, the cap amortization expense was approximately
$40,000. There was no income from the caps during this period and there were no
sales or termination of caps. During the quarter ended June 30, 1997, net cap
expense equaled approximately 0.02% of the average balance of the Company's
Mortgage Assets and 0.02% of the average balance of the Company's interest
bearing liabilities. For such periods, the net cap expense was approximately 7%
of net interest income. At June 30, 1997, the range of strike rates was 7.52% to
9.95% and the weighted average strike rate was 8.11%. Some of the Company's
interest rate cap agreements have strike rates and/or notional face amounts
which vary over time. The cap agreements do not become effective until the first
half of 1998. All of the interest rate caps reference the one month LIBOR.

Mortgage derivative securities can also be effective hedging instruments in
certain situations as the value and yields of some of these securities tend to
increase as interest rates rise and tend to decrease in value and yields as
interest rates decline, while the experience for others is the converse. As part
of the Company's hedging program, the Manager will monitor on an ongoing basis
the prepayment risks which arise in fluctuating interest rate environments and
consider alternative methods and costs of hedging such risks, which may include
the use of mortgage derivative securities. The Company intends to limit its
purchases of mortgage derivative securities to investments that qualify as
Qualified REIT Assets so that income from such securities will constitute
qualifying income for purposes of the 95% and 75% Gross Income Tests. The
Company does not currently intend to, but may in the future enter, into interest
rate swap agreements, buy and sell financial futures contracts and options on
financial futures contracts and trade forward contracts as a hedge against
future interest rate changes; however, the Company will not invest in these
instruments unless the Company and the Manager are exempt from the registration
requirements of the Commodities Exchange Act or otherwise comply with the
provisions of that act. The REIT provisions of the Code may restrict the
Company's ability to purchase hedges and may severely restrict the Company's
ability to employ other strategies. In all its hedging transactions, the Company
will contract only with counterparties that the Company believes are sound
credit risks. See "Federal Income Tax Consequences -- Requirements for
Qualification as a REIT -- Gross Income Tests."

Hedging involves transaction and other costs, and such costs increase as
the period covered by the hedging protection increases and also increase in
periods of rising and fluctuating interest rates. For example, in a typical
interest rate cap agreement, the cap purchaser makes an initial lump sum cash
payment to the cap seller in exchange for the seller's promise to make cash
payments to the purchaser on fixed dates during the contract term if prevailing
interest rates exceed the rate specified in the interest rate cap agreement.
Because of the cost involved, the Company may be prevented from effectively
hedging its interest rate risks without significantly reducing the Company's
return on equity.

Certain of the federal income tax requirements that the Company must
satisfy to qualify as a REIT limit the Company's ability to fully hedge its
interest rate and prepayment risks. The Manager monitors carefully, and may have
to limit, the Company's asset/liability management program to assure that it
does not realize excessive hedging income, or hold hedging assets having excess
value in relation to total assets, which would

40
<PAGE> 45

result in the Company's disqualification as a REIT or, in the case of excess
hedging income, the payment of a penalty tax for failure to satisfy certain REIT
income tests under the Code, provided such failure was for reasonable cause. In
addition, asset/liability management involves transaction costs which increase
dramatically as the period covered by the hedging protection increases.
Therefore, the Company may be prevented from effectively hedging its interest
rate and prepayment risks. See "Federal Income Tax Consequences -- Requirements
for Qualification as a REIT."

In particular, income from hedging the Company's variable rate borrowings
(other than with hedging instruments that are Qualified REIT Assets) qualifies
for the 95 percent of income test, but not for the 75 percent of income test,
for REIT qualification. The Company must limit its income from such hedging or
the sale of hedging contracts, along with other types of income that qualifies
for the 95 percent of income test, but not for the 75 percent of income test, to
less than 25 percent of the Company's gross revenues. In addition, hedging
instruments, such as swaps, caps, floors, collars, and financial futures
contracts, are securities for purposes of the quarterly asset tests for REIT
qualification. The Company must ascertain that securities, including the hedging
instruments (other than hedging instruments that are Qualified REIT Assets),
issued by a single issuer do not account for 5 percent or more of the value of
the Company's assets as of the last day of each calendar quarter. The Company
does not expect to encounter material problems complying with these tests.

Although the Company believes that, with the advice of the Manager, it has
developed a cost effective interest rate risk management program to provide a
level of protection against interest rate risks, developing an effective program
is complex and no program can completely insulate the Company from the effects
of interest rate changes. Further, the cost of hedging transactions and the
federal tax laws applicable to REITs may limit the Company's ability to fully
hedge its interest rate risks. See "Risk Factors -- Failure to Successfully
Manage Interest Rate Risks May Adversely Affect Results of Operations" and
"Federal Income Tax Consequences -- Requirements for Qualification as a REIT."

Interest Rate Sensitivity Gap. The interest rate sensitivity gap is a tool
used by financial institutions such as banks and savings and loans to analyze
the possible effects of interest rate changes on net income over time. Time gap
analysis ignores many important factors, and, in the Company's case, it ignores,
among other factors, the effect of the Company's hedging activities, the effect
of the periodic and lifetime caps on the Company's Mortgage Assets, and the
effect of changes in mortgage principal repayment rates. Nevertheless, the gap
time analysis can provide some useful information on the interest rate risk
profile of a financial institution.

A negative cumulative gap over a particular period means that the amount of
liabilities that will have an expense rate adjusting to prevailing market
conditions during that period will be greater than the amount of Mortgage Assets
that will have an earning rate adjustment. Thus a negative gap implies that
increasing interest rates would result in a falling level of net interest income
during the time period in question, as the cost of funds on the liabilities
would adjust more quickly to the interest rate increase than would the interest
income from the Mortgage Assets. A negative gap also implies that falling
interest rates would result in an increasing level of net interest during the
period in question.

Credit Risk Management

The Company will review with the Manager credit risks and other risks of
loss associated with each investment and determine the appropriate allocation of
capital to apply to such investment under the Company's Capital Policy. In
addition, the Company will attempt to diversify its Mortgage Asset portfolio to
avoid undue geographic, issuer, industry and certain other types of
concentrations. The Company will attempt to obtain protection against some risks
from sellers and servicers through representations and warranties and other
appropriate documentation. The Board of Directors will monitor the overall
portfolio risk and increase the allowance for Mortgage Loan losses when it
believes appropriate.

The risks presented by each Mortgage Loan acquired under the Direct
Purchase Program will be unique and must be analyzed separately. In order to
reduce the credit risks associated with acquisitions of such Mortgage Loans, the
Company will, with the advice of the Manager (i) employ a quality control
program, (ii) acquire Mortgage Loans that represent a broad range of moderate
risks as opposed to a concentrated risk,

41
<PAGE> 46

(iii) monitor the credit quality of newly acquired and existing Mortgage Assets,
and (iv) periodically adjust the Mortgage Loan loss allowances. The Company also
expects to arrange for servicing of Mortgage Loans acquired pursuant to the
Direct Purchase Program with servicing entities that have particular expertise
and experience in the types of Mortgage Loans being acquired. See "Risk
Factors -- Borrower Credit May Decrease Value of Mortgage
Loans -- Characteristics of Underlying Property May Decrease Value of Mortgage
Loans."

With respect to its Mortgage Securities, the Company will be exposed to
levels of credit and special hazard risk, depending on the nature of the
underlying Mortgage Loans and the nature and level of credit enhancements
supporting such Mortgage Securities. Most of the Mortgage Securities acquired by
the Company will have protection from normal credit losses. At June 30, 1997,
100% of the Company's Mortgage Securities were Agency Securities.

The Company may sell Mortgage Assets from time to time for a number of
reasons, including, without limitation, to dispose of Mortgage Assets as to
which credit risk concerns have arisen, to seek to reduce interest rate risk, to
substitute one type of Mortgage Asset for another to seek to improve yield or to
maintain compliance with the 55% requirement under the Investment Company Act,
and generally to re-structure the balance sheet when Management deems such
action advisable. The REIT Provisions of the Code limit in certain respects the
ability of the Company to sell Mortgage Assets. See "Federal Income Tax
Consequences -- Requirements for Qualification as a REIT -- Gross Income Tests"
and "Federal Income Tax Consequences -- Taxation of the Company."

COMPETITION

The Company's net interest income will depend, in large part, on the
Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. As a result of this
Offering, the Company will seek to acquire approximately $750 million to $1.1
billion or more of additional Mortgage Assets. There can be no assurance that
the Company will be able to acquire sufficient Mortgage Assets at spreads above
the Company's cost of funds. In acquiring Mortgage Assets, the Company will
compete with investment banking firms, savings and loan associations, banks,
mortgage bankers, insurance companies, mutual funds, other lenders, FHLMC, FNMA,
GNMA and other entities purchasing Mortgage Assets, many of which have greater
financial resources than the Company. In addition, there are several REITs
similar to the Company, and others may be organized in the future. The effect of
the existence of additional REITs may be to increase competition for the
available supply of Mortgage Assets suitable for purchase by the Company. As it
relates to the Direct Purchase Program, the Company competes on the basis of
product type. The Company will face competition from companies already
established in these markets. There can be no assurance that the Company will be
able to successfully compete with its competition.

The availability of Mortgage Loans meeting the Company's criteria is
dependent upon, among other things, the size of and level of activity in the
residential real estate lending market. The size and level of activity in the
residential real estate lending market depend on various factors, including the
level of interest rates, regional and national economic conditions and inflation
and deflation in residential property values. To the extent the Company is
unable to acquire a sufficient number of Mortgage Loans meeting its criteria,
the Company's results of operations will be adversely affected. See "Risk
Factors -- Material Portion of Offering Proceeds Not Committed to Specific
Mortgage Assets; Inability to Acquire Mortgage Assets."

EMPLOYEES

Currently, the Manager employs the six executive officers of the Company
and three additional employees. At the closing of the Offering, there will be a
total of nine employees. Each of the executive officers has between 10 and 24
years, and collectively, they have an average of 19 years of experience in the
residential mortgage industry and worked together previously as a management
team. The Manager is currently in the process of recruiting employees to support
the Direct Purchase Program. At the closing of this Offering, each employee of
the Manager will also become an employee of the Company. The Company anticipates
that at least through the end of 1997 employees hired by the Manager will also
be employees of the

42
<PAGE> 47

Company. See "Risk Factors -- The Company Has Significant Conflicts with, and Is
Dependent on, an Affiliate of the Executive Officers of the Company."

FACILITIES

The Company's and the Manager's executive offices are located at 445 Marine
View Avenue, Suite 230, Del Mar, California. The Company and the Manager
currently occupy approximately 4,000 square feet of space and the Manager has a
right of first refusal on an additional 1,000 square feet at its current
location beginning March 1998. The Manager leases facilities pursuant to a lease
expiring in March 2000. Management believes that these facilities are adequate
for the Company's and the Manager's foreseeable needs.

LEGAL PROCEEDINGS

There are no material pending legal proceedings to which the Company is a
party or to which any property of the Company is subject.

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<PAGE> 48

MANAGEMENT OF THE COMPANY

DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

The following table presents certain information concerning the directors
and executive officers of the Company:

<TABLE>
<CAPTION>
NAME AGE POSITION(1)
---------------------------------- --- ----------------------------------
<S> <C> <C>
John M. Robbins(2)................ 50 Chairman of the Board, Chief
Executive Officer and Director
Jay M. Fuller(2).................. 47 President, Chief Operating Officer
and Director
Mark A. Conger.................... 38 Executive Vice President and Chief
Financial Officer
John Dahl......................... 44 Executive Vice President, Capital
Markets and Loan Production
Rollie O. Lynn.................... 43 Senior Vice President, Capital
Markets
Lisa S. Faulk..................... 40 Senior Vice President, Operations
David E. De Leeuw(2)(3)(4)(6)..... 53 Director
George E. McCown(2)(5)............ 62 Director
</TABLE>

In addition, the following individuals have been elected directors of the
Company effective immediately following the closing of this Offering:

<TABLE>
<CAPTION>
NAME AGE POSITION
---------------------------------- --- ----------------------------------
<S> <C> <C>
H. James Brown, Ph.D.(3)(6)....... 56 Director
Ray McKewon(4)(6)................. 49 Director
Richard T. Pratt, Ph.D.(3)(6)..... 60 Director
Mark J. Riedy, Ph.D.(4)(6)........ 55 Director
</TABLE>

- ---------------

(1) Each executive officer and director holds the same position with the
Manager. See "The Manager."

(2) Each of Mr. Robbins, Mr. Fuller, Mr. De Leeuw and Mr. McCown and the private
equity firm of McCown De Leeuw & Co., of which Messrs. McCown and De Leeuw
are principals, was a founder of the Company.

(3) Member of the Audit Committee. See "Board Committees."

(4) Member of the Compensation Committee. See "Board Committees."

(5) Mr. McCown will resign as a director of the Company upon the closing of this
Offering.

(6) The directors who will be in office after the closing of this Offering and
who are not officers or employees of either the Company or the Manager are
deemed independent directors of the Company. See "-- Action by Independent
Directors."

JOHN M. ROBBINS has served as Chairman of the Board of Directors and Chief
Executive Officer and Director of the Company since its formation in February
1997. Prior to joining the Company, Mr. Robbins was Chairman of the Board of
AMRES Mortgage from 1990 until 1994 and President of AMRES Mortgage from the
time he co-founded it in 1983 until 1994. He also served as Executive Vice
President of Imperial Savings Association from 1983 to 1987. Mr. Robbins has
worked in the mortgage banking industry since 1973. Mr. Robbins has served two
terms on the Board of Governors and the Executive Committee of the Mortgage
Association of America, and has served on FNMA's National Advisory Board. Mr.
Robbins also serves as a director of Pacific Research & Engineering Corporation,
Garden Fresh Restaurant Corporation, National Bankcard and the University of San
Diego.

JAY M. FULLER has served as President, Chief Operating Officer and Director
of the Company since its formation in February 1997. Prior to joining the
Company Mr. Fuller served as President of Victoria Mortgage from 1995 to 1996.
Mr. Fuller was an Executive Vice President and Chief Administration Officer of
AMRES

44
<PAGE> 49

Mortgage from 1985 to 1994 and Senior Vice President from 1983 to 1985. In these
capacities, at various times, Mr. Fuller was responsible for, among other
things, Mortgage Loan originations and servicing for AMRES Mortgage. Mr. Fuller
has worked in the mortgage banking industry continuously since 1975. Mr. Fuller
currently serves as President of Friends of Santa Fe Christian Schools.

MARK A. CONGER has served as Senior Vice President and Chief Financial
Officer of the Company since its formation in February 1997 and recently became
an Executive Vice President. From 1994 through 1997 Mr. Conger was the sole
proprietor and manager of an unrelated business. Mr. Conger was a Senior Vice
President, Finance, of AMRES Mortgage from 1992 to 1994 responsible for the
areas of accounting, treasury and corporate planning. He was a Vice President of
AMRES Mortgage from 1987 to 1992 responsible for corporate planning and human
resources. Prior to joining AMRES Mortgage, Mr. Conger was an Assistant Vice
President, Accounting, for Imperial Savings Association from 1985 to 1987 and an
auditor for KPMG Peat Marwick LLP from 1981 to 1985. Mr. Conger has worked in
the mortgage banking industry for ten years. Mr. Conger received a Bachelor of
Science degree from the University of Missouri in 1981 and is a Certified Public
Accountant.

JOHN DAHL has served as Executive Vice President, Capital Markets and Loan
Production, of the Company since October 1997. Prior to joining the Company, Mr.
Dahl served as Managing Director of First Union Capital Markets Corporation from
1995 to 1997, responsible for marketing capital markets products and services to
corporate customers and prospects in diversified industries on the west coast,
and the speciality finance industry on a national basis. Prior to joining First
Union, Mr. Dahl served as Managing Director of First Chicago from 1988 to 1995,
responsible for marketing financial and operating services to corporate
customers and prospects in the mortgage banking industry. Mr. Dahl has worked in
the real estate and financial services industries continuously since 1976. Mr.
Dahl received his Bachelor of Science degree in 1976 from Northern Illinois
University and his Masters in Business Administration degree from San Francisco
State University in 1979.

ROLLIE O. LYNN has served as Senior Vice President, Capital Markets,
responsible for the areas of portfolio management for the Company since its
formation in February 1997. Prior to joining the Company, Mr. Lynn served as
Vice President, Capital Markets, of Long Beach Mortgage Company responsible for
managing, hedging and trading the firm's sub-prime residential Mortgage Loans.
Prior to joining Long Beach Mortgage, Mr. Lynn served as Vice President,
Secondary Marketing, of AMRES Mortgage from 1991 to 1994, as Vice President,
Capital Markets, of Imperial Savings from 1988 to 1992, and as Vice President of
Great American First Savings Bank of San Diego from 1985 to 1988. Mr. Lynn has
worked in the mortgage banking business continuously since 1977. Mr. Lynn
received two Bachelor of Arts degrees in 1976 from California State University
at Chico. Mr. Lynn is a licensed real estate broker in the State of California.

LISA S. FAULK has served as Senior Vice President, Operations, of the
Company since October 1997. Prior to joining the Company, Ms. Faulk served as
Vice President, Conduit Underwriting, for Advanta Mortgage Corporation where she
managed the Conduit Division's underwriting, funding and processing functions in
the non-conforming credit markets. Ms. Faulk was Vice President, Manager Credit
Risk Review, for Homefed Bank, Federal Savings Bank from 1984 to 1993.

DAVID E. DE LEEUW has served as a Director of the Company since its
formation in February 1997. Mr. De Leeuw is a co-founder and a Managing Partner
of McCown De Leeuw & Co., a private equity firm that buys and builds
middle-market companies in partnership with management teams. Prior to
co-founding McCown De Leeuw & Co. in 1984, Mr. De Leeuw was employed by Citibank
as Vice President and Deputy Head of the Merger and Acquisition Department and
as Head of the Leveraged Acquisition Unit. Mr. De Leeuw currently serves as a
Vice Chairman of Vans, Inc. and a director of Nimbus CD International, Inc. and
several other private companies.

GEORGE E. MCCOWN has served as a Director of the Company since its
formation in February 1997. Mr. McCown is a co-founder and a Managing Partner of
McCown De Leeuw & Co. Prior to co-founding McCown De Leeuw & Co. in 1984, Mr.
McCown spent 18 years at Boise-Cascade Corporation in a series of general
management positions in the paper, packaging, building materials and real estate
divisions.

45
<PAGE> 50

Mr. McCown is Chairman of BMC West Corporation, Vice Chairman of Vans, Inc. and
a director of Nimbus CD International, Inc., FiberMark, Inc. and several other
private companies.

In addition to the directors of the Company set forth above, the following
individuals have been elected directors of the Company to become effective upon
the closing of this Offering:

H. JAMES BROWN, PH.D. has served since 1996, as the President and Chief
Executive Officer of the Lincoln Institute of Land Policy, an educational
institution formed to study and teach land policy, including land economics and
land taxation. Prior to 1996, Dr. Brown was a professor at the Kennedy School of
Government at Harvard University from 1970 to 1996. During his tenure at Harvard
University, Dr. Brown served as a director of the Joint Center Housing Studies,
Chairman of the City and Regional Planning Program and as Director of the State,
Local and Intergovernmental Center at Harvard University and MIT/Harvard
University Joint Center for Urban Studies. In addition, Dr. Brown has served as
a Managing Partner of Strategic Property Investments, Inc., a company
specializing in real estate asset management from 1988 to 1991. Dr. Brown also
serves as a director of BMC West Corporation and Pelican Companies, Inc.,
distributors and retailers of building materials.

RAY MCKEWON is a co-founder and Executive Vice President of Accredited Home
Lenders, a mortgage banking firm founded in 1990 which specializes in sub-prime
credit. From 1980 to 1990, Mr. McKewon was a managing partner of the Enterprise
Management Company, a venture capital firm that he co-founded and which provided
capital to companies including Dura Pharmaceuticals, Cytotech (sold to Quidel),
Impulse Enterprise, McKewon & Timmins (sold to First Affiliated), Garden Fresh
Restaurants, Intelligent Images (merged into and renamed Darox) and Sunward
Technology (merged into Read-Rite).

RICHARD T. PRATT, PH.D. currently serves as Chairman of Richard T. Pratt
Associates, a position he has held since 1992, performing consulting activities,
including strategic studies for the Federal Home Loan Mortgage Corporation,
on-site consulting for the Housing Section Perform Project in Russia and
Kazakhstan for the U.S. Agency for International Development and various
strategic consultations for private sector institutions. Dr. Pratt is also a
Professor of Finance at the David Eccles School of Business at the University of
Utah, a position he has held since 1966. From 1983 to 1991, Dr. Pratt served as
Chairman of Merrill Lynch Mortgage, Inc., a subsidiary of Merrill Lynch &
Company. From 1991 to 1994, Dr. Pratt served as Managing Director of the
Financial Institutions Group of Merrill Lynch. Dr. Pratt also serves as a member
of the Board of Directors of Avigen, a development level gene therapy company.
Dr. Pratt was Chairman of the Federal Home Loan Mortgage Corporation from 1981
to 1983, and served as Chairman of the Federal Savings and Loan Insurance
Corporation from 1981 to 1983.

MARK J. RIEDY, PH.D. is currently employed as an Ernest W. Hahn Professor
of Real Estate Finance at the University of San Diego. In such capacity, he
teaches courses in real estate finance. Prior to his employment at the
University, Dr. Riedy served as President and Chief Executive Officer of the
National Council of Community Bankers in Washington, D.C. from 1988 to 1992.
From 1987 to 1988, Dr. Riedy served as President and Chief Operating Officer of
the J. E. Robert Companies. Dr. Riedy was President, Chief Operating Officer and
Director of the Federal National Mortgage Association from 1985 to 1986.

TERM OF OFFICE

Effective upon the closing of the Offering, the Board of Directors of the
Company will be divided into three classes. Each class of directors will consist
of two or three directors who will serve for a one, two or three year period
until the annual meeting of stockholders or until their successors are elected
and qualified.

46
<PAGE> 51

Thereafter, directors will serve staggered three year terms. The initial
classification of the directors is as follows:

<TABLE>
<CAPTION>
TERM OF
DIRECTOR CLASS OFFICE
-------------------------------------------- ----- -------
<S> <C> <C>
Dr. Brown................................... I 1998
Mr. McKewon................................. I 1998
Mr. De Leeuw................................ II 1999
Dr. Pratt................................... II 1999
Mr. Robbins................................. III 2000
Mr. Fuller.................................. III 2000
Dr. Riedy................................... III 2000
</TABLE>

Officers are elected by and serve at the discretion of the Board of
Directors.

