INCOME OPPORTUNITY REALTY INVESTORS INC /TX/, 10-K405, 1997-03-13

INCOME OPPORTUNITY REALTY INVESTORS INC /TX/
10-K405, 1997-03-13
REAL ESTATE INVESTMENT TRUSTS

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<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1996

Commission File Number 1-9525

INCOME OPPORTUNITY REALTY INVESTORS, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)

Nevada 75-2615944
- - -------------------------------- --------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

10670 North Central Expressway, Suite 300, Dallas, Texas 75231
- - -------------------------------------------------------- --------
(Address of Principal Executive Offices) (Zip Code)

(214) 692-4700
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act:

Name of each exchange on
Title of each class which registered
- - ---------------------------- -----------------------
Common Stock, $.01 par value American Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act:
NONE

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]

As of March 7, 1997, the Registrant had 1,519,888 shares of Common Stock
outstanding. Of the total shares outstanding 675,536 were held by other than
those who may be deemed to be affiliates, for an aggregate value of $7,768,664
based on the last trade as reported on the American Stock Exchange on March 7,
1997. The basis of this calculation does not constitute a determination by the
Registrant that all of such persons or entities are affiliates of the
Registrant as defined in Rule 405 of the Securities Act of 1933, as amended.

Documents Incorporated by Reference:
NONE

<PAGE> 2

INDEX TO
ANNUAL REPORT ON FORM 10-K

PART I Page
----

Item 1. Business............................................. 3

Item 2. Properties........................................... 6

Item 3. Legal Proceedings.................................... 13

Item 4. Submission of Matters to a Vote of Security
Holders........................................... 15

PART II

Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters................... 15

Item 6. Selected Financial Data.............................. 18

Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............... 19

Item 8. Financial Statements and Supplementary Data.......... 24

Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............... 58

PART III

Item 10. Directors, Executive Officers and Advisor of the
Registrant........................................ 58

Item 11. Executive Compensation............................... 67

Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................ 70

Item 13. Certain Relationships and Related Transactions....... 71

PART IV

Item 14. Exhibits, Consolidated Financial Statements,
Schedules and Reports on Form 8-K................. 73

Signature Page........................................................ 76

<PAGE> 3

PART I

ITEM 1. BUSINESS

Income Opportunity Realty Investors, Inc. (the "Company" or "Registrant"), a
Nevada corporation, is the successor to a California business trust organized
pursuant to a declaration of trust dated December 14, 1984. The Company has
elected to be treated as a Real Estate Investment Trust ("REIT") under Sections
856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code").
The Company has, in the opinion of the Company's management, qualified for
federal taxation as a REIT for all periods since May 1, 1985.

The Company's real estate at December 31, 1996, consisted of seven properties
held for investment and two properties held for sale, one of which was obtained
through foreclosure, and an interest in a partnership which owns five
properties. The Company's mortgage notes receivable at December 31, 1996
consisted of one mortgage loan. No mortgage loans were funded during 1996. In
addition, the Company has an interest in a partnership which holds one
wraparound mortgage loan. The Company's real estate and mortgage notes
receivable portfolios are more fully discussed in ITEM 2. "PROPERTIES."

Business Plan

The Company's primary business and only industry segment is investing in equity
interests in real estate through direct equity investments and partnerships and
financing real estate and real estate related activities through investments in
mortgage loans. The Company's real estate is located in the Pacific, Southeast,
Southwest and Midwest regions of the continental United States. Information
regarding the real estate and mortgage note receivable portfolios of the
Company is set forth in ITEM 2. "PROPERTIES," and in Schedules III and IV to
the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA."