BOARD COMMITTEES

The Board of Directors has recently appointed a compensation committee (the
"Compensation Committee") which will make recommendations to the Board of
Directors concerning salaries and incentive compensation for officers and
employees of the Company. Upon the closing of this Offering, the Compensation
Committee will consist of Mr. De Leeuw, Mr. McKewon and Dr. Riedy. The Board of
Directors also has appointed an audit committee (the "Audit Committee") which
will review the results and scope of the audit and accounting related issues.
Upon the closing of this Offering, the Audit Committee will consist of Dr.
Brown, Mr. De Leeuw and Dr. Pratt.

ACTION BY INDEPENDENT DIRECTORS

The Company's Bylaws require that a majority of the members of its Board of
Directors must be independent directors. The Bylaws provide that an "independent
director" is a director of the Company who is not an officer or employee of the
Company or any subsidiary or affiliate thereof. In addition to approval by the
Board of Directors, the following actions require approval by a majority of the
independent directors:

- termination of the Management Contract between the Company and the
Manager;

- revisions to the Company's investment policies; and

- amendment of the Company's Bylaws.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS

To date, the Company has had no compensation committee or other committee
performing an equivalent function. No officer or employee of the Company has
participated in deliberations by the Company's Board of Directors concerning
executive officer compensation, except that Mr. Robbins and Mr. Fuller
participated in the determination of Mr. Dahl's compensation at the time he was
hired by the Company.

After the closing of this Offering, Mr. McKewon will be a director of the
Company and a member of the Compensation Committee. Mr. McKewon is an executive
officer and director of Accredited Home Lenders. Mr. Robbins serves as a
director of Accredited Home Lenders. The Company may acquire Mortgage Loans
pursuant to the Direct Purchase Program from Accredited Home Lenders.

DIRECTOR COMPENSATION

Each independent director of the Company will be paid annual compensation
of $15,000 with an additional $1,000 paid for attendance of a regularly
scheduled meeting and $500 for attendance of a special or committee meeting. All
directors will be reimbursed for any expenses related to attendance at meetings
of the Board of Directors or committees of the Board of Directors. In addition
to cash compensation, it is currently anticipated that each non-employee
director of the Company, except Mr. De Leeuw, will receive an initial

47
<PAGE> 52

grant of options to purchase 7,500 shares of the Common Stock of the Company at
fair market value which will vest over a three year period (one-third every
twelve months). Thereafter, following the annual meeting of stockholders, the
Company anticipates making annual grants to each non-employee director, except
Mr. De Leeuw, of options to purchase 2,500 shares of the Company's Common Stock
which will vest after one year.

LIMITATION OF LIABILITY AND INDEMNIFICATION

As permitted by the MGCL, the Company's Charter obligates the Company to
indemnify its present and former directors and officers and to pay or reimburse
reasonable expenses for such individuals in advance of the final disposition of
a proceeding to the maximum extent permitted from time to time by Maryland law.
The MGCL permits a corporation to indemnify its present and former directors and
officers, among others, against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by them in connection with any proceeding
to which they may be made a party by reason of their service in those or other
capacities, unless it is established that (a) the act or omission of the
director or officer was material to the matter giving rise to such proceeding
and was committed in bad faith or was the result of active and deliberate
dishonesty, (b) the director or officer actually received an improper personal
benefit in money, property or services, or (c) in the case of any criminal
proceeding, the director or officer had reasonable cause to believe that the act
or omission was unlawful. The Bylaws implement the provisions relating to
indemnification contained in the Company's Charter. Maryland law permits the
charter of a Maryland corporation to include a provision limiting the liability
of its directors and officers to the corporation and its stockholders for money
damages, except to the extent that (i) the person actually received an improper
benefit or profit in money, property or services, or (ii) a judgment or other
final adjudication is entered in a proceeding based on a finding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's Charter contains a provision providing for elimination
of the liability of its directors or officers to the Company or its stockholders
for money damages to the maximum extent permitted by Maryland law from time to
time. In addition, the Underwriters are indemnified against certain liabilities
by the Company under the Underwriting Agreement relating to the Offering. See
"Underwriting."

The Company will maintain officers' and directors' insurance for the
benefit of its officers and directors. The Company intends to enter into
indemnity agreements with each of its officers and directors pursuant to which
the Company will indemnify its officers and directors to the fullest extent
allowed by law.

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<PAGE> 53

EXECUTIVE COMPENSATION

None of the Company's executive officers received compensation from the
Company or any of its affiliates in 1996. The following table sets forth
information with respect to the estimated compensation for 1997 for the five
executive officers of the Company.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
1997 LONG-TERM
COMPENSATION
1997 ANNUAL AWARDS
COMPENSATION --------------
(ESTIMATED) SECURITIES
------------------------- UNDERLYING
NAME AND PRINCIPAL POSITION SALARY(1) BONUS OPTIONS
------------------------------------ --------- ----------- --------------
<S> <C> <C> <C>
John M. Robbins..................... $ 266,250 (2) 220,000(3)
CEO and Chairman of the Board of
Directors
Jay M. Fuller....................... 221,875 (2) 220,000(3)
President and Chief Operating
Officer
Mark A. Conger...................... 133,125 (2) 30,400(3)
Executive Vice President and Chief
Financial Officer
John Dahl........................... 43,750 $100,000(4) 75,000(3)
Executive Vice President, Capital
Markets and Loan Production
Rollie O. Lynn...................... 88,750 (2) 26,400(3)
Senior Vice President, Capital
Markets
</TABLE>

- ---------------

(1) Includes cash compensation paid or estimated to be paid to employees of the
Company and the Manager. Based on amounts actually paid from February 11,
1997 through July 31, 1997 and estimated payments from August 1, 1997
through December 31, 1997 based on current salary levels. All salary amounts
are currently paid by the Manager. After the closing of this Offering, all
base salary amounts will be paid directly by the Company and reimbursed to
the Company by the Manager. See "The Manager."

(2) Bonuses during years 1997 and 1998 will be paid solely in the discretion of
the Board of Directors of the Company. Thereafter, bonuses will be paid as a
percentage of salary if certain financial objectives agreed upon by
management of the Company and the Board of Directors are achieved. See
"-- Employment Contracts and Termination of Employment and Change in Control
Arrangements." All bonus amounts are to be paid by the Manager. The Company
currently estimates that each executive officer may be paid a bonus in 1997
equal to between 75% and 100% of his annualized base salary.

(3) Includes options to purchase 80,000, 80,000, 16,000, 75,000 and 14,400
shares of Common Stock to be issued to Mr. Robbins, Mr. Fuller, Mr. Conger,
Mr. Dahl and Mr. Lynn, respectively, at the effectiveness of this Offering
pursuant to their employment agreements. See "-- Employment Contracts and
Termination of Employment and Change of Control Arrangements."

(4) At the commencement of his employment, Mr. Dahl received a $100,000 note
from the Manager representing a signing bonus and his bonus for 1997.

49
<PAGE> 54

OPTION GRANTS

None of the executive officers of the Company were granted options to
purchase the Company's Common Stock in 1996. The following table sets forth
information concerning stock options granted or to be granted to the executive
officers in 1997. Each of the stock options is exercisable to purchase Common
Stock of the Company. None of the options has been exercised.

OPTION/SAR GRANTS IN 1997

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS IN 1997 POTENTIAL REALIZABLE
---------------------------------------------------- VALUE AT ASSUMED
NUMBER OF % OF TOTAL EXERCISE ANNUAL RATES OF STOCK
SECURITIES OPTIONS/SARS OR PRICE APPRECIATION FOR
UNDERLYING GRANTED TO BASE OPTION TERM
OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION -----------------------
NAME GRANTED (#)(1) 1997 (2) ($/SH) DATE 5%($)(3) 10%($)(3)
- --------------------------------- -------------- ------------ ------ --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
John M. Robbins.................. 140,000(4) 21.4% $12.50 2/11/07 $1,100,568 $2,789,052
80,000(5) 12.3 15.00(6) (7) 754,672 1,912,488
Jay M. Fuller.................... 140,000(4) 21.4 12.50 2/11/07 1,100,568 2,789,052
80,000(5) 12.3 15.00(6) (7) 754,672 1,912,488
Mark A. Conger................... 14,400(8) 2.2 12.50 2/11/07 113,201 286,874
16,000(5) 2.5 15.00(6) (7) 150,934 382,498
John Dahl........................ 75,000(5) 11.5 15.00(6) (7) 707,505 1,792,958
Rollie O. Lynn................... 12,000(8) 1.8 12.50 2/11/07 94,334 239,062
14,400(5) 2.2 15.00(6) (7) 135,841 344,248
</TABLE>

- ---------------

(1) Options issued by the Company to date and to be issued at the effectiveness
of this Offering provide for acceleration of vesting at such time as the
Company receives cumulative gross proceeds from all public or private
offerings of at least $150,000,000. In addition, the options accelerate and
become fully vested upon the consummation of a transaction resulting in a
change of control of the Company.

(2) Based on currently outstanding options and options to be issued upon the
closing of this Offering. See "-- Employment Contracts and Termination of
Employment and Change in Control Arrangements."

(3) Amounts represent hypothetical gains that could be achieved for the
respective options if exercised at the end of the option term. The assumed
5% and 10% rates of stock price appreciation are mandated by rules of the
Securities and Exchange Commission and do not represent the Company's
estimate or projection of the future price of the Common Stock. The
potential realizable value set forth in the table is based on the fair
market value of the Common Stock on the date of grant, as determined by the
Board of Directors.

(4) Includes options to purchase 140,000 shares of Common Stock and SAR's with
respect to an additional 140,000 shares of Common Stock granted in tandem
with such options. The SARs are for 35% of the difference between the fair
market value of the Common Stock at the time the related option is exercised
and the exercise price, up to a maximum of $20 per share. Options and tandem
SARs are each vested and exercisable as to 20% of the shares of Common Stock
with an additional 20% to vest and become exercisable on February 11 of
1998, 1999, 2000 and 2001.

(5) Options granted upon the effectiveness of this Offering. The exercise price
equals the initial public offering price. These options will vest 20% on the
closing of this Offering with an additional 20% on each anniversary of the
closing of this Offering for four years.

(6) Based on the initial public offering price of $15.00.

(7) Options will expire 10 years after the closing of this Offering.

(8) Options to purchase Common Stock of the Company are vested and exercisable
as to 20% of the shares of Common Stock with an additional 20% to vest and
become exercisable on each of February 11, 1998, 1999, 2000 and 2001.

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<PAGE> 55

1997 STOCK INCENTIVE PLAN

The Company's 1997 Stock Incentive Plan (the "Incentive Plan") provides for
the grant of incentive stock options, nonqualified stock options and stock
appreciation rights ("SARs"). The Incentive Plan was adopted on February 11,
1997 (the "Effective Date") and a total of 315,200 shares of Common Stock have
been reserved for issuance under the Incentive Plan. As of August 1, 1997, a
total of 315,200 shares of Common Stock were subject to outstanding options
under the Incentive Plan at an exercise price of $12.50 per share of Common
Stock. In addition, SARs with respect to an additional 280,000 shares were
outstanding at an exercise price of $12.50 per share of Common Stock. The SARs
were granted in tandem with options and provide the participant with the right
to receive payment equal to 35% of the difference between the fair market value
of a share of Common Stock on the date of the option exercise and the fair
market value of a share of Common Stock on the date of grant, up to a maximum of
$20 per share. Payment upon the exercise of the SAR may be made in cash, shares
of Common Stock, or any combination thereof. The Company does not intend to
issue any additional options or SARs under the Incentive Plan.

1997 STOCK OPTION PLAN

The Board of Directors has reserved a total of 474,800 shares of Common
Stock for issuance under the Company's 1997 Stock Option Plan (the "Option
Plan"). The Option Plan permits the grant of options intended to qualify as
incentive stock options ("ISOs") within the meaning of section 422 of the Code,
as well as nonstatutory stock options. Options to purchase 337,800 shares of
Common Stock were issued upon the effectiveness of this Offering and options to
purchase 137,000 shares of Common Stock will remain available for future grant
under the Option Plan. Options may be granted to employees (including officers
and directors who are also employees), consultants and directors and prospective
employees, consultants, and directors, although only employees (including
officers and directors who are also employees) may receive ISOs. The exercise
price per share of a nonstatutory stock option must equal at least 85% of the
fair market value of a share of Common Stock on the date of grant, and in the
case of an incentive stock option, must be no less than the fair market value of
a share of Common Stock on the date of grant. In addition, the exercise price
for any option granted to an optionee who owns 10% or more of the total combined
voting power of the Company or any parent or subsidiary of the Company must
equal at least 110% of the fair market value of a share of Common Stock on the
date of grant. Generally, options granted under the Option Plan are immediately
exercisable and must be exercised within ten years, and shares subject to an
option generally will vest over four years from the date of grant. In the event
of certain "change in control" transactions involving the Company, shares
subject to options granted under the Option Plan will become fully vested and
exercisable. In addition, the acquiring company may assume or substitute for
such outstanding options.

1997 EMPLOYEE STOCK PURCHASE PLAN

A total of 20,000 shares of Common Stock have been reserved for issuance
under the Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan"),
none of which have yet been issued. The Purchase Plan permits eligible employees
to purchase Common Stock at a discount through accumulated payroll deductions.
Employees (including officers and directors who are also employees) are
generally eligible to participate in the Purchase Plan if they are customarily
employed for more than 20 hours per week and five months per calendar year. The
Purchase Plan is implemented through sequential offering periods, each of which
is approximately six months in duration. However, the initial offering period
under the Purchase Plan will commence on the closing of this Offering and will
end on July 31, 1998. Participants will purchase shares of Common Stock on the
last day of each offering period. The price at which shares are purchased under
the Purchase Plan is equal to 85% of the fair market value of a share of Common
Stock on the first day of the offering period or the last day of the offering
period, whichever is lower. Employees may end their participation in the
Purchase Plan at any time during an offering period and participation ends
automatically upon the participant's termination of employment.

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<PAGE> 56

1997 OUTSIDE DIRECTORS STOCK OPTION PLAN

A total of 60,000 shares of Common Stock have been reserved for issuance
under the Company's 1997 Outside Directors Stock Option Plan (the "Directors
Plan"). Prior to the closing of this Offering, no options have been granted
under the Directors Plan. The Directors Plan provides for the automatic grant of
nonstatutory stock options to directors of the Company who are not employees of
the Company or any parent or subsidiary of the Company or McCown De Leeuw & Co.
("Outside Directors"). On the closing of this Offering, each Outside Director
automatically will be granted an option to purchase 7,500 shares of Common Stock
under the Directors Plan, and thereafter, each new Outside Director elected
after the closing of this Offering automatically will be granted, on the date of
his or her initial election, an option to purchase 7,500 shares of Common Stock
("initial options"). Shares of Common Stock subject to initial options will vest
in three equal annual increments following the date of grant. In addition, each
Outside Director, other than an Outside Director who has served on the Board of
Directors for less than six months, will thereafter be granted automatically an
option to purchase 2,500 shares of Common Stock at each annual meeting of the
stockholders, provided the Outside Director continues to serve in such capacity
following the annual meeting ("annual options"). Shares of Common Stock subject
to annual options will become fully vested one year after the date of grant. The
exercise price per share of Common Stock for options granted under the Directors
Plan will be equal to the fair market value of a share of Common Stock on the
date of grant. Options granted under the Directors Plan must be exercised within
ten years from the date of grant. In the event of certain "change in control"
transactions involving the Company, shares subject to options granted under the
Directors Plan will become fully vested and exercisable. In addition, the
acquiring company may assume or substitute for such outstanding options.

EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL
ARRANGEMENTS

The Manager has entered into Employment and Non-Competition Agreements with
Mr. Robbins and Mr. Fuller effective as of February 11, 1997 (the "Employment
Agreements"). The Employment Agreements are for a term of five years, commencing
on February 11, 1997 and provide for a minimum monthly base salary of not less
than $25,000 in the case of Mr. Robbins and $20,833 in the case of Mr. Fuller.
The Employment Agreements also provide for one year's salary to be paid upon
termination of either of such employees without cause. Bonus payments in 1997
and 1998 will be at the discretion of the Board of Directors of the Manager.
Subsequent to 1998, the Employment Agreements provide for payment of a bonus of
up to 100% base salary if certain financial targets and objectives are achieved.
Upon the effectiveness of this Offering, each of Messrs. Robbins and Fuller were
granted options to purchase 80,000 shares of the Company's Common Stock at an
exercise price equal to the initial public offering price.

Mr. Robbins and Mr. Fuller each purchased stock of the Manager which is
subject to repurchase by the Manager in the event the executive officer
terminates his employment with the Company and the Manager. See "Certain
Transactions."

The Manager has also entered into letter agreements with Mr. Conger, Mr.
Dahl and Mr. Lynn which provide for base compensation of $150,000, $175,000 and
$100,000 per year, respectively. In addition, the agreements provide for bonus
payments after 1998 of up to 75%, 100% and 75%, respectively, of the employee's
base salary if certain financial targets and objectives are achieved. Mr. Conger
and Mr. Lynn were each issued Contingent Warrants to purchase up to 34,299
shares of the common stock of the Manager at an exercise price of $0.01 per
share (the "Contingent Warrants"). The Contingent Warrants expire on February
11, 2007 and are exercisable only to the extent that certain letters of credit
which collateralize debt of the Manager are reduced from their current principal
amounts. Mr. Conger and Mr. Lynn were also issued percentage interests in
Holdings initially equal to 1.5% each. These interests may also vary based upon
the extent to which such letters of credit continue to be outstanding. See
"Certain Transactions." Upon the effectiveness of this Offering, Mr. Conger, Mr.
Dahl, and Mr. Lynn were granted options to purchase 16,000 shares, 75,000 shares
and 14,400 shares of the Company's Common Stock, respectively, at an exercise
price equal to the initial public offering price.

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<PAGE> 57

All options and SARs granted to date and granted at the effectiveness of
this Offering pursuant to the Incentive Plan and the Option Plan contain
provisions pursuant to which unvested portions of outstanding options become
fully vested upon a change of control in the Company, as defined under the
relevant plan.

Each of the officers of the Manager has modified his Employment Agreement
with the Manager to allow each such person to become an employee of the Company
upon the closing of this Offering. The Manager will reimburse the Company on a
dollar for dollar basis for the actual cost to the Company of paying the base
salaries of such officers. See "The Manager -- The Management Agreement."

FIDUCIARY OBLIGATIONS

Generally, under applicable state corporate law, a director of a company is
required to first offer to the company corporate opportunities learned of solely
as a result of his or her service as a member of the board of directors.
Maryland law provides that, in order for a contract or other transaction between
a corporation and any of its directors or in which a director has a material
financial interest not to be void or voidable, (i) the contract or transaction
must be fair and reasonable to the corporation or (ii) the fact of such interest
must be disclosed or known to the board or committee that authorizes, approves
or ratifies the contract or transaction and such authorization, approval or
ratification must be by a vote of the majority of disinterested directors.

The Company's policy is that the approval of the Board of Directors (with
any interested director abstaining) is required for any director, officer,
securityholder or affiliate of the Company (i) to realize for their own account
corporate opportunity learned of solely as a result of their service to or
representation of the Company or (ii) to have any direct or indirect pecuniary
interest in any investment to be acquired or disposed of by the Company or in
any transaction to which the Company is a party or has an interest.

BENEFITS OF OFFERING TO MANAGEMENT

Although no additional fees will be payable to the Manager solely as a
result of this Offering, investment of the net proceeds of this Offering will
result in an increase in the Company's Mortgage Assets and thus an increase in
the management fees to be paid to the Manager. At the discretion of the
Manager's board of directors, the Manager may elect to pay a portion of such
fees to its executive officers as a bonus. The executive officers may also
benefit in a number of other ways from this Offering. First, upon the
effectiveness of this Offering, options to purchase an aggregate of 315,400
shares of Common Stock of the Company were issued to the executive officers at
an exercise price equal to the initial public offering price. Second, upon the
closing of this Offering, John Robbins and Jay Fuller will realize net increases
in the value of certain of their shares of Common Stock of the Company of
$20,000 and $15,000, respectively, and net increases in the implied value of
their vested options of $70,000 each. Third, options held by the executive
officers to purchase an aggregate of 621,800 shares of the Company's Common
Stock will vest in full in the event the Company completes additional public or
private offerings which generate proceeds that, when combined with the net
proceeds of this Offering, exceed $150 million. See "-- Option Grants" and
"Conflicts of Interest."

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<PAGE> 58

THE MANAGER

The Manager was created for the purpose of managing the day-to-day
operations of the Company, subject to direction by the Company's Board of
Directors. The Company believes that its use of an external manager has enabled
and will continue to enable the Company to avoid certain of the costs associated
with beginning its operations and establishing an infrastructure. In particular,
the Company believes that the Manager may incur significant up-front costs with
respect to the development of the Direct Purchase Program. Because the Company
pays management and incentive fees to the Manager based solely upon the
principal amounts of Mortgage Assets held by the Company and the Company's net
income, the Company's net income will not be directly affected by the employee
and other infrastructure expenses incurred by the Manager. Further, because the
Manager's incentive compensation is tied to return on equity, in periods of low
earnings, the Manager's incentive compensation will be reduced, thereby lowering
the Company's operating expenses. See "Management and Termination Fees."

The Manager and the Company were financed by McCown De Leeuw & Co.,
TCW/Crescent Mezzanine, L.L.C., certain of their respective affiliates and
members of the management team of the Company. The Manager and its affiliates
own 1,614,000 shares of the Common Stock of the Company, which will constitute
approximately 20% of the outstanding shares of the Common Stock of the Company
immediately after the closing of this Offering. In addition, David E. De Leeuw
and George E. McCown, the principals of McCown De Leeuw & Co., currently serve
on the Board of Directors of the Company. Mr. De Leeuw will continue as a
director of the Company after the closing of this Offering.

The Manager funded the Company at its formation with a $20 million
investment through an intermediary entity. See "-- Relationship between the
Manager and the Company." Currently, the Manager derives substantially all of
its income from the Company, a majority of which is from dividends and incentive
fees. In addition, the executive officers of the Company are also the executive
officers of the Manager and four of the executive officers beneficially own an
interest in the Manager. See "The Company," "Conflicts of Interest," "Certain
Transactions" and "Principal Stockholders."

The Manager's executive officers have expertise in the acquisition and
management of Mortgage Assets, mortgage finance, asset/liability management and
the management of corporations in the real estate lending business. Each of the
executive officers of the Manager has between 10 and 24 years, and collectively,
have an average of 19 years of experience in the residential mortgage industry.
Four of the executive officers have worked together previously as a management
team. However, the Manager and the executive officers have had no experience in
managing a REIT and limited experience with certain tailored Mortgage Loan
products, and there can be no assurance that the past experience will be
appropriate to the business of the Company. The Manager is currently in the
process of recruiting employees to support the Direct Purchase Program. At the
closing of this Offering, each employee of the Manager will become an employee
of the Company. See "Risk Factors -- Manager's Lack of Prior Experience in
Managing a REIT Could Adversely Affect the Company's Business, Financial
Condition and Results of Operations; Limited Operating History Does Not
Necessarily Predict Future Performance of Company" and "Conflicts of Interest."

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<PAGE> 59

DIRECTORS AND EXECUTIVE OFFICERS OF THE MANAGER

The following table represents certain information concerning the directors
and executive officers of the Manager:

<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------ --- ----------------------------------------------------
<S> <C> <C>
John M. Robbins (1) 50 Chairman of the Board and Chief Executive Officer
Jay M. Fuller (1) 47 President, Chief Operating Officer and Director
Mark A. Conger (1) 38 Executive Vice President and Chief Financial Officer
John Dahl (1) 44 Executive Vice President Capital Markets and Loan
Production
Rollie O. Lynn (1) 43 Senior Vice President, Capital Markets
Lisa S. Faulk (1) 40 Senior Vice President, Operations
David E. De Leeuw (1) 53 Director
George E. McCown (1) 62 Director
Jean-Marc Chapus 38 Director
</TABLE>

- ---------------

(1) See "Management of the Company -- Directors and Executive Officers of the
Company."

JEAN-MARC CHAPUS has served as a Director of the Manager since February
1997. Mr. Chapus is currently Managing Director and Portfolio Manager of Trust
Company of the West, a diversified investment management firm, and President of
TCW/Crescent Mezzanine Partners, L.L.C., a private investment fund. From 1991 to
1995, Mr. Chapus served as a Managing Director and principal of Crescent Capital
Corporation, with primary responsibility for the firm's private lending and
private placement activities. From 1986 to 1991, Mr. Chapus was a First Vice
President at Drexel Burnham Lambert Incorporated in the firm's High Yield and
Corporate Finance Departments. Mr. Chapus is currently a director of Starwood
Lodging Corporation and FirstAmerica Automotive, Inc. Mr. Chapus received his
A.B. degree in Economics from Harvard College in 1981 and his Masters in
Business Administration degree from Harvard Business School in 1986.

THE MANAGEMENT AGREEMENT

Term of the Management Agreement and Termination Fee

The Company has entered into a Management Agreement with the Manager for an
initial term of two years beginning February 11, 1997. The Management Agreement
is renewed automatically for successive one year periods unless a notice of
non-renewal is timely delivered by the Company. The Company may elect to prevent
the automatic renewal of the Management Agreement only by vote of both a
majority of the Board of Directors and a majority of the directors who are not
executive officers or employees of the Company followed by delivery of a written
notice of non-renewal to the Manager at least 60 days prior to the end of the
then-current period of the Management Agreement. The Management Agreement shall
terminate at the expiration of the then-current period in which such notice of
non-renewal is delivered. Upon non-renewal of the Management Agreement without
cause, a termination fee will be payable to the Manager. See "Management and
Termination Fees." In addition, the Company has the right to terminate the
Management Agreement at any time upon the happening of certain specified events,
after notice and an opportunity to cure, including a material breach by the
Manager of any provision contained in the Management Agreement. Upon such a
termination for cause, no termination fee will be payable to the Manager.

Administrative Services Provided by the Manager

The Manager will be responsible for the day-to-day operations of the
Company and will perform such services and activities relating to the assets and
operations of the Company as may be appropriate, including:

(i) serving as the Company's consultant with respect to the
formulation of investment criteria and the preparation of policy
guidelines;

55
<PAGE> 60

(ii) assisting the Company in developing criteria for Mortgage Asset
purchase commitments that are specifically tailored to the Company's long
term investment objectives and making available to the Company its
knowledge and experience with respect to Mortgage Loan underwriting
criteria;

(iii) representing the Company in connection with the purchase of, and
commitment to purchase, Mortgage Assets, including the formation of
Mortgage Asset purchase commitment criteria;

(iv) arranging for the issuance of Mortgage Securities from pools of
Mortgage Loans and providing the Company with supporting services in
connection with the creation of Mortgage Securities;

(v) furnishing reports and statistical and economic research to the
Company regarding the Company's activities and the performance of the
Manager;

(vi) monitoring and providing to the Board of Directors on an ongoing
basis price information and other data, which price information and other
data shall be obtained from certain nationally recognized dealers and other
entities that maintain markets in Mortgage Assets as selected by the Board
of Directors from time to time, and providing advice to the Board of
Directors to aid the Board of Directors in the selection of such dealers
and other entities;

(vii) administering the day-to-day operations of the Company and
performing and supervising the performance of such other administrative
functions necessary in the management of the Company as may be agreed upon
by the Manager and the Board of Directors, including the collection of
revenues and the payment of the Company's expenses, debts and obligations
and maintenance of appropriate computer services to perform such
administrative functions;

(viii) designating a servicer and/or subservicer for those Mortgage
Loans sold to the Company by originators that have elected not to service
such Mortgage Loans and arranging for the monitoring and administering of
such servicer and subservicer;

(ix) counseling the Company in connection with policy decisions to be
made by the Board of Directors;

(x) evaluating and recommending hedging strategies to the Board of
Directors and, upon approval by the Board of Directors, facilitating the
implementation and monitoring the performance of these strategies;

(xi) supervising compliance with the REIT Provisions of the Code and
Investment Company Act status, including setting up a system to monitor
hedging activities on a periodic basis for such compliance;

(xii) establishing quality control procedures for the Mortgage Assets
of the Company, including audits of Mortgage Loan underwriting files and
the hiring of any agents with such particular knowledge and expertise as
may be appropriate to perform any such quality control procedures, and
administering, performing and supervising the performance of the quality
control procedures of the Company and performing and supervising the
performance of such other functions related thereto necessary or advisable
to assist in the performance of such procedures and the attainment of the
purposes thereof;

(xiii) upon request by and in accordance with the directions of the
Board of Directors, investing or reinvesting any money of the Company;

(xiv) conducting, or causing to be conducted, a legal document review
of each Mortgage Loan acquired to verify the accuracy and completeness of
the information contained in the Mortgage Loans, security instruments and
other pertinent documents in the mortgage file;

(xv) providing the Company with data processing, legal and
administrative services to the extent required to implement the business
strategy of the Company;

(xvi) providing all actions necessary for compliance by the Company
with all federal, state and local regulatory requirements applicable to the
Company in respect of its business activities, including preparing or
causing to be prepared all financial statements required under applicable
regulations and

56
<PAGE> 61

contractual undertakings and all reports and documents, if any, required
under the Securities Exchange Act of 1934, as amended;

(xvii) providing all actions necessary to enable the Company to make
required federal, state and local tax filings and reports and to generally
enable the Company to maintain its status as a REIT, including soliciting
stockholders for required information to the extent provided in the REIT
Provisions of the Code;

(xviii) communicating on behalf of the Company with the holders of the
equity and debt securities of the Company as required to satisfy the
reporting and other requirements of any governmental bodies or agencies and
to maintain effective relations with such holders; and

(xix) performing such other services as may be required from time to
time for management and other activities relating to the assets of the
Company as the Board of Directors shall reasonably request or the Manager
shall deem appropriate under the particular circumstances.

Except in certain circumstances, the Manager may not assign its rights and
duties under the Management Agreement, in whole or in part, without the written
consent of the Company and the consent of a majority of the Company's
independent directors who are not affiliated with the Manager.

Servicing of the Mortgage Loans

The Company expects to acquire certain of its Mortgage Loans on a servicing
released basis and to act as the servicer of such Mortgage Loans while they are
in the Company's Mortgage Asset portfolio. The Company will contract with a
subservicer for a fixed dollar fee per Mortgage Loan per year or a percentage of
the outstanding mortgage balance and the right to hold escrow account balances
and retain certain ancillary charges. The Manager will monitor the servicing of
the Mortgage Loans. Such monitoring will include, but not be limited to, the
following: (i) serving as the Company's consultant with respect to the servicing
of Mortgage Loans; (ii) collection of information and submission of reports
pertaining to the Mortgage Loans and to moneys remitted to the Manager or the
Company by any servicer; (iii) periodic review and evaluation of the performance
of each servicer to determine its compliance with the terms and conditions of
the applicable subservicing or servicing agreement and, if deemed appropriate,
recommending to the Company the termination of such agreement; (iv) acting as a
liaison between servicers and the Company and working with servicers to the
extent necessary to improve their servicing performance; (v) review of and
recommendations as to fire losses, easement problems and condemnation,
delinquency and foreclosure procedures with regard to the Mortgage Loans; (vi)
review of servicer's delinquency, foreclosure and other reports on Mortgage
Loans; (vii) supervising claims filed under any mortgage insurance policies; and
(viii) enforcing the obligation of any servicer to repurchase Mortgage Loans
from the Company. The Manager may enter into subcontracts with other parties,
including its affiliates, to provide any such services for the Manager.

Limits of Responsibility

Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Company's Board of Directors in
following or declining to follow its advice or recommendations. The Manager, its
directors, officers, stockholders and employees will not be liable to the
Company, any issuer of Mortgage Securities, any subsidiary of the Company, the
Company's independent directors, the Company's stockholders or any subsidiary's
stockholders for acts performed in accordance with and pursuant to the
Management Agreement, except by reason of acts or omissions constituting bad
faith, willful misconduct, gross negligence or reckless disregard of their
duties under the Management Agreement. The Manager is a newly formed company and
does not have significant assets other than its interest in the Management
Agreement. Consequently, there can be no assurance that the Company would be
able to recover any damages for claims it may have against the Manager. The
Company has agreed to indemnify the Manager, and its respective directors,
officers, stockholders and employees with respect to all expenses, losses,
damages, liabilities, demands, charges and claims arising from any acts or
omissions of the Manager made in good faith in the performance of its duties
under the Management Agreement and not constituting bad faith, willful
misconduct, gross negligence or

57
<PAGE> 62

reckless disregard of its duties. The Management Agreement does not limit or
restrict the right of the Manager or any of its officers, directors, employees
or affiliates to engage in any business or to render services of any kind to any
other person, including the purchase of, or rendering advice to others
purchasing Mortgage Assets which meet the Company's policies and criteria,
except that the Manager and its officers, directors or employees will not be
permitted to provide for any such services to any residential mortgage REIT,
other than the Company or another REIT sponsored by the Manager or its
affiliates, which has operating policies and strategies different in one or more
material respects from those of the Company, as confirmed by a majority of the
independent directors of the Company. See "Risk Factors -- The Company has
Significant Conflicts with, and Is Dependent on, an Affiliate of the Executive
Officers of the Company."

RELATIONSHIP BETWEEN THE MANAGER AND THE COMPANY

In addition to the Management Agreement between the Manager and the
Company, the Manager also has limited rights in the shares of the Company's
Common Stock held by Holdings, an intermediate holding company. The Manager
contributed $20 million in 1997 to Holdings which used the funds to acquire the
shares of the Company's Common Stock. In exchange for its contribution to
Holdings, the Manager received a senior right to receive distributions equal to
5% per quarter of the capital contributed by the Manager, compounded quarterly
to the extent unpaid. After payment of the preference amount in full, the
Manager has a right to receive approximately 50% of any remaining distributions
in repayment of its capital contribution. The Manager has also been appointed to
oversee the day-to-day operations of Holdings. However, after payment in full of
its preference amount and return of its capital contribution, the Manager will
have no further rights to distributions from Holdings. Holdings' sole asset is
its shares of the Company's Common Stock and its sole source of income is
dividends declared by the Company. See "The Company."

MANAGEMENT AND TERMINATION FEES

MANAGEMENT FEES

The Manager will receive an annual base management fee payable monthly in
arrears of an amount representing the monthly portion of the per annum
percentage of "gross mortgage assets" of the Company and its subsidiaries. These
fees shall be applicable during the entire operational stage of the Company's
business. The Company will pay to the Manager the following management fees and
incentive compensation:

- 1/8 of 1% per year, to be paid monthly (the "Agency Percentage"), of the
principal amount of Agency Securities;

- 3/8 of 1% per year, to be paid monthly (the "Non-Agency Percentage"), of
the principal amount of all other Mortgage Assets; and

- 25% of the amount by which the Company's net income (calculated prior to
deduction of this incentive compensation fee) exceeds the annualized
return on equity equal to the average Ten Year U.S. Treasury Rate plus
2%.

The term "gross mortgage assets" means for any month the aggregate book
value of the consolidated Mortgage Assets of the Company and its subsidiaries,
before allowances for depreciation or bad debts or other similar noncash
allowances, computed at the end of such month prior to any dividend distribution
made during each month.

The incentive compensation calculation and payment will be made quarterly
in arrears. The term "Return on Equity" is calculated for any quarter by
dividing the Company's Net Income for the quarter by its Average Net Worth for
the quarter. For such calculations, the "Net Income" of the Company means the
net income of the Company determined in accordance with GAAP before the
Manager's incentive compensation, the deduction for dividends paid and net
operating loss deductions arising from losses in prior periods. A deduction for
the Company's interest expenses for borrowed money is taken when calculating Net
Income. "Average Net Worth" for any period means (i) $20,165,000 plus (ii) the
arithmetic average of the sum of the gross proceeds from any offering of its
equity securities by the Company, before deducting any underwriting

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<PAGE> 63

discount and commissions and other expenses and costs relating to the offering,
plus the Company's retained earnings (without taking into account any losses
incurred in prior periods and excluding amounts reflecting taxable income to be
distributed as dividends and amounts reflecting valuation allowance adjustments)
computed by taking the daily average of such values during such period. The
definition "Return on Equity" is used only for purposes of calculating the
incentive compensation payable, and is not related to the actual distributions
received by stockholders. The incentive compensation payments to the Manager
will be made before any income distributions are made to the stockholders of the
Company.

The Manager's base management fee shall be calculated by the Manager within
15 days after the end of each month, and such calculation shall be promptly
delivered to the Company. The Company is obligated to pay the amount of the
final base management fee in excess of the amount paid to the Manager at the
beginning of the month pursuant to the Manager's good faith estimate within 30
days after the end of each month. The Company shall pay the incentive fee with
respect to each fiscal quarter within 15 days following the delivery to the
Company of the Manager's written statement setting forth the computation of the
incentive fee for such quarter. The Manager shall compute the annual incentive
fee within 45 days after the end of each fiscal year, and any required
adjustments shall be paid by the Company or the Manager within 15 days after the
delivery of the Manager's written computation to the Company.

Set forth below for illustrative purposes only is a breakdown of annual
management fees which might be paid to the Manager under hypothetical
circumstances. For purposes of this illustration, the following is assumed: (i)
that the aggregate principal amount of Mortgage Assets held by the Company
remained static at $1.13 billion for an entire year; (ii) that the relative
allocation of Mortgage Assets for the entire year remained static at 70% and
30%, respectively, for the Agency Percentage and Non-Agency Percentage, and
(iii) the Company's net income (calculated prior to the deduction of the
incentive compensation fee) exceeded by $5,000,000 the annualized Return on
Equity equal to the average Ten Year U.S. Treasury Rate plus 2%.

<TABLE>
<CAPTION>
HYPOTHETICAL ANNUAL MANAGER COMPENSATION
- ----------------------------------------------------------------------
BASE COMPENSATION
- --------------------------------------- INCENTIVE TOTAL
AGENCY NON-AGENCY TOTAL COMPENSATION COMPENSATION
- --------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
$988,750 $1,271,250 $2,260,000 $1,250,000 $3,510,000
</TABLE>

The Company emphasizes that the foregoing information is provided for
illustrative purposes only and that actual compensation could be less or
greater. Significant variables in the determination of actual compensation paid
to the Manager include (i) the time period over which funds are invested in
Mortgage Assets, (ii) the relative allocation of Mortgage Assets between Agency
Securities and all other Mortgage Assets, (iii) the Company's actual net income
which will be affected by (i) and (ii) above plus other factors, such as the
Company's ability to execute its leveraging strategy and interest rate
fluctuations and (iv) fluctuations (positive or negative) in the average Ten
Year U.S. Treasury Rate which may be caused by factors unrelated to the
performance of the Manager. See "Risk Factors" and "Conflicts of Interest."

TERMINATION FEES

The Company may elect to prevent the automatic renewal of the Management
Agreement by vote of both a majority of the Board of Directors and a majority of
the directors who are not executive officers or employees of the Company
followed by delivery of a written notice of non-renewal to the Manager at least
60 days prior to the end of the then-current period of the Management Agreement.
The Management Agreement shall terminate at the expiration of the then-current
period in which such notice of non-renewal is delivered. Upon non-renewal of the
Management Agreement without cause, a termination fee will be payable to the
Manager, in an amount equal to the greater of (i) the fair value of the
Management Agreement as established by an independent appraiser, or (ii) three
times the total of the base and incentive compensation fees paid to the Manager
for the four most recently completed calendar quarters ending on or prior to the
date

59
<PAGE> 64

of termination. In addition, the Company has the right to terminate the
Management Agreement at any time upon the happening of certain specified events,
after notice and an opportunity to cure, including a material breach by the
Manager of any provision contained in the Management Agreement. Upon such a
termination for cause, no termination fee will be payable to the Manager.

For illustrative purposes only, if the Company terminated the Management
Agreement without cause effective immediately following the end of a four
calendar quarter period in which the total compensation paid to the Manager was
$3,510,000, as illustrated above, the minimum termination fee would be
$10,530,000. If the appraised fair value of the Management Agreement were
higher, the termination fee would be equal to the appraised fair value.

The foregoing information is for illustrative purposes only. If the
management fees paid to the Manager for the four calendar quarters prior to
termination of the Management Agreement were higher or lower than $3,510,000,
the minimum fee would be higher or lower, respectively, than $10,530,000. See
"Risk Factors," "-- Management Fees," and "Conflicts of Interest."

EXPENSES

The Company will pay all operating expenses, except those specifically
required to be borne by the Manager under the Management Agreement. The
operating expenses required to be borne by the Manager include the compensation
and other employment costs of the Manager's officers in their capacities as such
and the cost of office space and out-of-pocket costs, equipment and other
personnel required for performance of the Company's day-to-day operations. The
expenses that will be paid by the Company will include issuance and transaction
costs incident to the acquisition, disposition and financing of investments,
regular legal and auditing fees and expenses, the fees and expenses of the
Company's directors, premiums for directors' and officers' liability insurance,
premiums for fidelity and errors and omissions insurance, subservicing expenses,
the costs of printing and mailing proxies and reports to stockholders, and the
fees and expenses of the Company's custodian and transfer agent, if any. The
Company, rather than the Manager, will also be required to pay expenses
associated with litigation and other extraordinary or non-recurring expenses.
Expense reimbursements will be made monthly.

SALARY REIMBURSEMENTS

The Company will employ certain employees of the Manager involved in the
day-to-day operations of the Company, including the Company's executive
officers, so that such employees may maintain certain benefits that are
available only to employees of the Company under the Code. These benefits
include the ability to receive incentive stock options under the 1997 Stock
Option Plan and to participate in the Company's Employee Stock Purchase Plan. In
order to receive the aggregate benefits of the Management Agreement originally
negotiated between the Company and the Manager, the Company will pay the base
salaries of such employees and will be reimbursed monthly by the Manager for all
costs incurred with respect to such payments.

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<PAGE> 65

CERTAIN TRANSACTIONS

DISCUSSION OF SECURITIES PURCHASE AGREEMENT

The following summary of certain terms of the Securities Purchase Agreement
between the Manager and the Company does not purport to be complete and is
subject to and qualified in its entirety by the Securities Purchase Agreement, a
copy of which is filed as an exhibit to the Registration Statement of which this
Prospectus is a part. When particular provisions or terms used in the Securities
Purchase Agreement are referred to, the actual provisions (including definitions
of terms) are incorporated by reference to such agreement.

In connection with the private financings of the Manager and the Company in
February 1997, the Company, the Manager and Holdings entered into a Securities
Purchase Agreement, dated as of February 11, 1997, with the institutional
investors therein named providing for, among other things, the purchase by the
Investors of senior secured notes due February 11, 2002 issued by the Manager.

Covenants

The Securities Purchase Agreement contains various covenants of the Company
and the Manager setting forth requirements respecting financial reporting and
minimum acceptable financial ratio compliance and limitations on operating
activities, among other things, which will apply so long as the Notes remain
outstanding. The following is a general summary of certain covenants affecting
the activities of the Company (as opposed to the Manager).

Limitation on Investments. The Company's investments are generally limited
to adjustable rate Mortgage Assets relating to single-family residential
properties. The Company is permitted, however, to invest up to 5% of the fair
market value of its total Mortgage Assets in any of the following types of
assets; (i) Mortgage Assets relating to multi-family or commercial properties,
(ii) derivatives purchased as investments (rather than for hedging purposes),
(iii) Mortgage Assets having fixed interest rates and (iv) REMIC residual
interests and investments in subsidiaries holding REMIC or other residual
interests.

Limitations on Transactions with Affiliates. Both the Company and the
Manager are generally prohibited from selling assets to or purchasing assets
from any affiliate of the Company or the Manager and from lending or advancing
any funds to any affiliate of either the Company or the Manager (any of these
transactions being referred to as an "Affiliate Transaction") unless certain
conditions designed to insure the fairness of any Affiliate Transaction are
satisfied. Such conditions require that any Affiliate Transaction be on terms
that are no less favorable than could be obtained from an unrelated person in a
comparable transaction. In addition, for any Affiliate Transaction that exceeds
$100,000 in value, a majority of the disinterested members of the Board of
Directors of the Manager must approve the transaction. For any Affiliate
Transaction that exceeds $2.5 million, the Board of Directors of the Manager is
also required to obtain a fairness opinion for the transaction from an appraiser
or investment banking firm.

No Restrictions on Dividend Paying Ability. The Company is generally
prohibited from encumbering or restricting its ability to pay dividends or to
make loans to the Manager.

Limitation on Capital Expenditures. The Company is generally prohibited
from incurring capital expenditures in any fiscal year in an aggregate amount in
excess of $100,000.

Limitation on Business and Tax Status. The Company is generally prohibited
from engaging in any business or activity other than the business of investing
in and disposing of investments of the type described above under "Limitation on
Investments." Prior to the consummation of a qualified public equity offering
(which this Offering will constitute), the Company is prohibited from investing
in any B/C Mortgages (i.e., below "A" or "A-") unless the aggregate fair market
value of the investments by the Company in B/C Mortgages does not exceed 20% of
the aggregate fair market value of all of the assets of the Company. At all
times, the Company is required to operate and qualify as a REIT under Section
856 et seq. of the Code, the income of which is taxed pursuant to Section 857 of
the Code.

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<PAGE> 66

Limitation on Indebtedness and Leverage Ratios. The Company is generally
prohibited from incurring debt except for short term adjustable rate
obligations, such as reverse repurchase agreements, that are secured by assets
and limited in amount by the fair market value of such assets. The Company is
permitted, however, to incur debt (a) in the form of securitized obligations
such as collateralized mortgage bonds or notes where recourse is limited to the
assets securitized and certain other criteria are met or (b) constituting one of
the following: (i) trade debt incurred in the ordinary course of business; (ii)
indebtedness secured by permitted liens; (iii) capitalized lease obligations in
an aggregate amount not to exceed at any one time $500,000; or (iv) indebtedness
of the Company in an amount not to exceed $1,000,000 incurred solely for the
purchase or financing of fixed or capital assets acquired by the Company.