The Company's business is not seasonal. The Company has previously pursued and
intends to continue to pursue a balanced investment strategy, seeking both
current income and capital appreciation. With respect to new investments, the
Company's plan of operation is to acquire "Class A" apartment and commercial
properties in keeping with the current class of properties in the Company's
real estate portfolio. The Company intends to place an emphasis in 1997, on
apartment acquisitions to maintain balance in its real estate portfolio. The
Company does not expect that it will seek to fund or acquire new mortgage
loans. It may, however, originate mortgage loans in conjunction with providing
purchase money financing of a property sale. The Company also intends to
continue its strategy of maximizing each property's operating income by
aggressive property management through closely monitoring expenses while at the
same time making property renovations and/or improvements where appropriate.
While such expenditures increase the amount of revenue required to cover
operating expenses, the Company's management believes that such expenditures
are necessary to maintain or enhance the value of the Company's properties.

<PAGE> 4

ITEM 1. BUSINESS (Continued)

Management of the Company

Although the Company's Board of Directors is directly responsible for managing
the affairs of the Company and for setting the policies which guide it, the
day-to-day operations of the Company are performed by Basic Capital Management,
Inc. ("BCM" or the "Advisor"), a contractual advisor under the supervision of
the Company's Board of Directors. The duties of the Advisor include, among
other things, locating, investigating, evaluating and recommending real estate
and mortgage note investment and sales opportunities, as well as financing and
refinancing sources for the Company. The Advisor also serves as a consultant in
connection with the Company's business plan and investment decisions made by
the Company's Board of Directors.

BCM is a company owned by a trust for the benefit of the children of Gene E.
Phillips. Mr. Phillips served as a Trustee of the Trust until December 31,
1992. Mr. Phillips also served as a director of BCM until December 22, 1989,
and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips
serves as a representative of his children's trust which owns BCM and, in such
capacity, has substantial contact with the management of BCM and input with
respect to its performance of advisory services to the Company. BCM is more
fully described in ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE
REGISTRANT - The Advisor."

BCM has been providing advisory services to the Company since March 28, 1989.
Renewal of BCM's advisory agreement with the Company was approved by the
Company's stockholders at the Company's annual meeting of stockholders held on
May 31, 1996. BCM also serves as advisor to Continental Mortgage and Equity
Trust ("CMET") and Transcontinental Realty Investors, Inc. ("TCI"). The
Directors of the Company are also trustees of CMET and directors of TCI and the
officers of the Company are also officers of CMET and TCI. Mr. Phillips is a
general partner of Syntek Asset Management, L.P. ("SAMLP"), the general partner
of National Realty, L.P. ("NRLP") and National Operating, L.P. ("NOLP"), the
operating partnership of NRLP. BCM performs certain administrative functions
for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to
American Realty Trust, Inc. ("ART"). Mr. Phillips served as a director and
Chairman of the Board of ART until November 16, 1992. Randall M. Paulson,
President of the Company, also serves as President of CMET, TCI and BCM,
Executive Vice President of ART, and as the President and sole director of
Syntek Asset Management, Inc. ("SAMI"), the managing general partner of SAMLP.
The officers of the Company are also officers of ART. As of March 7, 1997, ART
and TCI each owned approximately 29.6% and 22.5% of the Company's outstanding
shares of Common Stock and BCM owned approximately 39.6% of ART's outstanding
shares of common stock.

Since February 1, 1990, affiliates of BCM have provided property management
services to the Company. Currently Carmel Realty Services, Ltd. ("Carmel,
Ltd.") provides such property management services. Carmel, Ltd. subcontracts
with other entities for the provision of the property-level management services
to the Company. The general partner

<PAGE> 5

ITEM 1. BUSINESS (Continued)

Management of the Company (Continued)

of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i)
Syntek West, Inc. ("SWI"), of which Mr. Phillips is the sole
shareholder, (ii) Mr. Phillips, and (iii) a trust for the benefit of the
children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level
management and leasing of four of the Company's office buildings and the
commercial properties owned by a real estate partnership in which the
Company and TCI are partners to Carmel Realty, Inc. ("Carmel Realty"),
which is a company owned by SWI. Carmel Realty is entitled to receive
property and construction management fees and leasing commissions in
accordance with the terms of its property-level management agreement
with Carmel, Ltd.