The Company is generally required to maintain the ratio of its total
indebtedness to total assets below 0.925. The maximum leverage ratio is
permitted to be 0.935 immediately before and after new equity issuances by the
Company to permit the Company to fully invest the proceeds of such issuances
more quickly than would otherwise be the case.

Investment Hedging and Leverage Policy. At least once during each fiscal
year, the Board of Directors of the Company is required to adopt a statement of
policy regarding investment of the assets of the Company, the duration of the
Company's assets and liabilities, hedging activities to be conducted by the
Company, the range of leverage ratios to be maintained by the Company and the
types of indebtedness that may be incurred by the Company. Any material
difference between any policy to be so adopted and the then most recently
adopted policy must be approved by Investors holding a majority interest in the
Notes. At least once during each fiscal year, the Manager is required to engage
a professional services firm, which is not an affiliate of the Manager or the
Company, to issue a report (a "REIT Compliance Report") addressed to each of the
Manager, Holdings, the Company and the Investors stating whether the Company has
complied in all material respects with the then most recently adopted policy.
The Company is generally prohibited from maintaining a repricing differential
between the Company's assets and liabilities of greater than 180 days. As a
result, the interest rates on the Company's assets must adjust, on average,
within 180 days of the average adjustment date of the interest rates on its
liabilities.

Board of Director Observation Rights. Each of the Investors has the right
to have one representative present (whether in person or by telephone) at all
meetings of the Board of Directors (and committees thereof) of the Manager and
the Company. However, such representative shall not be entitled to vote at such
meetings.

Events of Default. The Securities Purchase Agreement provides for certain
Events of Default including, among other things, breach of a covenant by the
Manager or the Company (subject to a 30-day cure period in certain instances)
and failure by the Company to pay dividends for two consecutive quarters
beginning in October 1997. Upon an Event of Default, the Notes can be
accelerated and the shares of Common Stock of the Company pledged to secure the
Notes can be sold to satisfy the debt. See "Risk Factors -- Default of Manager
Under Securities Purchase Agreement; Restrictive Covenants."

Amendment and Waiver. The Securities Purchase Agreement can be amended, and
waivers of terms and provisions given, by the Investors holding a majority
interest in the Notes.

OTHER TRANSACTIONS

The following transactions were concluded in connection with the formation
of the Company, and involve the Company, the Manager and certain executive
officers, directors and affiliates of the Company and the Manager. Because of
the relationships between the parties to each transaction, there can be no
assurance that transactions described below were on terms as favorable to the
Company as could have been obtained from unaffiliated third parties. See "The
Company," "The Manager" and "Conflicts of Interest."

On February 11, 1997, in connection with the founding of the Company,
Holdings, Mr. Robbins and Mr. Fuller each purchased 1.6 million, 8,000 and 6,000
shares, respectively, of the Company's Common Stock at a price of $12.50 per
share in cash.

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<PAGE> 67

The Company and the Manager entered into a Management Agreement pursuant to
which the Company pays base Management fees and incentive compensation to the
Manager. The executive officers and directors of the Company are also executive
officers and directors of the Manager. See "The Manager -- The Management
Agreement," "Management and Termination Fees" and "Conflicts of Interest."

On February 11, 1997, in connection with the founding of the Manager, the
Manager issued the following securities to the Company's officers, directors,
beneficial holders of 5% or more of the Company's Common Stock and their
Affiliates:

- The Manager issued 1,000,000 shares of its common stock to entities
affiliated with McCown De Leeuw & Co. and 127,032 shares to each of Mr.
Robbins and Mr. Fuller. The shares of Manager's common stock were issued
at a purchase price of $0.01 per share and paid in cash.

- The Manager issued 12% senior secured notes in the principal amount of
$25,000,000 (the "Notes") to entities affiliated with TCW/Crescent
Mezzanine, L.L.C. The Notes were issued at a purchase price equal to
$994.56 per $1,000 principal amount, paid in cash.

- The Manager issued warrants to purchase up to 666,667 shares of its
common stock to entities affiliated with TCW/Crescent Mezzanine, L.L.C.
The warrants were purchased at a price of $0.20 per warrant share paid in
cash and have an exercise price of $0.01 per share. The warrants expire
on February 11, 2007; the Company paid TCW/Crescent Mezzanine, L.L.C. a
fee of approximately $500,000 in connection with the sale and issuance of
the Notes and these warrants.

- The Manager issued warrants to purchase up to 17,149, 51,448, 34,299, and
34,299 shares of its common stock to entities affiliated with
TCW/Crescent Mezzanine, L.L.C., entities affiliated with McCown De Leeuw
& Co., Mr. Conger and Mr. Lynn, respectively. The warrants have an
exercise price of $0.01 per share. The warrants expire on February 11,
2007. The warrants are not currently exercisable and will become
exercisable only to the extent that certain letters of credit issued for
the benefit of the Manager are reduced over a period of four years.

The shares of the Manager's common stock held by Mr. Robbins and Mr. Fuller
are subject to a right of repurchase by the Manager which lapses after the
earlier of February 11, 2002 and the closing of a public offering by the Company
which generates proceeds to the Company, which, when aggregated with the
proceeds of all other public offerings, equals $150 million or more. The
purchase price for the shares of the Manager's common stock in the event of a
repurchase shall be (i) equal to the book value of the securities in the event
that the executive officer's employment is terminated without cause or in the
event that the executive officer resigns for good cause, (ii) fair market value
of the securities in the case of death, and (iii) a nominal amount in all other
circumstances.

In connection with the founding of the Manager and the Company, on February
11, 1997, Holdings issued 29.91%, 45.98%, 1.5% and 1.5% ownership interests to
entities affiliated with TCW/Crescent Mezzanine, L.L.C., entities affiliated
with McCown De Leeuw & Co., Mr. Conger and Mr. Lynn, respectively.

The Manager and MDC Management Company II, L.P., ("MDC"), an affiliate of
McCown De Leeuw & Co., have entered into an advisory services agreement pursuant
to which MDC will provide financial and management services to the Manager.
Under the terms of the advisory services agreement, the Manager has accrued an
initial fee obligation of $500,000 with an additional annual fee of $250,000 to
be paid to MDC. The annual payments will begin in March 1998 and continue for a
minimum of five years. The initial fee will be paid only after the Manager has
retired certain debt and preferred equity obligations.

The Company intends to enter into indemnity agreements with each of its
officers and directors. For a description of the limitations of liability
applicable to the Company's officers and directors, see "Management of the
Company -- Limitation of Liability and Indemnification."

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<PAGE> 68

CONFLICTS OF INTEREST

The Company is subject to conflicts of interest with the Manager and
certain of its executive officers, directors and principal stockholders. Upon
the closing of this Offering, John Robbins, Jay Fuller, Mark Conger, John Dahl,
Rollie Lynn and Lisa Faulk will serve as executive officers of both the Company
and the Manager, and Messrs. Robbins and Fuller will also be directors and
principal stockholders of the Company. In addition, David DeLeeuw will serve as
a director of the Company and the Manager. Mr. De Leeuw and George McCown are
affiliated with MDC. MDC and TCW/Crescent Mezzanine L.L.C. are principal
stockholders of the Manager and affiliates of Holdings, a principal stockholder
of the Company. See "The Company."

Under the terms of the Management Agreement, the Manager will receive an
annual base management fee payable monthly in arrears and the Manager will have
the opportunity to earn incentive compensation under the Management Agreement
based upon the Company's annualized net income. The Management Agreement does
not limit or restrict the right of the Manager to render services of any kind to
any third party except that the Manager and its officers, directors or employees
will not be permitted to provide any such services to any real estate investment
trust which invests in residential Mortgage Assets other than the Company.
Additionally, under the Company's Capital Policy, the Company is not prohibited
from acquiring Mortgage Assets originated by affiliates of the Manager. See "The
Manager -- The Management Agreement" and "Management and Termination Fees."

The base management fee is calculated using the Agency Percentage and the
Non-Agency Percentage. Because the Non-Agency Percentage is three times greater
than the Agency Percentage, the Manager has an incentive to invest in Mortgage
Assets other than Agency Securities in order to maximize the base management
fee. By holding a larger amount of Mortgage Assets other than Agency Securities,
the Company's portfolio may be subject to a higher risk of loss. In addition,
the incentive compensation fee paid to the Manager increases proportionally with
any increase in the Company's net income. Accordingly, in evaluating Mortgage
Assets for investment and other strategies, Management could emphasize
maximizing income at the expense of other criteria, in order to achieve higher
incentive compensation for the Manager, which could result in increased risk to
the value of the Company's portfolio of Mortgage Assets. Moreover, in the event
of termination of the Management Agreement without cause, the termination fee
will not be less than three times the total of the base and incentive
compensation fees paid to the Manager for the four most recently completed
calendar quarters ending on or prior to the date of termination. See "Management
and Termination Fees."

The Manager is, however, subject to the Capital Policy and other guidelines
which have been approved by the Company's Board of Directors and which may not
be modified without the approval of the Company's Board of Directors. Upon the
closing of this Offering, a majority of the directors of the Company will be
independent directors and not subject to the conflicts of interest set forth
under this section. Additionally, the executive officers of the Company also own
securities of the Company, with an incentive to ensure the success of the
Company's operations. Moreover, certain large stockholders of the Manager also
have a beneficial interest in shares of the Company's Common Stock. Finally,
because the Manager derives substantially all of its income from the Company,
the success of the Manager is substantially dependent upon the success of the
Company. See "Risk Factors -- The Company has Significant Conflicts with, and Is
Dependent on, an Affiliate of the Executive Officers of the Company,"
"-- Policies and Strategies May Be Revised at the Discretion of the Board of
Directors," "-- The Manager and Certain Affiliates Will Control Approximately
20% of Outstanding Shares after Offering," "The Company," "Management of the
Company -- Directors and Executive Officers of the Company," "-- Action by
Independent Directors," "Benefits of Offering to Management," "The
Manager -- Relationship between the Manager and the Company," "Certain
Transactions," and "Principal Stockholders."

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<PAGE> 69

PRINCIPAL STOCKHOLDERS

The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company's Common Stock as of October
15, 1997, and as adjusted to reflect the sale of Common Stock being offered
hereby, by (i) each person known to the Company to beneficially own more than 5%
of the Company's Common Stock, (ii) each director, (iii) each executive officer
and (iv) all directors and executive officers as a group. Unless otherwise
indicated in the footnotes to the table, the beneficial owners named have, to
the knowledge of the Company, sole voting and investment power with respect to
the shares of Common Stock beneficially owned, subject to community property
laws where applicable.

<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
------------------------
AFTER
NUMBER OF SHARES BEFORE OFFERING
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING (1)
- ---------------------------------------------------------- ------------------ ---------- -----------
<S> <C> <C> <C>
MDC REIT Holdings, LLC (2)................................ 1,600,000 99.1% 19.7%
John M. Robbins (3)....................................... 52,000 3.1 *
Jay M. Fuller (3)......................................... 50,000 3.0 *
Mark A. Conger (4)........................................ 6,080 * *
John Dahl (5)............................................. 15,000 * *
Rollie O. Lynn (6)........................................ 5,280 * *
David E. De Leeuw (7)..................................... -- -- --
George E. McCown (7)...................................... -- -- --
All Directors and Executive Officers as a group
(8 persons) (3)(7)(8)................................... 138,360 8.0 1.7
</TABLE>

- ---------------

* Less than 1%

(1) Assuming no exercise of the Underwriters' over-allotment option.

(2) The address for MDC REIT Holdings, L.L.C. is 445 Marine View Avenue, Suite
230, Del Mar, CA 92014. The Manager is the managing member of Holdings
pursuant to an operating agreement. Accordingly, the Manager may be deemed
to have voting control of the shares of the Company's Common Stock held by
Holdings with respect to ordinary and usual matters. See "The Manager."
Transactions which could result in the disposition of the shares of the
Company's Common Stock require the approval of the members of Holdings
having membership interests which constitute more than 80% of all
membership interests. No single member or group of affiliated members of
Holdings holds 80% of the membership interests of Holdings. The shares of
the Company's Common Stock held by the LLC have been pledged as collateral
to certain entities affiliated with TCW/Crescent Mezzanine, L.L.C. See
"Risk Factors -- Default of Manager Under Securities Purchase Agreement;
Restrictive Covenants."

(3) Includes 44,000 shares of Common Stock of the Company issuable upon
exercise of options within 60 days of October 15, 1997, including shares
issuable upon exercise of options issued at the effectiveness of this
Offering. Mr. Robbins and Mr. Fuller are directors of the Manager. They
each disclaim beneficial ownership of the shares of the Company's Common
Stock held by Holdings. See Note 2 above.

(4) Includes 6,080 shares of Common Stock of the Company issuable upon exercise
of options within 60 days of October 15, 1997, including shares issuable
upon exercise of options issued at the effectiveness of this Offering.

(5) Includes 15,000 shares of Common Stock of the Company issuable upon
exercise of options within 60 days of October 15 1997, including shares
issuable upon exercise of an option issued at the effectiveness of this
Offering.

(6) Includes 5,280 shares of Common Stock of the Company issuable upon exercise
of options within 60 days of October 15, 1997, including shares issuable
upon exercise of options issued at the effectiveness of this Offering.

(7) Mr. De Leeuw and Mr. McCown are also directors of the Manager. They each
disclaim beneficial ownership of the shares of the Company's Common Stock
held by Holdings. See Note 2 above.

(8) Includes 124,280 shares of Common Stock of the Company issuable upon
exercise of options within 60 days of October 15, 1997, including shares
issuable upon the exercise of options issued at the effectiveness of this
Offering.

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<PAGE> 70

DESCRIPTION OF CAPITAL STOCK

GENERAL

The following summary is a description of provisions of the Company's
Charter and Bylaws with respect to the Company's Capital Stock. This summary
does not purport to be complete and is qualified by reference to the Charter and
Bylaws. Under the Company's Charter and Bylaws, the total number of shares of
all classes of capital stock that the Company has authority to issue is
25,000,000 shares, par value $0.01 per share, initially consisting of 25,000,000
shares of Common Stock. The Board of Directors is authorized to classify or
reclassify any unissued portion of the authorized shares of capital stock to
provide for the issuance of shares in other classes or series, including
Preferred Stock in one or more series. The Company has no current intention to
issue shares of any class or series other than Common Stock.

COMMON STOCK

The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Holders of Common
Stock do not have cumulative voting rights in the election of directors, which
means that holders of more than 50% of the shares of Common Stock voting for the
election of directors can elect all of the directors if they choose to do so and
the holders of the remaining shares cannot elect any directors. Subject to
preferential rights with respect to any outstanding shares of preferred stock,
holders of Common Stock are entitled to receive ratably such dividends as may be
declared by the Board of Directors out of funds legally available therefor. The
shares of Common Stock are not convertible into any other class or series.
Holders of Common Stock do not have preemptive rights, which means they have no
right to acquire any additional shares of Common Stock that may be issued by the
Company at a subsequent date. The outstanding shares of Common Stock are, and
the Shares to be outstanding upon the closing of this Offering will be, fully
paid and nonassessable. The Shares have been approved for listing on the New
York Stock Exchange.

ADDITIONAL CLASSES AND SERIES OF STOCK

The Board of Directors is authorized to establish one or more classes and
series of stock, including series of preferred stock, from time to time, and to
establish the number of shares in each class or series and to fix the
preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of such class or series, without any further vote or action by the
stockholders, unless such action is required by applicable law or the rules of
any stock exchange or automated quotation system on which the Company's
securities may be listed or traded. The issuance of additional classes or series
of capital stock may have the effect of delaying, deferring or preventing a
change in control of the Company without further action of the stockholders. The
issuance of additional classes or series of capital stock with voting and
conversion rights may adversely affect the voting power of the holders of
capital stock of the Company, including the loss of voting control to others.
The ability of the Board of Directors to issue additional classes or series of
capital stock, while providing flexibility in connection with possible
acquisitions or other corporate purposes, could have the effect of making it
more difficult for a third party to acquire, or of discouraging a third party
from acquiring, a majority of the outstanding voting stock of the Company, even
where such an acquisition may be beneficial to the Company or its stockholders.

REGISTRATION RIGHTS

Upon the closing of this Offering the beneficial holders of approximately
1.6 million shares of Common Stock of the Company are entitled to certain rights
with respect to the registration of such shares under the Securities Act.
Subject to certain limitations, if the Company registers any of its securities
under the Securities Act, either for its own account or the account of other
security holders, such holders are entitled to written notice of the
registration and are entitled to include such shares therein, provided, among
other conditions, that the underwriters of any offering have the right to limit
the number of such shares included in the registration. All fees, costs and
expenses of such registrations (other than the underwriting discount and
commissions and legal expenses of such holders) will generally be borne by the
Company. In addition,

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beginning 180 days after the closing of this Offering, certain of such
beneficial holders may require, on up to six occasions, the Company to use its
best efforts to file a registration statement under the Securities Act at the
Company's expense with respect to their shares of Common Stock, subject to
certain conditions and limitations. Further, such holders may require the
Company, at the Company's expense, to register their shares on Form S-3 when
such form becomes available to the Company, subject to certain conditions and
limitations.

REPURCHASE OF SHARES AND OWNERSHIP LIMITATIONS

Two of the requirements of qualification for the tax benefits accorded by
the REIT provisions of the Code are that (1) during the last half of each
taxable year not more than 50% in value of the outstanding shares may be owned
directly or indirectly by five or fewer individuals (the "50%/5 stockholder
test") and (2) there must be at least 100 stockholders on 335 days of each
taxable year of 12 months.

In order that the Company may meet these requirements at all times, the
Charter prohibits any person from acquiring or holding, directly or indirectly,
shares of Common Stock in excess of 9.9% in value of the aggregate of the
outstanding shares of Common Stock or in excess of 9.9% in value of the
aggregate of the outstanding shares of Common Stock of the Company. For this
purpose, the term "ownership" is defined in accordance with the REIT provisions
of the Code and the constructive ownership provisions of Section 544 of the
Code, as modified by Section 856(h)(1)(B) of the Code.

For purposes of the 50%/5 stockholder test, the constructive ownership
provisions applicable under Section 544 of the Code attribute ownership of
securities owned by a corporation, partnership, estate or trust proportionately
to its stockholders, partners or beneficiaries, attribute ownership of
securities owned by family members and partners to other members of the same
family, treat securities with respect to which a person has an option to
purchase as actually owned by that person, and set forth rules as to when
securities constructively owned by a person are considered to be actually owned
for the application of such attribution provisions (i.e., "reattribution").
Thus, for purposes of determining whether a person holds shares of Common Stock
in violation of the ownership limitations set forth in the Charter, many types
of entities may own directly more than the 9.9% limit because such entities'
shares are attributed to its individual stockholders. For example, it is
contemplated that Holdings and perhaps other corporate investors will own in
excess of 9.9% of the Common Stock outstanding immediately after closing of this
Offering. On the other hand, a person will be treated as owning not only shares
of Common Stock actually or beneficially owned, but also any shares of Common
Stock attributed to such person under the attribution rules described above.
Accordingly, under certain circumstances, shares of Common Stock owned by a
person who individually owns less than 9.9% of the shares of Common Stock
outstanding may nevertheless be in violation of the ownership limitations set
forth in the Charter. Ownership of shares of the Company's Common Stock through
such attribution is generally referred to as constructive ownership. The 100
stockholder test is determined by actual, and not constructive, ownership. The
Company will have greater than 100 stockholders of record.

The Charter further provides that if any transfer of shares of Common Stock
occurs which, if effective, would result in any person beneficially or
constructively owning shares of Common Stock in excess or in violation of the
above transfer or ownership limitations, then that number of shares of Common
Stock the beneficial or constructive ownership of which otherwise would cause
such person to violate such limitations (rounded to the nearest whole shares)
shall be automatically transferred to a trustee (the "Trustee") as trustee of a
trust (the "Trust") for the exclusive benefit of one or more charitable
beneficiaries (the "Charitable Beneficiary"), and the intended transferee shall
not acquire any rights in such shares. Shares of Common Stock held by the
Trustee shall be issued and outstanding shares of Common Stock. The intended
transferee shall not benefit economically from ownership of any shares held in
the Trust, shall have no rights to dividends, and shall not possess any rights
to vote or other rights attributable to the shares held in the Trust. The
Trustee shall have all voting rights and rights to dividends or other
distributions with respect to shares held in the Trust, which rights shall be
exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend
or other distribution paid to the intended transferee prior to the discovery by
the Company that shares of Common Stock have been transferred to the Trustee
shall be paid with respect to such shares to the Trustee by the intended
transferee upon demand and any dividend or other distribution authorized but
unpaid

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shall be paid when due to the Trustee. The Board of Directors of the Company
may, in their discretion, waive these requirements on owning shares in excess of
the ownership limitations.

Within 20 days of receiving notice from the Company that shares of Common
Stock have been transferred to the Trust, the Trustee shall sell the shares held
in the Trust to a person, designated by the Trustee, whose ownership of the
shares will not violate the ownership limitations set forth in the Charter. Upon
such sale, the interest of the Charitable Beneficiary in the shares sold shall
terminate and the Trustee shall distribute the net proceeds of the sale to the
intended transferee and to the Charitable Beneficiary as follows. The intended
transferee shall receive the lesser of (1) the price paid by the intended
transferee for the shares or, if the intended transferee did not give value for
the shares in connection with the event causing the shares to be held in the
Trust (e.g., in the case of a gift, devise or other such transaction), the
Market Price (as defined below) of the shares on the day of the event causing
the shares to be held in the Trust, and (2) the price per share received by the
Trustee from the sale or other disposition of the shares held in the Trust. Any
net sales proceeds in excess of the amount payable to the intended transferee
shall be immediately paid to the Charitable Beneficiary. In addition, shares of
Common Stock transferred to the Trustee shall be deemed to have been offered for
sale to the Company, or its designee, at a price per share equal to the lesser
of (i) the price per share in the transaction that resulted in such transfer to
the Trust (or, in the case of a devise or gift, the Market Price at the time of
such devise or gift) and (ii) the Market Price on the date the Company, or its
designee, accepts such offer. The Company shall have the right to accept such
offer until the Trustee has sold shares held in the Trust. Upon such a sale to
the Company, the interest of the Charitable Beneficiary in the shares sold shall
terminate and the Trustee shall distribute the net proceeds of the sale to the
intended transferee.