Carmel Realty is also entitled to receive real estate brokerage
commissions in accordance with the terms of a nonexclusive brokerage
agreement as discussed in ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND
ADVISOR TO THE REGISTRANT - The Advisor."

The Company has no employees. Employees of the Advisor render services to the
Company.

Competition

The real estate business is highly competitive and the Company competes with
numerous entities engaged in real estate activities (including certain entities
described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related
Party Transactions"), some of which may have greater financial resources than
those of the Company. The Company's management believes that success against
such competition is dependent upon the geographic location of the property, the
performance of the property managers in areas such as marketing, collection and
the ability to control operating expenses, the amount of new construction in
the area and the maintenance and appearance of the property. Additional
competitive factors with respect to commercial properties are the ease of
access to the property, the adequacy of related facilities, such as parking,
and sensitivity to market conditions in setting rent levels. With respect to
apartments, competition is also based upon the design and mix of the units and
the ability to provide a community atmosphere for the tenants. The Company's
management believes that general economic circumstances and trends and new or
renovated properties in the vicinity of each of the Company's properties are
also competitive factors.

To the extent that the Company seeks to sell any of its properties, the sales
prices for such properties may be affected by competition from other real
estate entities and financial institutions also attempting to sell their
properties located in areas in which the Company's properties are located.

As described above and in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS" - Related Party Transactions," the officers and Directors of the
Company also serve as officers, directors or trustees of certain

<PAGE> 6

ITEM 1. BUSINESS (Continued)

Competition (Continued)

other entities, each of which is also advised by BCM, and each of which has
business objectives similar to those of the Company. The Company's Directors,
officers and Advisor owe fiduciary duties to such other entities as well as to
the Company under applicable law. In determining to which entity a particular
investment opportunity will be allocated, the officers, trustees or directors
and the Advisor consider the respective investment objectives of each such
entity and the appropriateness of a particular investment in light of each such
entity's existing real estate and mortgage notes receivable portfolios. To the
extent that any particular investment opportunity is appropriate to more than
one of such entities, such investment opportunity will be allocated to the
entity which has had funds available for investment for the longest period of
time or, if appropriate, the investment may be shared among all or some of such
entities.

In addition, also as described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS - Certain Business Relationships," the Company also competes with
other entities which are affiliates of the Advisor and which may have
investment objectives similar to the Company's and that may compete with the
Company in the acquisition, sale, leasing and financing real estate. In
resolving any potential conflicts of interest which may arise, the Advisor has
informed the Company that it intends to continue to exercise its best judgment
as to what is fair and reasonable under the circumstances in accordance with
applicable law.

Certain Factors Associated with Real Estate and Related Investments

The Company is subject to all the risks incident to ownership and financing of
real estate and interests therein, many of which relate to the general
illiquidity of real estate investments. These risks include, but are not
limited to, changes in general or local economic conditions, changes in
interest rates and the availability of permanent mortgage financing which may
render the acquisition, sale or refinancing of a property difficult or
unattractive and which may make debt service burdensome, changes in real estate
and zoning laws, increases in real estate taxes, federal or local economic or
rent controls, floods, earthquakes, hurricanes and other acts of God, and other
factors beyond the control of the Company's management or Advisor. Also, the
illiquidity of real estate investments may impair the ability of the Company to
respond promptly to changing circumstances. The Company's management believes
that such risks are partially mitigated by the diversification by geographic
region and property type of the Company's real estate portfolio. However, to
the extent property acquisitions are concentrated in any particular geographic
region, the advantages of diversification may be mitigated.

ITEM 2. PROPERTIES

The Company's principal offices are located at 10670 North Central Expressway,
Suite 300, Dallas, Texas 75231. In the opinion of the Company's management, the
Company's offices are suitable and adequate for its present operations.

<PAGE> 7

ITEM 2. PROPERTIES (Continued)

Details of the Company's real estate and mortgage notes receivable portfolios
at December 31, 1996, are set forth in Schedules III and IV, respectively, to
the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA." The discussions set forth below under the headings
"Real Estate" and "Mortgage Loans" provide certain summary information
concerning the Company's real estate and mortgage notes receivable portfolios.

The Company's real estate portfolio consists of properties held for investment,
investments in partnerships and properties held for sale, one of which was
obtained through foreclosure. The Company holds a fee simple title to all of
the properties in its real estate portfolio. The foreclosed property held for
sale was obtained through foreclosure of the collateral securing a mortgage
note receivable. The discussion set forth below under the heading "Real Estate"
provides certain summary information concerning the Company's real estate and
further summary information with respect to the Company's properties held for
investment, properties held for sale and investments in partnerships.

The Company's real estate is geographically diverse. At December 31, 1996, the
Company held equity investments in apartments and office buildings in the
Pacific, Southwest, Southeast and Midwest regions of the continental United
States, as shown more specifically in the table under "Real Estate" below. The
majority of the Company's properties, however, are located in California and
Texas. At December 31, 1996, the Company held one wraparound mortgage note
receivable, secured by a shopping center in Joliet, Illinois.

At December 31, 1996, three of the Company's properties, Porticos Apartments,
Daley Plaza Corporate Center, and Saratoga Office Building each exceeded 10% of
the Company's total assets. At December 31, 1996, 73% of the Company's assets
consisted of real estate held for investment, 11% consisted of properties held
for sale, 3% consisted of a mortgage note and interest receivable and 4%
consisted of investments in partnerships. The remaining 9% of the Company's
assets at December 31, 1996, were cash, cash equivalents and other assets. The
percentage of the Company's assets invested in any one category is subject to
change and no assurance can be given that the composition of the Company's
assets in the future will approximate the percentages listed above. See ITEM 1.
"BUSINESS - Business Plan."

To continue to qualify for federal taxation as a REIT under the Code, the
Company is required, among other things, to hold at least 75% of the value of
its total assets in real estate assets, government securities, cash and cash
equivalents at the close of each quarter of each taxable year.

[THIS SPACE INTENTIONALLY LEFT BLANK.]

<PAGE> 8

ITEM 2. PROPERTIES (Continued)

Geographic Regions

The Company has divided the continental United States into the following
geographic regions.

Northeast region comprised of the states of Connecticut, Delaware,
Maryland, Massachusetts, New Hampshire, New Jersey, New York,
Pennsylvania, Rhode Island and Vermont, and the District of
Columbia. The Company has no properties in this region.

Southeast region comprised of the states of Alabama, Florida, Georgia,
Mississippi, North Carolina, South Carolina, Tennessee and Virginia.
The Company has 1 commercial property in this region.

Southwest region comprised of the states of Arizona, Arkansas,
Louisiana, New Mexico, Oklahoma and Texas. The Company has 3
apartments in this region.

Midwest region comprised of the states of Illinois, Indiana, Iowa,
Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North
Dakota, Ohio, South Dakota, West Virginia and Wisconsin. The Company
has 1 apartment in this region.

Mountain region comprised of the states of Colorado, Idaho, Montana,
Nevada, Utah and Wyoming. The Company has no properties in this
region.

Pacific region comprised of the states of California, Oregon and
Washington. The Company has 1 apartment and 3 commercial properties in
this region.

Real Estate

At December 31, 1996, approximately 85% of the Company's assets were invested
in real estate, located throughout the continental United States, either on a
leveraged or nonleveraged basis. The Company's real estate portfolio consists
of properties held for investment, investments in partnerships and properties
held for sale, one of which was obtained through foreclosure.

Types of Real Estate Investments. The Company's real estate consists of
apartments and commercial properties (office buildings) or similar properties
having established income-producing capabilities. In selecting real estate for
investment, the location, age and type of property, gross rentals, lease terms,
financial and business standing of tenants, operating expenses, fixed charges,
land values and physical condition are considered. The Company may acquire
properties subject to, or assume, existing debt and may mortgage, pledge or
otherwise obtain financing for its properties. The Company's Board of Directors
may alter the types of and criteria for selecting new real estate investments
and for obtaining financing without a vote of stockholders.