The term "Market Price" on any date shall mean, with respect to any class
or series of outstanding shares of the Company's stock, the Closing Price (as
defined below) for such shares on such date. The "Closing Price" on any date
shall mean the last sale price for such shares, regular way, or, in case no such
sale takes place on such day, the average of the closing bid and asked prices,
regular way, for such shares, in either case as reported in the principal
consolidated transaction reporting system with respect to securities listed or
admitted to trading on the New York Stock Exchange ("NYSE") or, if such shares
are not listed or admitted to trading on the NYSE, as reported on the principal
consolidated transaction reporting system with respect to securities listed on
the principal national securities exchange on which such shares are listed or
admitted to trading or, if such shares are not listed or admitted to trading on
any national securities exchange, the last quoted price, or, if not so quoted,
the average of the high bid and low asked prices in the over-the-counter market,
as reported by the National Association of Securities Dealers, Inc. Automated
Quotation System or, if such system is no longer in use, the principal other
automated quotation system that may then be in use or, if such shares are not
quoted by any such organization, the average of the closing bid and asked prices
as furnished by a professional market maker making a market in such shares
selected by the Board of Directors or, in the event that no trading price is
available for such shares, the fair market value of the shares, as determined in
good faith by the Board of Directors.

Every owner of more than 5%, in the case of 2,000 or more stockholders of
record and 1% in the case of more than 200 but fewer than 2,000 stockholders of
record, of all classes or series of the Company's stock, within 30 days after
the end of each taxable year, is required to give written notice to the Company
stating the name and address of such owner, the number of shares of each class
and series of stock of the Company beneficially owned and a description of the
manner in which such shares are held. Each such owner shall provide to the
Company such additional information as the Company may request in order to
determine the effect, if any, of such beneficial ownership on the Company's
status as a REIT and to ensure compliance with the ownership limitations.

Subject to certain limitations, the Board of Directors may increase or
decrease the ownership limitations. In addition, to the extent consistent with
the REIT Provisions of the Code, the Board of Directors may waive the ownership
limitations for and at the request of certain purchasers in this Offering or
subsequent purchasers.

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The provisions described above may inhibit market activity and the
resulting opportunity for the holders of the Company's Common Stock to receive a
premium for their shares that might otherwise exist in the absence of such
provisions. Such provisions also may make the Company an unsuitable investment
vehicle for any person seeking to obtain ownership of more than 9.9% of the
outstanding shares of Common Stock. See "Risk Factor -- Ownership of Common
Stock May Be Restricted."

TRANSFER AGENT AND REGISTRAR

American Stock Transfer & Trust Company will act as the transfer agent and
registrar with respect to the Common Stock.

SHARES ELIGIBLE FOR FUTURE SALE

Upon the closing of this Offering, the Company will have outstanding
8,114,000 shares of Common Stock. Of the outstanding shares, the 6,500,000
shares of Common Stock to be sold in this Offering will be freely tradable
without restriction or further registration under the Securities Act, unless
purchased by "affiliates" of the Company, as that term is defined in Rule 144
under the Securities Act.

The remaining 1,614,000 shares of Common Stock to be outstanding after the
closing of this Offering will be "restricted securities" as that term is defined
in Rule 144, none of which will become eligible for sale under Rule 144 until
February 11, 1998. As described below, Rule 144 permits resales of restricted
securities subject to certain restrictions.

In general, under Rule 144, as currently in effect, a person (or persons
whose shares are aggregated) who beneficially owned shares for at least one
year, including any person who may be deemed an "affiliate" of the Company,
would be entitled to sell within any three month period a number of such shares
that does not exceed the greater of 1% of the shares of the Company's Common
Stock then outstanding or the average weekly trading volume in the Company's
Common Stock during the four calendar weeks preceding the date on which notice
of the sale is filed with the Commission. A person who is not deemed to have
been an "affiliate" of the Company at any time during the three months preceding
a sale and who has beneficially owned shares for at least two years would be
entitled to sell such shares under Rule 144 without regard to the volume
limitation described above.

Beginning 180 days after the closing of this Offering, the beneficial
holders of the 1,614,000 shares of Common Stock currently outstanding may
require the Company to register such shares of sale in the public market. See
"Description of Capital Stock -- Registration Rights."

The Company and its stockholders have agreed with the Underwriters that,
for a period of 180 days following this Offering, they will not sell, contract
to sell or otherwise dispose of any shares of Common Stock or rights to acquire
such shares (other than pursuant to employee plans) without the prior written
consent of PaineWebber Incorporated.

In addition, upon the closing of this Offering, the Company will have
outstanding options to purchase 683,000 shares of Common Stock and will have
reserved an aggregate of 167,000 additional shares of Common Stock for grant of
future options under the Option Plan and the Directors Plan. The Company has
also reserved 20,000 shares of Common Stock for issuance under the Purchase
Plan. The Company intends to file Registration Statements on form S-8 covering
the shares that have been reserved for issuance under these plans, thus
permitting the resale of such shares in the public market after such stock
options have been exercised.

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FEDERAL INCOME TAX CONSEQUENCES

THE FOLLOWING DISCUSSION SUMMARIZES THE MATERIAL FEDERAL INCOME TAX
CONSEQUENCES THAT MAY BE RELEVANT TO A PROSPECTIVE HOLDER OF SHARES OF STOCK OF
THE COMPANY. THIS DISCUSSION IS BASED ON CURRENT LAW. THE FOLLOWING DISCUSSION
IS NOT EXHAUSTIVE OF ALL POSSIBLE TAX CONSEQUENCES. IT DOES NOT GIVE A DETAILED
DISCUSSION OF ANY STATE, LOCAL OR FOREIGN TAX CONSEQUENCES, NOR DOES IT DISCUSS
ALL OF THE ASPECTS OF FEDERAL INCOME TAXATION THAT MAY BE RELEVANT TO A
PROSPECTIVE STOCKHOLDER IN LIGHT OF SUCH STOCKHOLDER'S PARTICULAR CIRCUMSTANCES
OR TO CERTAIN TYPES OF STOCKHOLDERS (INCLUDING INSURANCE COMPANIES, CERTAIN
TAX-EXEMPT ENTITIES, FINANCIAL INSTITUTIONS, BROKER/DEALERS, FOREIGN
CORPORATIONS AND PERSONS WHO ARE NOT CITIZENS OR RESIDENTS OF THE UNITED STATES)
SUBJECT TO SPECIAL TREATMENT UNDER FEDERAL INCOME TAX LAWS.

EACH PROSPECTIVE PURCHASER OF COMMON STOCK OF THE COMPANY SHOULD CONSULT
WITH HIS OR HER OWN TAX ADVISOR REGARDING THE SPECIFIC CONSEQUENCES TO HIM OR
HER OF THE PURCHASE, OWNERSHIP AND SALE OF STOCK IN AN ENTITY ELECTING TO BE
TAXED AS A REIT, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX
CONSEQUENCES OF SUCH PURCHASE, OWNERSHIP, SALE AND ELECTION AND THE POTENTIAL
CHANGES IN APPLICABLE TAX LAWS.

GENERAL

The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussion below summarizes the material
provisions applicable to the Company as a REIT for federal income tax purposes
and to its stockholders in connection with their ownership of shares of stock of
the Company. However, it is impractical to set forth in this Prospectus all
aspects of federal, state, local and foreign tax law that may have tax
consequences with respect to an investor's purchase of the Company's Common
Stock. The discussion of various aspects of federal taxation contained herein is
based on the Code, administrative regulations, judicial decisions,
administrative rulings and practice, all of which are subject to change. In
brief, if certain detailed conditions imposed by the Code are met, entities that
invest primarily in real estate assets, including Mortgage Loans, and that
otherwise would be taxed as corporations are, with certain limited exceptions,
not taxed at the corporate level on their taxable income that is currently
distributed to their stockholders. This treatment eliminates most of the "double
taxation" (at the corporate level and then again at the stockholder level when
the income is distributed) that typically results from the use of corporate
investment vehicles. A qualifying REIT, however, may be subject to certain
excise and other taxes, as well as normal corporate tax, on taxable income that
is not currently distributed to its stockholders. See "-- Taxation of the
Company."

The Company plans to make an election to be taxed as a REIT under the Code
commencing with its taxable year ending December 31, 1997.

OPINION OF SPECIAL COUNSEL

Jeffers, Wilson, Shaff & Falk, LLP ("Special Tax Counsel"), special tax and
ERISA counsel to the Company, has advised the Company in connection with this
Offering of the Company's Common Stock and the Company's election to be taxed as
a REIT. Based on existing law and certain representations made to Special Tax
Counsel by the Company and assuming that the Company operates in the manner
described in this Prospectus, in the opinion of Special Tax Counsel, commencing
with the Company's taxable year ending December 31, 1997, the Company has been
organized in conformity with the requirements for qualification as a REIT under
the Code and the Company's actual and proposed method of operation described in
this Prospectus and as represented by the Company to Special Tax Counsel will
enable the Company to qualify as a REIT. However, whether the Company will in
fact so qualify will depend on actual operating results and compliance with the
various tests for qualification as a REIT relating to its income, assets,
distributions,

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ownership and certain administrative matters, the results of which may not be
reviewed by Special Tax Counsel. Moreover, certain aspects of the Company's
method of operations have not been considered by the courts or the Internal
Revenue Service (the "Service"). There can be no assurance that the courts or
the Service will agree with this opinion. In addition, qualification as a REIT
depends on future transactions and events that cannot be known at this time.
Accordingly, Special Tax Counsel is unable to opine whether the Company will in
fact qualify as a REIT under the Code in all events. In the opinion of Special
Tax Counsel, the section of the Prospectus entitled "Federal Income Tax
Consequences" identifies and fairly summarizes the federal income tax
consequences that are likely to be material to holders of the Common Stock of
the Company, and, to the extent such summaries involve matters of law, such
statements of law are correct under the Code. Special Tax Counsel's opinions are
based on various assumptions and on the factual representations of the Company
concerning its business and assets. Accordingly, no assurance can be given that
the actual results of the Company's operation for any one taxable year will
satisfy such requirements. See "Termination or Revocation of REIT Status" below.

The opinions of Special Tax Counsel are based upon existing law, including
the Code, existing Treasury Regulations, Revenue Rulings, Revenue Procedures,
proposed regulations and case law, all of which are subject to change either
prospectively or retroactively. Moreover, relevant laws or other legal
authorities may change in a manner that could adversely affect the Company or
its stockholders. Special Tax Counsel's opinions also are based in part on the
opinion of special Maryland counsel, Piper & Marbury, L.L.P., that the Company
is duly organized and existing under Maryland law.

In the event that the Company does not qualify as a REIT in any year, it
will be subject to federal income tax as a domestic corporation and its
stockholders will be taxed in the same manner as stockholders of ordinary
corporations. To the extent that the Company would, as a consequence, be subject
to potentially significant tax liabilities, the amount of earnings and cash
available for distribution to its stockholders would be reduced. See
"Termination or Revocation of REIT Status" below.

REQUIREMENTS FOR QUALIFICATION AS A REIT

To qualify for tax treatment as a REIT under the Code, the Company must
meet certain tests which are described immediately below.

Stock Ownership Tests

For all taxable years after the first taxable year for which a REIT
election is made, the Company's shares of stock must be transferable and must be
held by a minimum of 100 persons for at least 335 days of a 12 month year (or a
proportionate part of a short tax year). The Company must also use the calendar
year as its taxable year. In addition, at all times during the second half of
each taxable year, no more than 50% in value of the shares of any class of the
stock of the Company may be owned directly or indirectly by five or fewer
individuals. In determining whether the Company's shares are held by five or
fewer individuals, the attribution rules of Sections 544 of the Code apply. For
a description of the attribution rules, see "Description of Capital Stock." The
Company's Charter imposes certain repurchase provisions and transfer
restrictions to avoid more than 50% by value of any class of the Company's stock
being held by five or fewer individuals (directly or constructively) at any time
during the last half of any taxable year. Such repurchase and transfer
restrictions will not cause the stock not to be treated as "transferable" for
purposes of qualification as a REIT. The Company intends to satisfy both the 100
stockholder and 50%/5 stockholder individual ownership limitations described
above for as long as it seeks qualification as a REIT. See "Description of
Capital Stock." The Company uses the calendar year as its taxable year for
income tax purposes.

Asset Tests

On the last day of each calendar quarter, at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government securities,
cash and cash items (the "75% of assets test"). The Company expects that
substantially all of its assets will be Qualified REIT Assets. Qualified REIT
Assets

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include interests in real property, interests in Mortgage Loans secured by real
property and interests in REMICs.

On the last day of each calendar quarter, of the investments in securities
not included in the 75% of assets test, the value of any one issuer's securities
may not exceed 5% by value of the Company's total assets, and the Company may
not own more than 10% of any one issuer's outstanding voting securities. Hedging
contracts (other than those which are Qualified REIT Assets) and certain types
of other Mortgage Assets may be treated as securities of the entity issuing such
agreements or interests. The Company will take measures to prevent the value of
such contracts, interests or assets issued by any one entity to exceed 5% of the
value of the Company's assets as of the end of each calendar quarter. Moreover,
pursuant to its compliance guidelines, the Company intends to monitor closely
(on not less than a quarterly basis) the purchase and holding of the Company's
assets in order to comply with the above assets tests. In particular, as of the
end of each calendar quarter the Company intends to limit and diversify its
ownership of hedging contracts and other mortgage securities that do not
constitute Qualified REIT Assets to less than 25%, in the aggregate, by value of
its portfolio, to less than 5% by value as to any single issuer, and to less
than 10% of the voting stock of any single issuer (collectively the "25% of
assets limits"). If such limits are ever exceeded, the Company intends to take
appropriate remedial action to dispose of such excess assets within the 30 day
period after the end of the calendar quarter, as permitted under the Code.

When purchasing mortgage-related securities, the Company may rely on
opinions of counsel for the issuer or sponsor of such securities given in
connection with the offering of such securities, or statements made in related
offering documents, for purposes of determining whether and to what extent those
securities (and the income therefrom) constitute Qualified REIT Assets (and
income) for purposes of the 75% of assets test (and the source of income tests
discussed below). If the Company invests in a partnership, the Company will be
treated as receiving its share of the income and loss of the partnership and
owning a proportionate share of the assets of the partnership and any income
from the partnership will retain the character that it had in the hands of the
partnership. If the Company forms a taxable affiliate to conduct mortgage
origination and other activities, the Company will obtain an opinion of counsel
that the proposed organization and ownership of an interest in the taxable
affiliate will not adversely affect the Company's status as a REIT.

Where a failure to satisfy any of the asset tests discussed above results
from an acquisition of securities or other property during a quarter, the
failure can be cured by disposition of sufficient non-qualifying assets within
30 days after the close of such quarter. The Company intends to maintain
adequate records of the value of its assets to determine its compliance with the
asset tests, and intends to take such action as may be required to cure any
failure to satisfy the test within 30 days after the close of any quarter.

Gross Income Tests

The Company must meet three separate income-based tests for each year in
order to qualify as a REIT.

1. The 75% Test. At least 75% of the Company's gross income (the "75% of
income test") for the taxable year must be derived from the following sources:
(i) rents from real property; (ii) interest (other than interest based in whole
or in part on the income or profits of any person) on obligations secured by
mortgages on real property or on interests in real property; (iii) gains from
the sale or other disposition of interests in real property and real estate
mortgages other than gain from stock in trade, inventory or property held
primarily for sale to customers in the ordinary course of the Company's trade or
business ("dealer property"); (iv) dividends or other distributions on shares in
other REITs and, provided such shares are not dealer property, gain from the
sale of such shares; (v) abatements and refunds of real property taxes; (vi)
income from the operation, and gain from the sale, of property acquired at or in
lieu of a foreclosure of the mortgage secured by such property or as a result of
a default under a lease of such property ("foreclosure property"); (vii) income
received as consideration for entering into agreements to make loans secured by
real property or to purchase or lease real property (including interests in real
property and interests in mortgages on real property) (for example, commitment
fees); and (viii) income attributable to stock or debt instruments acquired with
the proceeds from the sale of stock or certain debt obligations ("new capital")
of the Company received during the one year period beginning on the day such
proceeds were received ("qualified temporary

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investment income"). The investments that the Company intends to make (as
described under "Description of Mortgage Assets") will give rise primarily to
mortgage interest qualifying under the 75% of income test.

2. The 95% Test. In addition to deriving 75% of its gross income from the
sources listed above, at least an additional 20% of the Company's gross income
for the taxable year must be derived from those sources, or from dividends,
interest or gains from the sale or disposition of stock or other securities that
are not dealer property (the "95% of income test"). Income attributable to
mortgage warehouse participations, Mortgage Securities (other than Qualified
REIT Assets) that the Company holds directly, dividends on stock, interest on
any other obligations not secured by real property, and gains from the sale or
disposition of stock or other securities that are not Qualified REIT Assets will
constitute qualified income for purposes of the 95% of income test only, but
will not be qualified income for purposes of the 75% of income test. Income from
mortgage servicing contracts, loan guarantee fees (or other contracts under
which the Company would earn fees for performing services) and hedging (other
than from Qualified REIT Assets) will not qualify for either the 95% or 75% of
income tests. The Company intends to severely limit its acquisition of any
assets or investments, the income from which does not qualify for purposes of
the 95% of income test. Moreover, in order to help ensure compliance with the
95% of income test and the 75% of income test, the Company intends to limit
substantially all of the assets that it acquires to Qualified REIT Assets. The
policy of the Company to maintain REIT status may limit the type of assets,
including hedging contracts, that the Company otherwise might acquire.

For purposes of determining whether the Company complies with the 75% of
income test and the 95% of income test detailed above, gross income does not
include gross income from "prohibited transactions." A "prohibited transaction"
is one involving a sale of dealer property, other than foreclosure property. Net
income from "prohibited transactions" is subject to a 100% tax. See "-- Taxation
of the Company."

3. The 30% of Income Limit. For the 1997 taxable year, the Company must
also derive less than 30% of its gross income from the sale or other disposition
of (i) Qualified REIT Assets held for less than four years, other than
foreclosure property or property involuntarily or compulsorily converted through
destruction, condemnation or similar events, (ii) stock or securities held for
less than one year (including hedges) and (iii) property in a prohibited
transaction (together the "30% of income limit"). As a result of the Company's
having to closely monitor such gains, the Company may have to hold Mortgage
Loans and Mortgage Securities although the Company might otherwise have opted
for the disposition of such assets for short term gains, in order to ensure that
it maintains compliance with the 30% of income limit. Effective with the 1998
taxable year, the 30% of income limit has been repealed from the Code and will
no longer apply. The Company expects to make the election to treat any real
property taken by the Company in foreclosure, or in lieu of foreclosure, of a
Mortgage Loan as foreclosure property.

The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions, futures contracts and sales
of Mortgage Assets to comply with the 75% of income test, the 95% of income test
and, for the 1997 taxable year, the 30% of income limit. See "-- Taxation of the
Company" for a discussion of the potential tax cost of the Company's selling
certain Mortgage Securities on a regular basis. In order to help insure its
compliance with the REIT provisions of the Code, the Company has adopted
guidelines the effect of which will be to limit the Company's ability to earn
certain types of income, including income from hedging, other than hedging
income from Qualified REIT Assets. See "Business -- Risk Management -- Interest
Rate Risk Management."

If the Company fails to satisfy one or both of the 75% or 95% of income
tests for any year, it may face either (a) assuming such failure was for
reasonable cause and not willful neglect, a 100% tax on the greater of the
amounts of income by which it failed to comply with the 75% test of income or
the 95% of income test, reduced by estimated related expenses or (b) loss of
REIT status. There can be no assurance that the Company will always be able to
maintain compliance with the gross income tests for REIT qualification despite
the Company's periodic monitoring procedures. Moreover, there is no assurance
that the relief provisions for a failure to satisfy either the 95% or the 75% of
income tests will be available in any particular circumstance.

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Distribution Requirement

The Company must distribute to its stockholders on a pro rata basis each
year an amount equal to (i) 95% of its taxable income before deduction of
dividends paid and excluding net capital gain, plus (ii) 95% of the excess of
the net income from foreclosure property over the tax imposed on such income by
the Code, less (iii) any "excess noncash income" (the "95% distribution test").
See "Dividend Policy and Distributions." The Company intends to make
distributions to its stockholders in amounts sufficient to meet the 95%
distribution test. Such distributions must be made in the taxable year to which
they relate or, if declared before the timely filing of the Company's tax return
for such year and paid not later than the first regular dividend payment after
such declaration, in the following taxable year. A nondeductible excise tax,
equal to 4% of the excess of such required distributions over the amounts
actually distributed will be imposed on the Company for each calendar year to
the extent that dividends paid during the year (or declared during the last
quarter of the year and paid during January of the succeeding year) are less
than the sum of (i) 85% of the Company's "ordinary income," (ii) 95% of the
Company's capital gain net income plus, and (iii) income not distributed in
earlier years.

The Service has ruled that if a REIT's dividend reinvestment plan allows
stockholders of the REIT to elect to have cash distributions reinvested in
shares of the REIT at a purchase price equal to at least 95% of fair market
value on the distribution date, then such cash distributions qualify under the
95% distribution test.

If the Company fails to meet the 95% distribution test as a result of an
adjustment to the Company's tax returns by the Service, the Company by following
certain requirements set forth in the Code, may pay a deficiency dividend within
a specified period which will be permitted as a deduction in the taxable year to
which the adjustment is made. The Company would be liable for interest based on
the amount of the deficiency dividend. A deficiency dividend is not permitted if
the deficiency is due to fraud with intent to evade tax or to a willful failure
to file a timely tax return.

RECORDKEEPING REQUIREMENTS

A REIT is required to maintain records regarding the actual and
constructive ownership of its shares, and other information, and within 30 days
after the end of its taxable year, to demand statements from persons owning
above a specified level of the REIT's shares (e.g., if the Company has over 200
but fewer than 2,000 stockholders of record, from persons holding 1% or more of
the Company's outstanding shares of stock and if the Company has 200 or fewer
stockholders of record, from persons holding 1/2% or more of the stock)
regarding their ownership of shares. The Company must maintain, as part of the
Company's records, a list of those persons failing or refusing to comply with
this demand. Stockholders who fail or refuse to comply with the demand must
submit a statement with their tax returns setting forth the actual stock
ownership and other information. The Company also is required to maintain
permanent records of its assets as of the last day of each calendar quarter. The
Company intends to maintain the records and demand statements as required by
these regulations.

TERMINATION OR REVOCATION OF REIT STATUS

The Company's election to be treated as a REIT will be terminated
automatically if the Company fails to meet the requirements described above. In
that event, the Company will not be eligible again to elect REIT status until
the fifth taxable year which begins after the year for which the Company's
election was terminated unless all of the following relief provisions apply: (i)
the Company did not willfully fail to file a timely tax return with respect to
the termination taxable year; (ii) inclusion of incorrect information in such
return was not due to fraud with intent to evade tax; and (iii) the Company
establishes that failure to meet requirements was due to reasonable cause and
not willful neglect. The Company may also voluntarily revoke its election,
although it has no intention of doing so, in which event the Company will be
prohibited, without exception, from electing REIT status for the year to which
the revocation relates and the following four taxable years.