<PAGE> 9

ITEM 2. PROPERTIES (Continued)

Real Estate (Continued)

At December 31, 1996, the Company had no properties on which significant
capital improvements were in process. However, the Company expects that in 1997
it will expend approximately $750,000 for capital and tenant improvements at
the Daley Plaza Corporate Center, an office building the Company acquired in
1996.

Although the Company has typically invested in developed real estate, and has
no current intentions to do otherwise, the Company may also invest in new
construction or development either directly or in partnership with
nonaffiliated parties or affiliates (subject to approval by the Company's Board
of Directors). To the extent that the Company invests in construction and
development projects, the Company would be subject to business risks, such as
cost overruns and construction delays, associated with such higher risk
projects.

In the opinion of the Company's management, the properties owned by the Company
are adequately covered by insurance.

The following table sets forth the percentages, by property type and geographic
region, of the Company's real estate at December 31, 1996.

<TABLE>
<CAPTION>
Commercial
Region Apartments Properties
--------- ---------- ----------
<S> <C> <C>
Pacific...................... 16% 91%
Southwest.................... 50 -
Southeast.................... - 9
Midwest...................... 34 -
--- ---
100% 100%
</TABLE>

The foregoing table is based solely on the number of apartment units and
commercial square footage owned by the Company and does not reflect the value
of the Company's investment in each region. See Schedule III to the
Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA" for a more detailed description of the Company's real
estate.

A summary of activity in the Company's owned real estate portfolio during 1996
is as follows:

<TABLE>
<S> <C>
Owned properties at January 1, 1996............... 7
Properties acquired through purchase.............. 2
-
Owned properties at December 31, 1996............. 9
=
</TABLE>

[THIS SPACE INTENTIONALLY LEFT BLANK.]

<PAGE> 10

ITEM 2. PROPERTIES (Continued)

Real Estate (Continued)

Properties Held for Investment. Set forth below are the Company's properties
held for investment and the monthly rental rate for apartments and the average
annual rental rate for office buildings and occupancy thereof at December 31,
1996, 1995 and 1994:

<TABLE>
<CAPTION>
Units/ Rent Per Square Foot Occupancy
------ -------------------- ---------
Property Location Square Footage 1996 1995 1994 1996 1995 1994
- - ----------------- -------------- --------------- ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Apartments
- - -----------
Eastpoint Mesquite, TX 126 units/
113,138 sq. ft. $ .66 $ .62 $ .60 97% 99% 99%
Porticos Milwaukee, WI 256 units/
269,036 Sq. Ft. .86 .86 .86 95% 94% 91%
Treehouse San Antonio, TX 106 units/
88,957 sq. ft. .75 .75 .71 94% 94% 98%
Office Buildings
- - ----------------
Daley Plaza
Corporate Center San Diego, CA 122,795 sq. ft. 12.88 * * 80% * *
Olympic Building Los Angeles, CA 46,685 sq. ft. 16.09 * * 73% * *
Saratoga Saratoga, CA 89,825 sq. ft. 19.42 19.07 18.11 98% 100% 92%
Town Center Boca Raton, FL 24,518 sq. ft. 8.21 7.77 7.65 100% 100% 100%
</TABLE>
- - -------------------

* Property was acquired in 1996.

In March 1996, the Company obtained mortgage financing of $7.3 million secured
by the previously unencumbered Saratoga Office Building in Saratoga,
California. The Company received net cash of $6.6 million after funding
required tax and insurance escrows and the payment of various closing costs
associated with the financing. The mortgage bears interest at 9.0% per annum,
requires monthly payments of principal and interest of $61,261 and matures in
April 2006. The Company paid a mortgage brokerage and equity refinancing fee of
$73,000 to BCM based on the $7.3 million financing.

In September 1996, the Company purchased the Daley Plaza Corporate Center, a
three building, 122,795 square foot office facility in San Diego, California,
for $7.1 million, consisting of $3.6 million in cash and seller provided
mortgage financing of $3.5 million. The mortgage bears interest at 6.0% per
annum, compounded monthly. Principal and accrued but unpaid interest are due on
September 25, 1997, the mortgage's maturity date. The Company paid a real
estate brokerage commission of $212,000 to Carmel Realty, and an acquisition
fee of $71,000 to BCM, based on the $7.1 million purchase price.

In September 1996, the Company obtained mortgage financing of $1.2 million
secured by the previously unencumbered Town Center Plaza Office Building in
Boca Raton, Florida. The Company received net cash of $1.0 million after
funding required tax and insurance escrows and the payment of various closing
costs associated with the financing. The mortgage bears interest at 9.16% per
annum, requires monthly payments of principal and interest of $10,296 and
matures in October 2006. The Company paid a mortgage brokerage and equity
refinancing fee of $12,000 to BCM based on the $1.2 million financing.

<PAGE> 11

ITEM 2. PROPERTIES (Continued)

Real Estate (Continued)

In November 1996, the Company purchased the Olympic Building, a 57,000 square
foot office building in Los Angeles, California, for $6.0 million. The Company
paid $1.5 million in cash and obtained new mortgage financing of $4.5 million.
The mortgage bears interest at a variable rate, currently at 9.25% per annum,
requires monthly payments of principal and interest of $38,531 and matures in
November 2003. The Company paid a real estate brokerage commission of $190,000
to Carmel Realty and an acquisition fee of $60,000 to BCM, based on the $6.0
million purchase price.

In January 1997, the Company purchased the Chuck Yeager Building, a 60,000
square foot industrial/office building in Chantilly, Virginia, for $5.1
million. The Company paid $2.0 million in cash and obtained new mortgage
financing of $3.1 million. The mortgage bears interest at a variable rate,
currently 10.75% per annum, requires monthly payments of principal and interest
of $72,017 and matures in January 1999, with an option to extend the maturity
to January 2000. The Company paid a real estate brokerage commission of
$171,000 to Carmel Realty and an acquisition fee of $51,000 to BCM based on the
$5.4 million purchase price.

Properties Held for Sale. Set forth below are the Company's properties held for
sale, one of which was obtained through foreclosure, and monthly rental rate
and occupancy thereof at December 31, 1996, 1995 and 1994:

<TABLE>
<CAPTION>
Rent Per
Units/ Square Foot Occupancy
-------------------------- -------------------------
Property Location Square Footage 1996 1995 1994 1996 1995 1994
- - ----------------- -------------- --------------- ------ ------ ------ ------ ------ -----

<S> <C> <C> <C> <C> <C>
Apartments
- - -----------
Plumtree Martinez, CA 116 units/
97,734 Sq. Ft. $ .96 $ .92 $ .90 98% 99% 92%
Spanish Trace Irving, TX 136 units/
137,682 Sq. Ft. .49 .46 * 94% 95% *
</TABLE>

* Recorded as an insubstance foreclosure December 31, 1994.

At December 31, 1996, the Plumtree Apartments, a 116 unit apartment complex in
Martinez, California was under contract for sale. In March 1997, the Company
completed the sale for $7.8 million in cash. The Company received net cash of
$1.6 million, after payoff of $5.7 million in existing mortgage debt and the
payment of various closing costs associated with the sale. The Company and will
recognize a gain on the sale of approximately $1.8 million. The Company paid a
real estate sales commission of $226,000 to Carmel Realty based upon the $7.8
million sales price.