If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company would be subject to tax
(including any applicable alternative minimum tax) on its taxable

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income at regular corporate rates. Distributions to stockholders of the Company
with respect to any year in which the Company fails to qualify as a REIT would
not be deductible by the Company nor would they be required to be made. Failure
to qualify as a REIT would result in the Company's reduction of its
distributions to stockholders in order to pay the resulting taxes. If, after
forfeiting REIT status, the Company later qualifies and elects to be taxed as a
REIT again, the Company could face significant adverse tax consequences.

TAXATION OF THE COMPANY

In any year in which the Company qualifies as a REIT, it generally will not
be subject to federal income tax on that portion of its taxable income or net
capital gain which is distributed to its stockholders. The Company will,
however, be subject to tax at normal corporate rates upon any net income or net
capital gain not distributed. The Company intends to distribute substantially
all of its taxable income to its stockholders on a pro rata basis in each year.
See "Dividend Policy and Distributions."

In addition, the Company will also be subject to a tax of 100% of net
income from any prohibited transaction and will be subject to a 100% tax on the
greater of the amount by which it fails either the 75% or 95% of income tests,
reduced by approximated expenses, if the failure to satisfy such tests is due to
reasonable cause and not willful neglect and if certain other requirements are
met. The Company may be subject to the alternative minimum tax on certain items
of tax preference.

If the Company acquires any real property as a result of foreclosure, or by
a deed in lieu of foreclosure, the Company may elect to treat such real property
as "foreclosure property." Net income from the sale of foreclosure property is
taxable at the maximum federal corporate rate, currently 35%. Income from
foreclosure property will not be subject to the 100% tax on prohibited
transactions. The Company will determine whether to treat such real property as
foreclosure property on the tax return for the fiscal year in which such
property is acquired.

The Company may securitize Mortgage Loans and sell such Mortgage Loans
through a taxable subsidiary. However, if the Company itself were to sell such
Mortgage Securities on a regular basis, there is a substantial risk that they
would be deemed "dealer property" and that all of the profits from such sales
would be subject to tax at the rate of 100% as income from prohibited
transactions. The Company, therefore, intends to make any such sales through a
taxable subsidiary. The taxable subsidiary will form mortgage pools and create
mortgage-backed securities. See "Taxable Subsidiaries" The taxable subsidiary
will not be subject to this 100% tax on income from prohibited transactions,
which is only applicable to REITs.

The Company will also be subject to a nondeductible 4% excise tax if it
fails to make timely dividend distributions for each calendar year. See
"Requirements for Qualification as a REIT -- Distribution Requirements." The
Company intends to declare its fourth regular annual dividend during the final
quarter of the year and to make such dividend distribution no later than 31 days
after the end of the year in order to avoid imposition of the excise tax. Such a
distribution would be taxed to the stockholders in the year that the
distribution was declared, not in the year paid. Imposition of the excise tax on
the Company would reduce the amount of cash available for distribution to the
Company's stockholders.

TAXABLE SUBSIDIARIES

The Company may, in the future, cause the creation and sale of Mortgage
Securities through a taxable corporation. The Company and one or more persons or
entities will own all of the capital stock of that taxable corporation,
sometimes referred to as a "taxable subsidiary." In order to ensure that the
Company will not violate the prohibition on ownership of more than 10% of the
voting stock of a single issuer and the prohibition on investing more than 5% of
the value of its assets in the stock or securities of a single issuer, the
Company will own only shares of nonvoting preferred stock of that taxable
subsidiary corporation and will not own any of the taxable subsidiary's common
stock. The Company will monitor the value of its investment in the taxable
subsidiary on a quarterly basis to limit the risk of violating any of the tests
that comprise the 25% of assets limits. In addition, the dividends that the
taxable subsidiary pays to the Company will not qualify as income from Qualified
REIT Assets for purposes of the 75% of income test, and in all events would have
to be limited, along with the Company's other interest, dividends, gains on the
sale of securities, hedging income, and other

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<PAGE> 80

income not derived from Qualified REIT Assets to less than 25% of the Company's
gross revenues in each year. The taxable subsidiary will not elect REIT status,
will be subject to income taxation on its net earnings and will generally be
able to distribute only its net after-tax earnings to its stockholders,
including the Company, as dividend distributions. If the taxable subsidiary
creates a taxable mortgage pool, such pool itself will constitute a separate
taxable subsidiary of the taxable subsidiary. The taxable subsidiary would be
unable to offset the income derived from such a taxable mortgage pool with
losses derived from any other activities.

TAXATION OF STOCKHOLDERS

For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its stockholders out of
current or accumulated earnings and profits will be includible by the
stockholders as ordinary income for federal income tax purposes unless properly
designated by the Company as capital gain dividends. In the latter case, the
distributions will be taxable to the stockholders as long-term capital gains.

Distributions of the Company will not be eligible for the dividends
received deduction for corporations. Stockholders may not deduct any net
operating losses or capital losses of the Company.

Any loss on the sale or exchange of shares of the stock of the Company held
by a stockholder for six months or less will be treated as a long-term capital
loss to the extent of any capital gain dividend received on the stock held by
such stockholders.

If the Company makes distributions to its stockholders in excess of its
current and accumulated earnings and profits, those distributions will be
considered first a tax-free return of capital, reducing the tax basis of a
stockholder's shares until the tax basis is zero. Such distributions in excess
of the tax basis will be taxable as gain realized from the sale of the Company's
shares.

The Company does not expect to acquire or retain residual interests issued
by REMICs. Such residual interests, if acquired by a REIT, would generate excess
inclusion income. Excess inclusion income cannot be offset by net operating
losses of a stockholder. If the stockholder is a Tax-Exempt Entity, the excess
inclusion income is fully taxable as UBTI. If allocated to a foreign
stockholder, the excess inclusion income is subject to Federal income tax
withholding without reduction pursuant to any otherwise applicable tax treaty.
Potential investors, and in particular Tax Exempt Entities, are urged to consult
with their tax advisors concerning this issue.

The Company intends to finance the acquisition of Mortgage Assets by
entering into reverse repurchase agreements, which are essentially loans secured
by the Company's Mortgage Assets. The Company expects to enter into master
repurchase agreements with secured lenders known as "counterparties." Typically,
such master repurchase agreements have cross-collateralization provisions that
afford the counterparty the right to foreclose on the Mortgage Assets pledged as
collateral. If the Service were to successfully take the position that the
cross-collateralization provisions of the master repurchase agreements result in
the Company having issued debt instruments (the reverse repurchase agreements)
with differing maturity dates secured by a pool of Mortgage Loans, a portion of
the Company's income could be characterized as "excess inclusion income."
Special Tax Counsel has advised the Company that it is more likely than not that
the cross-collateralization provisions of the master repurchase agreements will
not cause the Company to realize excess inclusion income. Nevertheless, in the
absence of any definitive authority on this issue, Special Tax Counsel cannot
give complete assurance.

The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to stockholders of record on a specified
date in such month will be deemed to have been received by the stockholders and
paid by the Company on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year.

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TAXATION OF TAX-EXEMPT ENTITIES

In general, a Tax-Exempt Entity that is a stockholder of the Company is not
subject to tax on distributions. The Service has ruled that amounts distributed
by a REIT to an exempt employees' pension trust do not constitute UBTI and thus
should be nontaxable to such a Tax-Exempt Entity. Based on that ruling, but
subject to the discussion of excess inclusion income set forth under the heading
"Taxation of Stockholders," Special Tax Counsel is of the opinion that
indebtedness incurred by the Company in connection with the acquisition of real
estate assets such as Mortgage Loans will not cause dividends of the Company
paid to a stockholder that is a Tax-Exempt Entity to be UBTI, provided that the
Tax-Exempt Entity has not financed the acquisition of its stock with
"acquisition indebtedness" within the meaning of the Code. Under certain
conditions, if a tax-exempt employee pension or profit sharing trust were to
acquire more than 10% of the Company's stock, a portion of the dividends on such
stock could be treated as UBTI.

For social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts, and qualified group legal services plans exempt
from federal income taxation under Code Sections 501(c)(7), (c)(9), (c)(17) and
(c)(20), respectively, income from an investment in the Company will constitute
UBTI unless the organization is able to properly deduct amounts set aside or
placed in reserve for certain purposes so as to offset the UBTI generated by its
investment in the Company. Such entities should review Code Section 512(a)(3)
and should consult their own tax advisors concerning these "set aside" and
reserve requirements.

STATE AND LOCAL TAXES

The Company and its stockholders may be subject to state or local taxation
in various jurisdictions, including those in which it or they transact business
or reside. The state and local tax treatment of the Company and its stockholders
may not conform to the federal income tax consequences discussed above.
Consequently, prospective stockholders should consult their own tax advisors
regarding the effect of state and local tax laws on an investment in the Common
Stock.

CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS

The following discussion summarizes certain United States tax consequences
of the acquisition, ownership and disposition of the Common Stock by an initial
purchaser of the Common Stock that, for United States income tax purposes, is
not a "United States person" (a "Foreign Holder"). For purposes of discussion, a
"United States person" means: a citizen or resident of the United States; a
corporation, partnership, or other entity created or organized in the United
States or under the laws of the United States or of any political subdivision
thereof; or an estate or trust whose income is includible in gross income for
United States income tax purposes regardless of its source. This discussion does
not consider any specific facts or circumstances that may apply to a particular
Foreign Holder prospective investors are urged to consult their tax advisors
regarding the United States tax consequences of acquiring, holding and disposing
of Common Stock, as well as any tax consequences that may arise under the laws
of any foreign, state, local or other taxing jurisdiction.

Dividends

Dividends paid by the Company out of earnings and profits, as determined
for United States income tax purposes, to a Non-United States Holder will
generally be subject to withholding of United States federal income tax at the
rate of 30%, unless reduced or eliminated by an applicable tax treaty or unless
such dividends are treated as effectively connected with a United States trade
or business conducted by the Foreign Holder. A Foreign Holder eligible for a
reduction in withholding under an applicable treaty must so notify the Company
by completing the appropriate IRS form. Distributions paid by the Company in
excess of its earnings and profits will be treated as a tax-free return of
capital to the extent of the holder's adjusted basis in his Common Stock, and
thereafter as gain from the sale or exchange of a capital asset as described
below. If it cannot be determined at the time a distribution is made whether
such distribution will exceed the Company's earnings and profits (which, under
most circumstances, will correspond to the Company's net income before the
deduction for dividends paid), the distribution will be subject to withholding
at the same rate as dividends.

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Amounts so withheld, however, will be refundable or creditable against the
Foreign Holder's United States tax liability if the Company subsequently
determines that such distribution was, in fact, in excess of the earnings and
profits of the Company. If the receipt of the dividend is treated as being
effectively connected with the conduct of a trade or business within the United
States by a Foreign Holder, the dividend received by such holder will be subject
to the United States Federal income tax on net income that applies to United
States persons generally (and, in addition with respect to foreign corporate
holders and under certain circumstances, the branch profits tax).

For any year in which the Company qualifies as a REIT, distributions to a
Foreign Holder that are attributable to gain from the sales or exchanges by the
Company of "United States real property interests" will be treated as if such
gain were effectively connected with a United States business and will thus be
subject to tax at the normal capital gain rates applicable to United States
stockholders (subject to applicable alternative minimum tax) under the
provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled to a
treaty exemption. The Company is required to withhold 35% of any distribution
that could be designated by the Company as a capital gains dividend. This amount
may be credited against the Foreign Holder's FIRPTA tax liability.

Gain on Disposition

A Foreign Holder will generally not be subject to United States Federal
income tax on gain recognized on a sale or other disposition of the Common Stock
unless (i) the gain is effectively connected with the conduct of a trade or
business within the United States by the Foreign Holder, (ii) in the case of a
Foreign Holder who is a nonresident alien individual and holds the Common Stock
as a capital asset, such holder is present in the United States for 183 or more
days (computed in part by reference to days present in the two prior years) in
the taxable year and certain other requirements are met, or (iii) the Foreign
Holder is subject to tax under the FIRPTA rules discussed below. Gain that is
effectively connected with the conduct of a United States Holder will be subject
to the United States federal income tax on net income that applies to United
States persons generally (and, with respect to corporate holders and under
certain circumstances, the branch profits tax) but will not be subject to
withholding. Foreign Holders should consult applicable treaties, which may
provide for different rules.

Gain recognized by a Foreign Holder upon a sale of its Common Stock will
generally not be subject to tax under FIRPTA if the Company is a "domestically
controlled REIT," which is defined generally as a REIT in which at all times
during a specified testing period less than 50% in value of its shares were held
directly or indirectly by non-U.S. persons. Because only a minority of the
Company's stockholders are expected to be Foreign Holders, the Company
anticipates that it will qualify as a "domestically controlled REIT."
Accordingly, a Foreign Holder should not be subject to U.S. tax from gains
recognized upon disposition of the Common Stock.

Information Reporting and Backup Withholding

Under temporary United States Treasury regulations, United States
information reporting requirements and backup withholding tax will generally not
apply to dividends paid on the Common Stock to a Non-United States Holder at an
address outside the United States. Payments by a United States office of a
broker of the proceeds of a sale of the Common Stock is subject to both backup
withholding at a rate of 31% and information reporting unless the holder
certifies its Foreign Holder status under penalties of perjury or otherwise
establishes an exemption. Information reporting requirements (but not backup
withholding) will also apply to payments of the proceeds of sales of the Common
Stock by foreign offices of United States brokers, or foreign brokers with
certain types of relationships to the United States, unless the broker has
documentary evidence in its records that the holder is a Foreign Holder and
certain other conditions are met, or the holder otherwise establishes an
exemption.

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Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be refunded or credited against the Foreign
Holder's United States federal income tax liability, provided that the required
information is furnished to the Service.

These information reporting and backup withholding rules are under review
by the United States Treasury and their application to the Common Stock could be
changed by future regulations.

ERISA CONSIDERATIONS

In considering an investment in the Common Stock of the Company, a
fiduciary of a profit-sharing, pension stock bonus plan, or individual
retirement account, including a plan for self-employed individuals and their
employees or any other employee benefit plan subject to prohibited transaction
provisions of the Code or the fiduciary responsibility provisions of ERISA (an
"ERISA Plan") should consider (a) whether the ownership of Common Stock is in
accordance with the documents and instruments governing such ERISA Plan, (b)
whether the ownership of Common Stock is consistent with the fiduciary's
responsibilities and satisfies the requirements of Part 4 of Subtitle B of Title
I of ERISA (where applicable) and, in particular, the diversification, prudence
and liquidity requirements of Section 404 of ERISA, (c) ERISA's prohibitions in
improper delegation of control over, or responsibility for, "plan assets" and
ERISA's imposition of co-fiduciary liability on a fiduciary who participates in,
permits (by action or inaction) the occurrence of, or fails to remedy a known
breach of duty by another fiduciary, and (d) the need to value the assets of the
ERISA Plan annually.

In regard to the "plan assets" issue noted in clause (c) above, Special Tax
Counsel is of the opinion that, effective as of the date of the closing of this
Offering and the listing of the shares of Common Stock on the NYSE, and based on
certain representations of the Company, the Common Stock should qualify as a
"publicly-offered security," and, therefore, the acquisition of such Common
Stock by ERISA Plans should not cause the Company's assets to be treated as
assets of such investing ERISA Plans for purposes of the fiduciary
responsibility provisions of ERISA or the prohibited transaction provisions of
the Code. Fiduciaries of ERISA Plans and IRA's should consult with and rely upon
their own advisors in evaluating the consequences under the fiduciary provisions
of ERISA and the Code of an investment in Common Stock in light of their own
circumstances.

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UNDERWRITING

The underwriters named below (the "Underwriters"), represented by
PaineWebber Incorporated, Oppenheimer & Co., Inc., EVEREN Securities, Inc. and
Sutro & Co. Incorporated (the "Representatives"), have severally agreed to
purchase, and the Company has agreed to sell, subject to the terms and
conditions set forth in an underwriting agreement (the "Underwriting
Agreement"), the respective number of shares of Common Stock set forth opposite
their names below:

<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERWRITER TO BE PURCHASED
--------------------------------------------------------------------- ----------------
<S> <C>
PaineWebber Incorporated............................................. 1,755,000
Oppenheimer & Co., Inc. ............................................. 1,250,000
EVEREN Securities, Inc. ............................................. 1,000,000
Sutro & Co. Incorporated............................................. 1,000,000
Crowell, Weedon & Co. ............................................... 115,000
Fahnestock & Co. Inc. ............................................... 115,000
Friedman, Billings, Ramsey & Co., Inc. .............................. 115,000
Furman Selz LLC...................................................... 115,000
Gordon, Haskett Capital Corporation.................................. 115,000
Ladenburg Thalmann & Co. Inc......................................... 115,000
McDonald & Company Securities, Inc. ................................. 115,000
Morgan Fuller Capital Group.......................................... 115,000
Pennsylvania Merchant Group Ltd. .................................... 115,000
Principal Financial Securities, Inc. ................................ 115,000
Stifel, Nicolaus & Company, Incorporated............................. 115,000
Tucker Anthony Incorporated.......................................... 115,000
Unterberg Harris..................................................... 115,000
---------
Total...................................................... 6,500,000
=========
</TABLE>

In the Underwriting Agreement, the Underwriters have severally agreed,
subject to the terms and conditions set forth therein, to purchase all of the
shares of Common Stock being sold pursuant to the Underwriting Agreement (other
than those covered by the over-allotment option described below) if any shares
of Common Stock are purchased. The Underwriting Agreement provides that the
obligations of the Underwriters to purchase such shares of Common Stock are
subject to certain conditions precedent. The Underwriting Agreement also
provides that in the event of a default by any Underwriter, the purchase
commitments of the nondefaulting Underwriters may be increased or the
Underwriting Agreement may be terminated.

The Representatives have advised the Company that the Underwriters propose
to offer the shares of Common Stock in part to the public at the initial public
offering price set forth on the cover page of this Prospectus, and in part to
certain securities dealers (who may include the Underwriters) at such price less
a concession not in excess of $0.58 per share of Common Stock, and the
Underwriters and such dealers may reallow to certain dealers a discount not in
excess of $0.10 per share of Common Stock. After the closing of this Offering,
the public offering price, concessions to selected dealers and the discount to
other dealers may be changed by the Representatives. The Shares are offered
subject to receipt and acceptance by the Underwriters, and to certain other
conditions, including the right to reject orders in whole or in part.

The Company has granted the Underwriters an option exercisable for 30 days
after the date hereof to purchase up to 975,000 additional shares of Common
Stock to cover over-allotments, if any, at the initial public offering price
less the underwriting discount and commissions. If the Underwriters exercise
this option, each Underwriter will have a firm commitment, subject to certain
conditions, to purchase approximately the same percentage of such additional
shares of Common Stock as the number of shares of Common Stock to be purchased
by it shown in the foregoing table bears to the shares of Common Stock initially
offered hereby.

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The Underwriters may purchase such shares of Common Stock only to cover
over-allotments made in connection with this Offering.

The Company has agreed to indemnify the several Underwriters against
certain civil liabilities, including liabilities under the federal securities
laws, or to contribute to payments which the Underwriters may be required to
make in respect thereof.

The Company and the officers and directors of the Company have agreed that,
for a period of 180 days from the date of this Prospectus, they will not,
without the prior written consent of PaineWebber Incorporated, directly or
indirectly, sell, offer to sell, grant any option for the sale of, or otherwise
dispose of any shares of Common Stock or any security convertible into Common
Stock, except upon exercise of the options outstanding or to be issued pursuant
to the Incentive Plan, the Option Plan or the Outside Directors Plan or shares
of Common Stock to be issued pursuant to the Stock Purchase Plan.

PaineWebber Incorporated has in the past performed, and may continue to
perform, investment banking, broker dealer, lending and financial advisory
services for the Company and the Manager, and has received customary
compensation therefor. In connection with this Offering, the Company has agreed
to pay PaineWebber Incorporated an advisory fee equal to 0.5% of the gross
proceeds of this Offering for structuring and advisory services rendered in
connection with this Offering. In addition, the Company has a secured repurchase
credit facility and a collateralized line of credit with an affiliate of
PaineWebber Incorporated.

The Representatives have informed the Company that they do not expect the
Underwriters to confirm sales of Common Stock offered by this Prospectus to any
accounts over which they exercise discretionary authority.

Prior to this Offering, there has been no public market for the Common
Stock. Accordingly, the public offering price has been determined by
negotiations between the Company and the Representatives. Among the factors
which were considered in determining the initial public offering price were the
Company's future prospects, the experience of its management, the economic
condition of the financial services industry in general, the general condition
of the equity securities market, the demand for similar securities of companies
considered comparable to the Company and other relevant factors.

The initial public offering price set forth on the cover page of this
Prospectus should not be considered an indication of the actual value of the
Common Stock. The initial public offering price is subject to change as a result
of market conditions and other factors and no assurance can be given that the
Common Stock can be resold at the offering price.

Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase shares of Common Stock. As
an exception to these rules, the Representatives are permitted to engage in
certain transactions that stabilize the price of Common Stock. Such transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the Common Stock.

In addition, if the Representatives over-allot (i.e., if they sell more
shares of Common Stock than are set forth on the cover page of this Prospectus)
and thereby create a short position in the Common Stock in connection with this
Offering, then the Representatives may reduce that short position by purchasing
Common Stock in the open market. The Representatives may also elect to reduce
any short position by exercising all or part of the over-allotment option
described herein.

The Representatives may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
shares of Common Stock in the open market to reduce the Underwriters' short
position or to stabilize the price of the Common Stock, they may reclaim the
amount of the selling concession from the Underwriters and selling group members
who sold those shares as part of the offering.

In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might otherwise be in the absence of such purchases. The

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imposition of a penalty bid might also have an effect on the price of a security
to the extent that it were to discourage resales of the security by purchasers
in the offering.

Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the
Representatives will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.

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CERTAIN PROVISIONS OF MARYLAND LAW
AND THE COMPANY'S CHARTER AND BYLAWS

The following summary of material provisions of the MGCL and of the Charter
and the Bylaws of the Company does not purport to be complete and is subject to
and qualified in its entirety by reference to Maryland law and to the Charter
and the Bylaws of the Company, copies of which are filed as exhibits to the
Registration Statement of which this Prospectus is a part.

CERTAIN ANTI-TAKEOVER PROVISIONS

The Charter and the Bylaws of the Company contain certain provisions that
could discourage, impede or impair acquisition of control of the Company by
means of a tender offer, a proxy contest or otherwise. These provisions are
expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
the Company to negotiate first with the Board of Directors. The Company believes
that these provisions increase the likelihood that proposals initially will be
on more attractive terms than would be the case in their absence and increases
the likelihood of negotiations, which might outweigh the potential disadvantages
of discouraging such proposals because, among other things, negotiation of such
proposals might result in improvement of terms. The description set forth below
is a summary only, and is qualified in its entirety by reference to the Charter
and the Bylaws which have been filed as exhibits to the Registration Statement
of which this Prospectus is a part. See "Description of Capital
Stock -- Repurchase of Shares and Restrictions on Transfer" and "Risk
Factors -- Additional Risk Factors -- Limitations on Acquisition and Change in
Control."

STAGGERED BOARD OF DIRECTORS

The Charter and the Bylaws divide the Board of Directors into three classes
of directors, each class constituting approximately one-third of the total
numbers of directors, with the classes serving staggered three-year terms. The
classification of the Board of Directors will make it more difficult for
stockholders to change the composition of the Board of Directors because only a
minority of the directors can be elected at once. The Company believes, however,
that the staggered Board of Directors will help to ensure continuity and
stability of the Company's management and policies. The classification
provisions could also discourage a third party from accumulating the Company's
stock or attempting to obtain control of the Company, even though this attempt
might be beneficial to the Company and some, or a majority, of its stockholders.
Accordingly, under certain circumstances stockholders could be deprived of
opportunities to sell their shares of Common Stock at a higher price than might
otherwise be available.

NUMBER OF DIRECTORS, INDEPENDENT DIRECTORS, REMOVAL, FILLING VACANCIES

The Charter and Bylaws provide that, subject to any rights of holders of
preferred stock to elect additional directors under specified circumstances
("Preferred Holders Rights"), the number of directors will be four and may be
changed by a majority of the entire Board of Directors. Upon the closing of this
Offering, the number of directors will be increased to seven. The Bylaws provide
that a majority of the members of the Board of Directors must be independent
directors. The Bylaws provide that an "independent director" is a director of
the Company who is not an officer or employee of the Company or any subsidiary
or affiliate thereof. In addition to approval by the Board of Directors, the
following actions require approval by a majority of the independent directors:
termination of the Management Contract between the Company and the Manager,
revisions to the Company's investment policies and amendment of the Bylaws. In
addition, the Charter provides that, subject to any Preferred Holders Rights,
and unless the Board of Directors otherwise determines, any vacancies may be
filled by a vote of the stockholders or a majority of the remaining directors,
though less than a quorum, except vacancies created by an increase in the number
of directors, which only may be filled by a vote of the stockholders or a
majority of the entire Board of Directors. Accordingly, the Board of Directors
could temporarily prevent any stockholder from enlarging the Board of Directors
and filling the new directorship with such stockholder's own nominees. The
Charter and the Bylaws further provide that, subject to the rights of any class
or series to elect directors, directors may be removed only for cause upon the

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<PAGE> 88

affirmative vote of a majority of holders of all the then outstanding shares of
stock entitled to vote generally in the election of directors, voting together
as a single class.

ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER NOMINATIONS AND STOCKHOLDER PROPOSALS

The Charter and the Bylaws establish an advance notice procedure for
stockholders to nominate candidates for director or bring other business before
an annual meeting of stockholders of the Company (the "Stockholder Notice
Procedure"). The Bylaws provide that (i) only persons who are nominated by, or
at the direction of, the Board of Directors, or by a stockholder who has given
timely written notice containing specified information to the Secretary of the
Company prior to the meeting at which directors are to be elected, will be
eligible for election as directors of the Company and (ii) at an annual meeting,
only such business may be conducted as has been brought before the meeting by,
or at the direction of, the Chairman or the Board of Directors or by a
stockholder who has given timely written notice to the Secretary of the Company
of such stockholder's intention to bring such business before such meeting. In
general, for notice of stockholder nominations or proposed business (other than
business to be included in the Company's Proxy Statement under the Securities
and Exchange Commission's Rule 14a-8) to be conducted at an annual meeting to be
timely, such notice must be received by the Company not less than 60 days nor
more than 90 days prior to the first anniversary of the previous year's annual
meeting. The purpose of requiring stockholders to give the Company advance
notice of nominations and other business is to afford the Board of Directors a
meaningful opportunity to consider the qualifications of the proposed nominees
or the advisability of the other proposed business and, to the extent deemed
necessary or desirable by the Board of Directors, to inform stockholders and
make recommendations about such nominees or business, as well as to ensure an
orderly procedure for conducting meetings of stockholders. Although the Charter
and the Bylaws do not give the Board of Directors power to block stockholder
nominations for the election of directors or proposals for action, they may have
the effect of discouraging a stockholder from proposing nominees or business,
precluding a contest for the election of directors or the consideration of
stockholder proposals if procedural requirements are not met and deterring third
parties from soliciting proxies for a non-management slate of directors or
proposals, without regard to the merits of such slate or proposals.

RELEVANT FACTORS TO BE CONSIDERED BY THE BOARD OF DIRECTORS

The Charter provides that, in determining what is in the best interest of
the Company in a business combination or certain change of control events, a
director of the Company shall consider the interests of the stockholders of the
Company and, in his or her discretion, also may consider (i) the interests of
the Company's employees, suppliers, creditors and tenants, (ii) the economy of
the nation, (iii) community and societal interests, and (iv) both the long-term
and short-term interests of the Company and its stockholders, including the
possibility that these interests may be best served by the continued
independence of the Company. Pursuant to this provision, the Board of Directors
may consider subjective factors affecting a proposal, including certain
non-financial matters, and on the basis of these considerations may oppose a
business combination or other transaction which, evaluated only in terms of its
financial merits, might be attractive to some, or a majority, of the Company's
stockholders.

RIGHTS TO PURCHASE SECURITIES AND OTHER PROPERTY

The Board of Directors may create and authorize the Company to issue rights
entitling the holders thereof to purchase from the Company shares of capital
stock or other securities or property. The times at which and terms upon which
such rights are to be issued are within the discretion of the Board of
Directors. The provision is intended to confirm the Board of Directors'
authority to issue share purchase rights which could have terms that would
impede a merger, tender offer or other takeover attempt, or other rights to
purchase securities of the Company or any other entity.

BUSINESS COMBINATIONS

The MGCL prohibits certain "business combinations" (including certain
mergers, consolidations, share exchanges, asset transfers, sales, leases,
issuance or reclassification of equity securities and benefits) involving

84
<PAGE> 89

a Maryland corporation and an "Interested Stockholder." Interested Stockholders
are all persons (i) who beneficially own 10% or more of the voting power of the
corporation's stock or (ii) an affiliate or associate of the corporation who, at
any time within the two-year period prior to the date in question, was an
Interested Stockholder or an affiliate or an associate thereof. Such business
combinations are prohibited for five years after the most recent date on which
the Interested Stockholder became an Interested Stockholder. Thereafter, any
such business combination must be recommended by the board of directors of such
corporation and approved by the affirmative vote of at least (a) 80% of the
votes entitled to be cast by all holders of voting shares of the corporation,
and (b) 66 2/3% of the votes entitled to be cast by all holders of voting shares
of the corporation other than the voting shares held by the Interested
Stockholder or an affiliate or associate of the Interested Stockholder, with
whom the business combination is to be effected, unless, among other things, the
corporation's stockholders receive a minimum price (as defined in the MGCL) for
their shares and the consideration is received in cash or in the same form as
previously paid by the Interested Stockholder for its shares. These provisions
of Maryland law do not apply, however, to business combinations that are
approved or exempted by the board of directors of the corporation prior to the
time that the Interested Stockholder becomes an Interested Stockholder. The
Board of Directors of the Company has adopted a resolution exempting from the
foregoing provisions of the MGCL any business combination with any Interested
Stockholder, or any other person acting in concert or as a group with such
Interested Stockholder, although the Board of Directors may alter or repeal such
resolution, in whole or in part, at any time. A Maryland corporation may adopt
an amendment to its charter electing not to be subject to the special voting
requirements of the foregoing legislation. Any such amendment would have to be
approved by the affirmative vote of at least 80% of the votes entitled to be
cast by all holders of outstanding shares of voting stock and 66 2/3% of the
votes entitled to be cast by holders of outstanding shares of voting stock who
are not Interested Stockholders.

CONTROL SHARE ACQUISITIONS

The MGCL provides the "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares of stock owned by the acquiror or by the officers or directors
who are employees of the company. Control shares are voting shares of stock
which, if aggregated with all other shares of stock previously acquired by such
a person, would entitle the acquiror to exercise voting power in electing
directors within one of the following ranges of voting power: (i) 20% or more
but not less than 33 1/3%; (ii) 33 1/3% or more but less than a majority; or
(iii) a majority of all voting power. Control Shares do not include shares of
stock an acquiring person is entitled to vote as a result of having previously
obtained stockholder approval. A control share acquisition means, subject to
certain exceptions, the acquisition of, ownership of or the power to direct the
exercise of voting power with respect to, control shares. A person who has made
or proposed to make a "control share acquisition," upon satisfaction of certain
conditions (including an undertaking to pay expenses), may compel the board of
directors to call a special meeting of stockholders to be held within 50 days of
demand therefor to consider the voting rights of the shares. If no request for a
meeting is made, the corporation may itself present the question at any
stockholders' meeting. If voting rights are not approved at the meeting or if
the acquiring person does not deliver an acquiring person statement as permitted
by the statute, then, subject to certain conditions and limitations, the
corporation may redeem any or all of the control shares (except those for which
voting rights have previously been approved) for fair value determined, without
regard to voting rights, as of the date of the last control share acquisition or
of any meeting of stockholders at which the voting rights of such shares are
considered and not approved. If voting rights for "control shares" are approved
at a stockholders' meeting and the acquiror becomes entitled to vote a majority
of the shares entitled to vote, all other stockholders may exercise appraisal
rights. The fair value of the stock as determined for purposes of such appraisal
rights may not be less than the highest price per share paid in the control
share acquisition, and certain limitations and restrictions otherwise applicable
to the exercise of dissenters' rights do not apply in the context of a "control
share acquisition." The control share acquisition statute does not apply to
stock acquired in a merger, consolidation or stock exchange if the corporation
is a party to the transaction, or to acquisitions previously approved or
exempted by a provision in the charter or by-laws of the corporation. Pursuant
to the statute, the Bylaws have exempted control share

85
<PAGE> 90

acquisitions involving any shares of the capital stock of the Company now or
hereafter outstanding, although this provision may be altered or repealed, in
whole or in part, upon the affirmative vote of the Board of Directors, including
a majority of the independent directors. The limitation on ownership of shares
of Common Stock set forth in the Charter, as well as the provisions of the MGCL,
could have the effect of discouraging offers to acquire the Company and of
increasing the difficulty of consummating any such offer. See "Description of
Capital Stock -- Repurchase of Shares and Restrictions on Transfer."

LEGAL MATTERS

Certain legal matters will be passed on for the Company by Gray Cary Ware &
Freidenrich, a professional corporation, San Diego, California as counsel to the
Company in connection with this Offering. The validity of the Common Stock
offered hereby will be passed on by Piper & Marbury L.L.P., special Maryland
counsel to the Company. Certain tax matters will be passed on by Jeffers,
Wilson, Shaff & Falk, LLP, Irvine, California as Special Tax Counsel to the
Company in connection with this Offering. Certain legal matters will be passed
on for the Underwriters by O'Melveny & Myers LLP, San Francisco, California.
Gray Cary Ware & Freidenrich, Special Tax Counsel and O'Melveny & Myers LLP have
relied as to all matters of Maryland law on the opinion of special Maryland
counsel to the Company.

EXPERTS

The financial statements of American Residential Investment Trust, Inc. as
of June 30, 1997, and for the period from February 11, 1997 (commencement of
operations) through June 30, 1997, have been included herein in reliance on the
report of KPMG Peat Marwick LLP, independent auditors, appearing elsewhere
herein, and upon the authority of said firm as experts in accounting and
auditing.

ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C. 20549, a Registration Statement on Form S-11
under the Securities Act of 1933, as amended, with respect to the Common Stock
offered hereby. This Prospectus does not contain all the information set forth
in the Registration Statement and the exhibits and schedules thereto. For
further information with respect to the Company and such Common Stock, reference
is made to the Registration Statement and the exhibits and schedules filed as
part thereof. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and, in
each instance, if such contract or document is filed as an exhibit, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each statement being qualified in all respects by such
reference to such exhibit. The Registration Statement, including exhibits and
schedules thereto, may be inspected without charge at the Commission's principal
office in Washington, D.C., and copies of all or any part thereof may be
obtained from such office after payment of fees prescribed by the Commission.
The Commission maintains a Website that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission. The address of the site is http://www.sec.gov.

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<PAGE> 91

GLOSSARY

As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.

"AGENCY SECURITIES" means mortgage participation certificates issued by
FHLMC, FNMA or GNMA. These securities entitle the holder to receive a
pass-through of principal and interest payments on the underlying pool of
Mortgage Loans and are issued or guaranteed by federal government sponsored
agencies.

"CAPITAL CUSHION" is a term defined in the Company's Capital Policy. It
represents the equity reserve amount assigned to each Mortgage Asset which is
adjusted based upon the Company's assessment of the risk of delinquency, default
or loss on such Mortgage Asset.

"CAPITAL POLICY" means the policy established by the Company which limits
Management's ability to acquire additional Mortgage Assets during such times
that the actual capital base of the Company is less than a required amount
defined in the policy. The required amount is the sum of the "haircuts" required
by the Company's secured lenders (the required haircut) and the additional
capital levels called for under the policy which are determined with reference
to the various risks inherent in the Company's Mortgage Assets (the liquidity
capital cushion).

"CODE" means the Internal Revenue Code of 1986, as amended.

"CORRESPONDENTS" means entities which originate Mortgage Loans for resale
to the Company. The Company's Correspondents may include mortgage banks, savings
and loans, credit unions, commercial banks, institutional mortgage brokers and
other entities.

"COUPON RATE" means, with respect to Mortgage Assets, the annualized cash
interest income actually received from the asset, expressed as a percentage of
the face value of the asset.

"EARNING ASSETS" means the Company's Mortgage Assets and cash balances.

"EQUITY-FUNDED LENDING" means the portion of the Company's earning assets
acquired using the Company's equity capital.

"FEDERAL FUNDS RATE" means the interest rate that is charged by banks with
excess reserves at a Federal Reserve District Bank to banks needing the money to
meet reserve requirements. The Federal Funds Effective Rate is the average rate
at which Fed Funds were traded over the course of a day. The Fed will act to
ensure that the Fed Funds rate trades within a range of its Fed Funds Target
Rate, which is set at the FOMC meetings.

"FHA" means the United States Federal Housing Administration.

"FHLMC" means the Federal Home Loan Mortgage Corporation.

"FNMA" means the Federal National Mortgage Association.

"FULLY-INDEXED RATE" means, with respect to adjustable-rate Mortgage
Assets, the rate that would be paid by the borrower ("GROSS") or received by the
Company as owner of the Mortgage Asset ("NET") if the coupon rate on the
adjustable-rate Mortgage Assets were able to adjust immediately to a market rate
without being subject to adjustment periods, periodic caps, or life caps. It is
equal to the current yield of the adjustable-rate Mortgage Assets index plus the
gross or net margin.

"GAAP" means generally accepted accounting principles.

"GNMA" means the Government National Mortgage Association.

"GROSS ASSETS" means for any month the aggregate book value of the
consolidated assets of the Company and its subsidiaries, before reserves for
depreciation or bad debts or other similar noncash reserves, computed at the end
of such month prior to any dividend distribution made during each month.

"HAIRCUT" means the percentage by which the market value of the pledged
collateral is required by a lender to exceed the borrowing amount in connection
with a collateralized borrowing.

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<PAGE> 92

"INTEREST RATE ADJUSTMENT INDICES" means, in the case of Mortgage Assets,
any of the objective indices based on the market interest rates of a specified
debt instrument (such as United States Treasury Bills in the case of the
Treasury Index and United States dollar deposits in London in the case of LIBOR)
or based on the average interest rate of a combination of debt instruments (such
as the 11th District Cost of Funds Index), used as a reference base to reset the
interest rate for each adjustment period on the Mortgage Asset, and in the case
of borrowings, is used herein to mean the market interest rates of a specified
debt instrument (such as reverse repurchase agreements for Mortgage Securities)
as well as any of the objective indices described above that are used as a
reference base to reset the interest rate for each adjustment period under the
related borrowing instrument.

"INTEREST RATE ADJUSTMENT PERIOD" means, in the case of Mortgage Assets,
the period of time set forth in the debt instrument that determines when the
interest rate is adjusted and, with respect to borrowings, is used to mean the
term to maturity of a short term, fixed-rate debt instrument (such as a 30-day
reverse repurchase agreement) as well as the period of time set forth in a long
term, adjustable-rate debt instrument that determines when the interest rate is
adjusted.

"LIBOR" means London Inter-bank Offered Rate as specifically used as
interest rate adjustment indicia for Mortgage Assets and related borrowings.

"LIFETIME INTEREST RATE CAP" or "LIFE CAP" means the maximum coupon rate
that may accrue during any period over the term of an adjustable-rate Mortgage
Loan or, in the case of a Mortgage Security, the maximum weighted average coupon
rate that may accrue during any period over the term of such Mortgage Security.

"LIQUIDITY CAPITAL CUSHION" is a term defined in the Company's Capital
Policy. It represents a portion of the capital the Company is required to
maintain as part of this policy in order to continue to make asset acquisitions.
The liquidity capital cushion is that part of the required capital base which is
in excess of the Company's haircut requirements.

"MORTGAGE ASSETS" means Mortgage Securities and Mortgage Loans.

"MORTGAGE LOANS" means mortgage loans secured by residential or mixed use
properties.

"MORTGAGE SECURITIES" means Agency Securities and Privately Issued
Securities.

"NONCONFORMING MORTGAGE LOANS" means conventional single-family and
multifamily Mortgage Loans that do not conform to one or more requirements of
FHLMC or FNMA for participation in one or more of such agencies' mortgage loss
credit support programs.

"PERIODIC INTEREST RATE CAP" or "PERIODIC CAP" means the maximum change in
the coupon rate permissible under the terms of the loan at each coupon
adjustment date. Periodic caps limit both the speed by which the coupon rate can
adjust upwards in a rising interest rate environment and the speed by which the
coupon rate can adjust downwards in a falling rate environment.

"PRIVATELY ISSUED SECURITIES" means mortgage participation certificates
issued by certain private institutions. These securities entitle the holder to
receive a pass-through of principal and interest payments on the underlying pool
of Mortgage Loans and are issued or guaranteed by the private institution.

"REIT" means real estate investment trust.

"REIT PROVISIONS OF THE CODE" means sections 856 through 860 of the Code.

"REMIC" means Real Estate Mortgage Investment Conduit.

"REVERSE REPURCHASE AGREEMENT" means a borrowing device evidenced by an
agreement to sell securities or other assets to a third-party and a simultaneous
agreement to repurchase them at a specified future date and price, the price
difference constituting the interest on the borrowing.

"SPREAD LENDING" means the portion of the Company's earning assets acquired
using borrowed funds.

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<PAGE> 93

"TEN YEAR U.S. TREASURY RATE" for a quarterly period shall mean the
arithmetic average of the weekly per annum Ten Year Average Yields published by
the Federal Reserve Board during such quarter. In the event that the Federal
Reserve Board does not publish a weekly per annum Ten Year Average Yield during
any week in a quarter, then the Ten Year U.S. Treasury Rate for such week shall
be the weekly per annum Ten Year Average Yield published by any Federal Reserve
Bank or by any U.S. Government department or agency selected by the Company for
such week. In the event that the Company determines in good faith that for any
reason the Company cannot determine the Ten Year U.S. Treasury Rate for any
quarter as provided above, then the Ten Year U.S. Treasury Rate for such quarter
shall be the arithmetic average of the per annum average yields to maturity
based upon the daily closing bids during such quarter for each of the issues of
actively traded marketable U.S. Treasury fixed interest rate securities (other
than securities which can, at the option of the holder, be surrendered at face
value in payment of any federal estate tax) with a final maturity date not less
than eight nor more than twelve years from the date of each such quotation, as
chosen and for each business day (or less frequently if daily quotations shall
not be generally available) in each such quarterly period in New York City and
quoted to the Company by at least three recognized dealers in U.S. Government
securities selected by the Company.

"VA" means the United States Department of Veterans Affairs.

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<PAGE> 94

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors......................................................... F-2
Balance Sheet.......................................................................... F-3
Statement of Operations................................................................ F-4
Statement of Stockholders' Equity...................................................... F-5
Statement of Cash Flows................................................................ F-6
Notes to Financial Statements.......................................................... F-7
</TABLE>

F-1
<PAGE> 95

REPORT OF INDEPENDENT AUDITORS

The Board of Directors
American Residential Investment Trust, Inc.
Del Mar, California:

We have audited the accompanying balance sheet of American Residential
Investment Trust, Inc. (the Company) as of June 30, 1997 and the related
statements of operations, stockholders' equity and cash flows for the period
from February 11, 1997 (commencement of operations) through June 30, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of June 30,
1997, and the results of its operations and its cash flows for the period from
February 11, 1997 (commencement of operations) through June 30, 1997 in
conformity with generally accepted accounting principles.

/s/ KPMG Peat Marwick LLP

KPMG Peat Marwick LLP

San Diego, California
October 20, 1997.

F-2
<PAGE> 96

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)

ASSETS

<TABLE>
<CAPTION>
JUNE 30, 1997
-------------
<S> <C>
Cash and cash equivalents....................................................... $ 127
Mortgage Assets available-for-sale.............................................. 228,620
Interest rate agreements........................................................ 502
Accrued interest receivable..................................................... 2,259
Other assets.................................................................... 10
--------
$ 231,518
========

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Reverse repurchase agreements................................................... $ 209,539
Accrued interest payable........................................................ 1,088
Accrued expense and other liabilities........................................... 215
Management fee payable.......................................................... 73
--------
Total liabilities..................................................... 210,915
--------
Commitments and contingencies (Note 10)

Stockholders' Equity:
Preferred stock, par value $.01 per share; 1,000,000 shares authorized; no
shares issued and outstanding................................................. --
Common Stock, par value $.01 per share; 3,000,000 shares authorized; 1,614,000
shares issued and outstanding................................................. 16
Additional paid-in capital...................................................... 20,149
Cumulative dividends declared................................................... (146)
Retained earnings............................................................... 584
--------
Total stockholders' equity............................................ 20,603
--------
$ 231,518
========
</TABLE>

See accompanying notes to financial statements.