Partnership Properties. Set forth below are the properties owned by a
partnership in which the Company is an equity investee and the monthly

<PAGE> 12

ITEM 2. PROPERTIES (Continued)

Real Estate (Continued)

rental rate for apartments and the average annual rental rate for commercial
properties and occupancy thereof at December 31, 1996, 1995 and 1994:

<TABLE>
<CAPTION>
Rent Per
Units/ Square Foot Occupancy
-------------------------- --------------------------
Property Location Square Footage 1996 1995 1994 1996 1995 1994
- - ----------------- -------------- --------------- ------ ------ ------ ------ ------ ------

<S> <C> <C> <C> <C> <C>
Apartments
- - -------------
Inwood Greens Houston, TX 126 units/
105,960 sq. ft. $ .45 $ .44 $ .43 93% 93% 91%
Oaks of Inwood Houston, TX 198 units/
167,872 sq. ft. .44 .43 .43 93% 91% 90%
Office Building
- - ---------------
MacArthur Mills Carrollton, TX 53,472 sq. ft. 8.38 7.60 6.99 94% 95% 88%

Shopping Centers
- - ----------------
Chelsea Square Houston, TX 70,275 sq. ft. 9.32 9.51 8.67 69% 77% 78%
Summit at
Bridgewood Fort Worth, TX 48,696 sq. ft. 8.67 9.27 8.92 62% 63% 62%
</TABLE>

The Company owns a 36.3% general partner interest and TCI owns a 63.7% combined
general and limited partner interest in Tri-City Limited Partnership which in
turn owns the five properties listed above. See ITEM 8. "FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA." In 1996, the Company made advances to the partnership
of $65,000 and received $303,000 in operating distributions from the
partnership.

Mortgage Loans

Prior to 1991, a substantial portion of the Company's assets had been invested
in mortgage notes receivable secured by income-producing real estate. The
Company's mortgage notes have included first mortgage loans, wraparound
mortgage loans and junior mortgage loans. The Company has determined that it
will not seek to fund or acquire new mortgage loans, other than those which it
may originate in conjunction with providing purchase money financing of a
property sale. See ITEM 1. "BUSINESS". BCM, in its capacity as a mortgage
servicer, services the Company's mortgage note receivable.

During 1996, the Company funded no new mortgage loans and made no additional
advances on its existing mortgage loan.

Wraparound Mortgage Loans. A wraparound mortgage loan, sometimes called an
all-inclusive loan, is a mortgage loan having an original principal amount
equal to the outstanding balance under the prior existing mortgage loan(s) plus
the amount actually advanced under the wraparound mortgage loan.

At December 31, 1996, the Company's mortgage notes receivable portfolio
consisted of one performing wraparound mortgage note, with an outstanding
principal balance of $2.0 million, secured by a shopping center in Joliet,
Illinois.

<PAGE> 13

ITEM 2. PROPERTIES (Continued)

Mortgage Loans (Continued)

Partnership mortgage loans. The Company owns a 40% general partner interest and
TCI owns a 60% general partner interest in Nakash Income Associates ("NIA").
NIA in turn owns a wraparound mortgage note receivable. In 1996, the
partnership extended the maturity date to April 1, 1997, of the underlying note
payable secured by a building occupied by a Wal-Mart in Maulden, Missouri.

ITEM 3. LEGAL PROCEEDINGS

Olive Litigation

In February 1990, the Company, together with CMET, National Income Realty Trust
("NIRT") and TCI, three real estate entities with, at the time, the same
officers, directors or trustees and advisor as the Company, entered into a
settlement of a class and derivative action entitled Olive et al. v. National
Income Realty Trust et al., in the United States District Court for the
Northern District of California, relating to the operation and management of
each of the entities. On April 23, 1990, the Court granted final approval of
the terms of the settlement.

On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Modification") which settled subsequent
claims of breaches of the settlement which were asserted by the plaintiffs and
modified certain provisions of April 1990 settlement. The Modification was
preliminarily approved by the Court July 1, 1994 and final Court approval of
the Modification was entered on December 12, 1994. The effective date of the
Modification was January 11, 1995.