F-3
<PAGE> 97

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
FOR THE PERIOD
FEBRUARY 11, 1997
(COMMENCEMENT OF
OPERATIONS) THROUGH
JUNE 30, 1997
-------------------
<S> <C>
Interest income:
Mortgage Assets........................................................... $ 3,489
Cash and investments...................................................... 151
------
3,640
Interest expense:........................................................... 2,916
------
Net interest income......................................................... 724
Other expenses
Management fee............................................................ 69
General and administrative expenses....................................... 71
------
140
------
Net income.................................................................. $ 584
======
Net income per share of Common Stock........................................ $ 0.35
Dividends per share of Common Stock......................................... $ 0.09
</TABLE>

See accompanying notes to financial statements.

F-4
<PAGE> 98

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE
------------------ PAID-IN DIVIDENDS RETAINED
SHARES AMOUNT CAPITAL DECLARED EARNINGS TOTAL
--------- ------ ---------- ---------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Initial capital contribution,
February 11, 1997................... 1,614,000 $ 16 $ 20,149 $ -- $ -- $20,165
--------- --- ------- ----- ---- -------
Net income............................ -- -- -- -- 584 584
Dividends declared.................... -- -- -- (146) -- (146)
--------- --- ------- ----- ---- -------
Balance, June 30, 1997................ 1,614,000 $ 16 $ 20,149 $ (146) $ 584 $20,603
========= === ======= ===== ==== =======
</TABLE>

See accompanying notes to financial statements.

F-5
<PAGE> 99

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
FOR THE PERIOD
FEBRUARY 11, 1997
(COMMENCEMENT OF
OPERATIONS) THROUGH
JUNE 30, 1997
-------------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................ $ 584
Adjustments to reconcile net income to net cash used in operating
activities:
Amortization of mortgage assets premiums............................... 528
Amortization of interest rate cap agreements........................... 40
Increase in accrued interest receivable................................ (2,259)
Increase in other assets............................................... (10)
Increase in accrued interest payable................................... 1,088
Increase in accrued expenses........................................... 288
----------
Net cash provided by operating activities......................... 259
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of Mortgage Assets available-for-sale........................... (239,555)
Principal payments on Mortgage Assets available-for-sale.................. 10,407
Purchase of interest rate cap agreements.................................. (542)
----------
Net cash used in investing activities............................. (229,690)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements......................... 209,539
Net proceeds from stock issuance.......................................... 20,165
Dividends paid............................................................ (146)
----------
Net cash provided by financing activities......................... 229,558
Net increase in cash and cash equivalents................................... 127
Cash and cash equivalents at beginning of period............................ --
----------
Cash and cash equivalents at end of period.................................. $ 127
==========
Supplemental Information
Interest Paid............................................................. $ 1,828
==========
</TABLE>

See accompanying notes to financial statements.

F-6
<PAGE> 100

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Organization

American Residential Investment Trust, Inc. (the "Company"), a newly formed
Maryland corporation, commenced operations on February 11, 1997. The Company was
formed through a private equity funding from its manager, Home Asset Management
Corporation (the "Manager"). The Company operates as a mortgage real estate
investment trust which will elect to be taxed as a real estate investment trust
("REIT") for Federal income tax purposes, which generally will allow the Company
to pass through income to stockholders without payment of corporate level
federal income tax. The Company was formed for the purpose of investing in
residential adjustable-rate mortgage-backed securities and mortgage loans. The
Company has developed tailored mortgage loan products for mortgage loans to be
originated by and acquired directly from correspondents. The Company finances
its acquisitions of Mortgage Assets with equity and secured borrowings.

Basis of Financial Statement Presentation

The preparation of financial statements in conformity with generally
accepted accounting principles requires management of the Company to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the report amounts of revenue and expenses during
the reported period. Actual results could differ from those estimates.

A summary of the Company's significant accounting policies follows:

Cash and Cash Equivalents

For purposes of the statement of cash flows, cash and cash equivalents
include cash on hand and highly liquid investments with original maturities of
three months or less.

Mortgage Assets

The Company's Mortgage Assets consist of interests in mortgage loans which
have been securitized by others prior to acquisition by the Company.

Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to
classify its investments as either trading investments, available-for-sale
investments or held-to-maturity investments. Although the Company generally
intends to hold most of its Mortgage Assets until maturity, it may, from time to
time, sell any of its Mortgage Assets as part of its overall management of its
balance sheet. Accordingly, this flexibility requires the Company to classify
all of its Mortgage Assets as available-for-sale. All Mortgage Assets classified
as available-for-sale are reported at fair value, with unrealized gains and
losses excluded from earnings and reported as a separate component of
stockholders' equity.

Unrealized losses on Mortgage Assets that are considered other than
temporary, as measured by the amount of decline in fair value attributable to
factors other than temporary, are recognized in income and the cost basis of the
Mortgage Asset is adjusted. The determination of whether unrealized losses are
other than temporary is based on management of the Company's assessment of
various factors affecting the Mortgage Assets.

Interest income is accrued based on the outstanding principal amount of the
Mortgage Assets and their contractual terms. Premiums relating to Mortgage
Assets are amortized into interest income over the lives of

F-7
<PAGE> 101

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

the Mortgage Assets using the interest method. Gains or losses on the sale of
Mortgage Assets are based on the specific identification method.

Interest Rate Agreements

The Company uses interest rate cap agreements (the "Cap Agreements") for
interest rate risk protection. The Cap Agreements are purchased primarily to
reduce the Company's exposure to rising interest rates which would increase the
cost of liabilities above the maximum yield which could be earned on the
adjustable rate Mortgage Assets. The Company periodically evaluates the
effectiveness of these Cap Agreements under various interest rate scenarios.

The cost of the agreements are amortized over the life of the interest rate
agreements using the straight-line method. The Company has credit risk to the
extent counterparties to the Cap Agreements do not perform their obligations
under the Cap Agreements. In order to lessen this risk and to achieve
competitive pricing, the Company has entered into Cap Agreements only with
counterparties which are investment grade rated.

Income Taxes

The Company will elect to be taxed as a REIT and intends to comply with the
REIT Provisions of the Internal Revenue Code (the "Code") and the corresponding
provisions of State law. Accordingly, the Company will not be subject to Federal
or state income tax to the extent of its distributions to stockholders. In order
to maintain its status as a REIT, the Company is required, among other
requirements, to distribute at least 95% of its taxable income.

Earnings per Share

Earnings per share are based on the weighted average shares of Common Stock
outstanding plus common share equivalents outstanding for the period. The
treasury stock method calculation assumes all dilutive stock options and
Warrants are exercised and the funds generated by the exercise are used to buy
back outstanding Common Stock at the average market price during the reporting
period, for primary earnings per share, or at the end of period market price if
higher, for fully diluted earnings per share.

Recent Accounting Developments

In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 125 (SFAS 125), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,"
which supersedes SFAS 122. SFAS 125 provides accounting and reporting standards
for transfers and servicing of financial assets and extinguishments of
liabilities. These standards are based on consistent application of a financial
components approach that focuses on control. Under that approach, after a
transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and the liabilities it has incurred, derecognizes financial
assets when control has been surrendered and derecognizes liabilities when
extinguished. SFAS 125 provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings. SFAS 125 requires that liabilities and derivatives incurred or
obtained by transferors as part of a transfer of financial assets be initially
measured at fair value, if practicable. It also requires that servicing assets
and other retained interests in the transferred assets be measured by allocating
the previous carrying amount between the assets sold, if any, and retained
interests, if any, based on their relative fair values at the date of the
transfers. SFAS 125 includes specific provisions to deal with servicing assets
or liabilities. SFAS 125 will be effective for transactions occurring after
December 31, 1996, except for certain transactions which according to Statement
of Financial Accounting

F-8
<PAGE> 102

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

Standards No. 127, "Deferral of the Effective Date of Certain Provisions of FASB
125," will be effective if occurring after December 31, 1997.

In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("SFAS 128"). "Earnings per Share",
SFAS 128 supersedes APB Opinion No. 15 ("APB 15"), "Earnings per Share" and
specifies the computation, presentation and disclosure requirements for earnings
per share ("EPS") for entities with publicly held common stock or potential
common stock. SFAS 128 will replace the presentation of primary EPS with a
presentation of basic EPS, and fully diluted EPS with diluted EPS. SFAS 128 will
also require dual presentation of basic and diluted EPS on the face of the
income statement for all entities with complex capital structures and requires a
reconciliation of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS computation. This statement is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods; earlier application is not permitted. The
Company has determined that this statement will have no significant impact on
the Company's financial position or results of operations.

NOTE 2. MORTGAGE ASSETS

At June 30, 1997, Mortgage Assets consisted of the following Agency
Securities available-for-sale:

<TABLE>
<CAPTION>
FEDERAL HOME FEDERAL NATIONAL
LOAN MORTGAGE MORTGAGE
CORPORATION ASSOCIATION TOTAL
------------- ---------------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Mortgage Securities available-for-sale, principal....... $ 132,818 $ 87,571 $220,389
Unamortized premium..................................... 4,701 3,530 8,231
-------- ------- --------
Amortized cost.......................................... $ 137,519 $ 91,101 $228,620
======== ======= ========
</TABLE>

At June 30, 1997, all investments in Mortgage Assets consisted of interests
in adjustable rate mortgage loans on residential properties. The securitized
interests in pools of adjustable rate mortgages from the Federal Home Loan
Mortgage Corporation and the Federal National Mortgage Association are
guaranteed as to principal and interest. The original maturity of the vast
majority of the Mortgage Assets is over a period of thirty years; the actual
maturity is subject to change based on the prepayments of the underlying
mortgage loans.

At June 30, 1997, the weighted average net coupon on the Mortgage Assets
was 7.78% per annum based on the amortized cost of the Mortgage Assets. All
Mortgage Assets have repricing frequency of one year or less. At June 30, 1997,
the estimated fair value of Mortgage Assets approximated amortized cost.

NOTE 3. INTEREST RATE AGREEMENTS

The amortized cost of the Company's interest rate agreements was $502,000,
net of accumulated amortization of $40,000, at June 30, 1997.

Cap Agreements

The Company had twelve outstanding Cap Agreements at June 30, 1997.
Potential future earnings from each of these Cap Agreements are based on
variations in the London Interbank Offered Rate ("LIBOR"). The Cap Agreements at
June 30, 1997 have contractually stated notional amounts which vary over the
life of

F-9
<PAGE> 103

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

the Cap Agreements. Under these Cap Agreements the Company will receive cash
payments should the agreed-upon reference rate, one month LIBOR, increase above
the strike rates of the Cap Agreements.

All of the adjustable-rate mortgage securities and mortgage loans are
limited by periodic caps (generally interest rate adjustments are limited to no
more than 1% every six months) and lifetime interest rate caps. At June 30, 1997
the weighted average lifetime cap was 10.324%.

Cap agreements outstanding at June 30, 1997 are as follows:

<TABLE>
<CAPTION>
AVERAGE CAP EXPECTED
NOTIONAL FACE AVERAGE CAP LOW CAP HIGH CAP CAP EXPENSE
YEAR AMOUNT STRIKE RATE STRIKE RATE STRIKE RATE AMORTIZATION
- --------------------------------------- ------------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1997................................... $ -- 0% 0% 0% $ 132
1998................................... 133,903 8.11 7.52 9.95 182
1999................................... 121,284 8.11 7.52 9.95 182
2000................................... 93,179 8.11 7.52 9.95 46
----
Total........................ $ 542
====
</TABLE>

NOTE 4. REVERSE REPURCHASE AGREEMENTS

The Company has entered into reverse repurchase agreements to finance the
acquisition of its Mortgage Assets. The maximum aggregate amount available under
the reverse repurchase agreements at June 30, 1997 is over $500 million. These
reverse repurchase agreements are collateralized by a portion of the Company's
Mortgage Assets. At no time were there more than approximately 45% of the
reverse repurchase agreements with any one investment banking firm. At June 30,
1997, Mortgage Assets pledged had an estimated fair value of approximately $221
million.

At June 30, 1997, the Company had approximately $210 million of reverse
repurchase agreements outstanding with a weighted average borrowing rate of
5.69% per annum and a weighted average remaining maturity of 62 days. The
maximum month end balance and the average balance outstanding for the period
February 11, 1997 through June 30, 1997, was $210 million and $151.3 million,
respectively. At June 30, 1997, the reverse repurchase agreements had the
following characteristics:

<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
----------------------------------------------------------------------
REVERSE WEIGHTED AVERAGE
REPURCHASE UNDERLYING INTEREST RATE WEIGHTED AVERAGE
LIABILITY COLLATERAL (PER ANNUM) MATURITY DATE
---------- ---------- ---------------- -------------------
<S> <C> <C> <C> <C>
PaineWebber Incorporated......... $ 21,984 $ 22,588 5.60% July 21, 1997
Morgan Stanley................... 32,012 33,955 5.90 October 6, 1997
Goldman Sachs.................... 85,577 91,863 5.69 September 17, 1997
Federal Home Loan Mortgage
Corporation.................... 34,316 36,193 5.65 August 21, 1997
Lehman Brothers.................. 35,650 35,980 5.60 July 26, 1997
-------- -------- ---- ------------------
$209,539 $220,579 5.69% August 31, 1997
======== ======== ==== ==================
</TABLE>

At June 30, 1997, the Company had funds available under a $25 million
short-term line of credit at an interest rate equal to LIBOR plus 0.6%, secured
by certain receivables related to the Mortgage Assets. The balance under such
line of credit was zero at June 30, 1997.

F-10
<PAGE> 104

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS

The following disclosure of the estimated fair value of financial
instruments as of June 30, 1997, is made in accordance with the requirements of
Statement of Financial Accounting Standards ("SFAS") No. 107, Disclosure About
Fair Value of Financial Instruments, and SFAS 119, Disclosures About Derivative
Financial Instruments and Fair Value of Financial Instruments. The estimated
fair value amounts have been determined by the Company's management using
available market information and appropriate valuation methodologies; however,
considerable judgment is necessarily require to interpret market data to develop
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.

<TABLE>
<CAPTION>
AS OF
JUNE 30, 1997
---------------------
CARRYING FAIR
AMOUNT VALUE
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Assets
Cash and cash equivalents............................ $ 127 $ 127
Mortgage Assets available-for-sale................... 228,620 228,620
Interest rate agreements............................. 502 206
Liabilities
Reserve repurchase agreements........................ $209,539 $209,539
</TABLE>

The following describes the methods and assumptions used by the Company in
estimating fair values.

Cash and Cash Equivalents

The carrying amount for cash and cash equivalents approximates fair value
because these instruments are demand deposits and money market mutual funds and
do not present unanticipated interest rate or credit concerns.

Mortgage Assets Available-for-Sale

The fair value of Mortgage Assets available-for-sale is estimated based on
quoted market prices from dealers and brokers for similar types of Mortgage
Securities.

Interest Rate Agreements

The fair value of interest rate agreements is estimated based on quoted
market prices from dealers and brokers.

Reverse Repurchase Agreements

The fair value of reverse repurchase agreements approximates the carrying
amounts because of the short term maturity of the liabilities.

F-11
<PAGE> 105

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

NOTE 6. STOCK OPTION PLANS

The Company has adopted the 1997 Stock Incentive Plan (the "Incentive
Plan") and the 1997 Stock Option Plan (the "Option Plan") for executive officers
and key employees and has adopted the 1997 Outside Directors Option Plan (the
"Directors Plan") for directors who are not employees of the Company.

The Incentive Plan, the Option Plan and the Directors Plan authorize the
Board of Directors (or a committee appointed by the Board of Directors) to grant
incentive stock options ("ISOs"), as defined under section 422 of the Code,
options not so qualified ("NQSOs"), and stock appreciation rights ("Awards") to
such eligible recipients.

The Incentive Plan was adopted on February 11, 1997 (the "Effective Date"),
and a total of 315,200 shares of Common Stock have been reserved for issuance
under the Incentive Plan. During the period ended June 30, 1997, the Company
granted 315,200 options at an exercise price of $12.50 per share, 216,000 of
which were NQSOs and 99,200 of which were ISOs. All stock options granted under
the Incentive Plan vest the earlier of a four year period from the date of grant
or once the Company issues $150 million of new equity, and will expire within
ten years after the date of grant. As of June 30, 1997, the Company also granted
280,000 stock appreciation rights at an exercise price of $12.50 per share.
Stock appreciation rights were granted in tandem with options.

Also, the Company has adopted the 1997 Employee Stock Purchase Plan (the
"Purchase Plan") which permits eligible employees to purchase Common Stock at a
discount through accumulated payroll deductions. No shares were issued under the
Purchase Plan as of June 30, 1997.

The Board of Directors has reserved a total of 474,800, 60,000 and 20,000
shares of Common Stock for issuance under the Company's Stock Option Plan,
Directors Plan and Purchase Plan respectively. Upon the closing of the Company's
initial public offering (the "Offering"), options for 337,800 shares of Common
Stock are reserved for issuance under the Option Plan and 137,000 and 20,000
shares of Common Stock will remain available for future grant under the Option
Plan and the Purchase Plan, respectively. On the effective date of the Offering,
each Outside Director will be granted under the Directors Plan an option to
purchase 7,500 shares of Common Stock.

In November 1995, the FASB issued Statement of Financial Accounting
Standards No. 123 (SFAS 123), "Accounting for Stock Based Compensation." This
statement establishes financial accounting standards for stock-based employee
compensation plans. SFAS 123 permits the Company to choose either a new fair
value based method or the current APB Opinion 25 Intrinsic value based method of
accounting for its stock-based compensation arrangements. SFAS 123 requires pro
forma disclosures of net income (loss) computed as if the fair value based
method had been applied in financial statements of companies that continue to
follow current practice in accounting for such arrangements under Opinion 25.
SFAS 123 applies to all stock-based employee compensation plans in which an
employer grants shares of its stock or other equity instruments to employees
except for employee stock ownership plans. SFAS 123 also applies to plans in
which the employer incurs liabilities to employees in amounts based on the price
of the employer's stock, i.e., stock option plans, stock purchase plans,
restricted stock plans, and stock appreciation rights. The statement also
specifies the accounting for transactions in which a company issues stock
options or other equity instruments for services provided by nonemployees or to
acquire goods or services from the outside suppliers or vendors.

The Company elected to apply the APB Opinion 25 in accounting for its Plan
and, accordingly, no compensation cost has been recognized for its stock options
in the financial statements. Had the Company determined compensation cost based
on the fair value at the grant date for its stock options exercisable under SFAS
No. 123, the Company's net income and income per share for the period February
11, 1997

F-12
<PAGE> 106

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

(commencement of operations) through June 30, 1997 would have decreased to the
pro forma amounts indicated below.

<TABLE>
<CAPTION>
FOR THE PERIOD FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997
--------------------------------
(IN THOUSANDS EXCEPT SHARE DATA)
<S> <C>
Net income as reported............................................. $ 584
=====
Pro forma net income............................................... $ 47
=====
Income per share as reported....................................... $ 0.35
=====
Pro forma income per share......................................... $ 0.03
=====
</TABLE>

The derived fair value of the options granted during the period February
11, 1997 (commencement of operations) through June 30, 1997 was approximately
$1.9 million, using the Black-Scholes option pricing model with the following
assumptions; risk-free interest rate of 6.0%, expected life of 10 years, and
expected volatility of 20%.

NOTE 7. STOCKHOLDERS' EQUITY

On February 11, 1997, the Company issued 1,614,000 shares of Common Stock
at a price of $12.50 per share. The Company received proceeds of $20,165,000,
net of issuance costs of $10,000.

On July 17, 1997, the Company declared a dividend of $438,000, or $0.27 per
common share. This dividend was paid on July 17, 1997 to holders record of
Common Stock as of June 30, 1997. On May 1, 1997, the Company declared a
dividend of $146,000, or $0.09 per share of Common Stock. This dividend was paid
on May 1, 1997 to common stockholders of record as of March 31, 1997.

NOTE 8. STOCK SPLIT AND AUTHORIZED SHARES

On August 6, 1997, the Company authorized a 0.8-for-one reverse stock split
of all of the Common Stock. All references in the financial statements to the
number of shares, per share amounts and prices of the Company's Common Stock
have been retroactively restated to reflect the decreased number of shares of
Common Stock outstanding. On October 20, 1997, the Company increased the number
of total authorized shares of Capital Stock to 25,000,000 from 4,000,000.

NOTE 9. MANAGEMENT AGREEMENT

Effective February 11, 1997, the Company entered into a Management
Agreement with the Manager for an initial term of two years, to provide
management services to the Company. These services include the purchase,
financing, and administration of mortgage loans and mortgage securities.

The Manager receives management fees and incentive compensation as follows:

- 1/8 of 1% per year, to be paid monthly, of the principal amount of agency
securities;

- 3/8 of 1% per year, to be paid monthly, of the principal amount of all
Mortgage Assets other than agency securities; and

Management fees of $69,000 were recorded for the period from February 11,
1997 (commencement of operations) through June 30, 1997. The incentive
compensation is calculated for each fiscal quarter, and paid to the Manager
quarterly in arrears before any income distributions are made to stockholders.
No incentive

F-13
<PAGE> 107

AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE PERIOD FROM FEBRUARY 11, 1997
(COMMENCEMENT OF OPERATIONS)
THROUGH JUNE 30, 1997

compensation was recorded for the period from February 11, 1997 (commencement of
operations) to June 30, 1997.

NOTE 10. COMMITMENTS AND CONTINGENCIES

As of June 30, 1997, the Company had no outstanding commitments to purchase
or sell Mortgage Assets or to purchase, sell or terminate interest rate
agreements. The Company also had no commitments to enter into additional reverse
repurchase agreements or other borrowings.

F-14
<PAGE> 108

======================================================

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND REPRESENTATION
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE
UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT
RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION
OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL.
------------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary..................... 1
Risk Factors........................... 8
The Company............................ 18
Use of Proceeds........................ 20
Dividend Policy and Distributions...... 21
Capitalization......................... 22
Dilution............................... 23
Selected Financial Data................ 24
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 25
Business............................... 30
Management of the Company.............. 44
Benefits of Offering to Management..... 53
The Manager............................ 54
Management and Termination Fees........ 58
Certain Transactions................... 61
Conflicts of Interest.................. 64
Principal Stockholders................. 65
Description of Capital Stock........... 66
Shares Eligible for Future Sale........ 69
Federal Income Tax Consequences........ 70
ERISA Considerations................... 79
Underwriting........................... 80
Certain Provisions of Maryland Law and
the Company's Charter and Bylaws..... 83
Legal Matters.......................... 86
Experts................................ 86
Additional Information................. 86
Glossary............................... 87
Index to Financial Statements.......... F-1
</TABLE>

UNTIL NOVEMBER 23, ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK,
WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.

======================================================
======================================================

6,500,000 SHARES

LOGO

COMMON STOCK
-----------------
PROSPECTUS
-----------------

PAINEWEBBER INCORPORATED
OPPENHEIMER & CO., INC.
EVEREN SECURITIES, INC.
SUTRO & CO. INCORPORATED
------------------------

OCTOBER 28, 1997

======================================================