The Modification, among other things, provided for the addition of new
unaffiliated members to the Company's Board of Directors and set forth new
requirements for the approval of certain transactions with affiliates until
April 28, 1999. In addition, BCM, the Company's advisor, Gene E. Phillips and
William S. Friedman, who served as President and Director of the Company until
February 24, 1994, President of BCM until May 1, 1993 and director of BCM until
December 22, 1989, agreed to pay a total of $1.2 million to the Company, CMET,
NIRT and TCI, of which the Company's share was $150,000.

Under the Modification, the Company, CMET, NIRT, TCI and their stockholders
released the defendants from any claims relating to the plaintiffs'
allegations. The Company, CMET, NIRT and TCI also agreed to waive any demand
requirement for the plaintiffs to pursue claims on behalf of each of them
against certain persons or entities. The Modification also requires that any
shares of the Company held by Messrs. Phillips, Friedman or their affiliates
shall be (i) voted in favor of the reelection of all current members of the
Company's Board of Directors that stand for reelection during the two calendar
years following the effective date of the Modification and (ii) voted in favor
of all new members of the Company's Board of Directors appointed

<PAGE> 14

ITEM 3. LEGAL PROCEEDINGS (Continued)

Olive Litigation (Continued)

pursuant to the terms of the Modification that stand for reelection during the
three calendar years following the effective date of the Modification.

Pursuant to the terms of the Modification, certain related party transactions
which the Company may enter into prior to April 28, 1999, require the unanimous
approval of the Company's Board of Directors. In addition, such related party
transactions are to be discouraged and may only be entered into in exceptional
circumstances and after a determination by the Company's Board of Directors
that the transaction is in the best interests of the Company and that no other
opportunity exists that is as good as the opportunity presented by such
transaction.

For purposes of the Modification requirements, the term "related party
transaction" means and includes (i) any transaction between or among the
Company or CMET, NIRT or TCI or any of their affiliates or subsidiaries; (ii)
any transaction between or among the Company, its affiliates or subsidiaries
and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and
(iii) any transaction between or among the Company or any of its affiliates or
subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr.
Friedman or any of their affiliates has an ongoing or contemplated business or
financial transaction or relationship of any kind, whether direct or indirect,
or has had such a transaction or relationship in the preceding one year.

The Modification requirements for related party transactions do not apply to
direct contractual agreements for services between the Company and the Advisor
or one of its affiliates, (including the Advisory Agreement, the Brokerage
Agreement and the property management contracts). These agreements require the
prior approval by two-thirds of the Directors of the Company, and if required,
approval by a majority of the Company's stockholders. The Modification
requirements for related party transactions also do not apply to joint ventures
between or among the Company and CMET, NIRT or TCI or any of their affiliates
or subsidiaries and a third party having no prior or intended future business
or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any
affiliate of such parties. Such joint ventures may be entered into on the
affirmative vote of a majority of the Directors of the Company.

The Modification also terminated a number of the provisions of the settlement,
including the requirement that the Company, CMET, NIRT and TCI maintain a
Related Party Transaction Committee and a Litigation Committee of their
respective Boards. The Court retained jurisdiction to enforce the Modification,
and during August and September 1996, the Court held evidentiary hearings to
assess compliance with the terms of the Modification by various parties. The
Court issued no ruling or order with respect to the matters addressed at the
hearings.

Separately, in 1996, legal counsel for the plaintiffs notified the Company's
Board of Directors that he intends to assert that certain

<PAGE> 15

ITEM 3. LEGAL PROCEEDINGS (Continued)

Olive Litigation (Continued)

actions taken by the Board of Directors breached the terms of the Modification.
On January 27, 1997, the parties entered into an Amendment to the Modification
effective January 9, 1997 (the "Amendment"), which was submitted to the Court
for approval on January 29, 1997. The Amendment provides for the settlement of
all matters raised at the evidentiary hearings and by plaintiffs' counsel in
his notices to the Company's Board of Directors. As of March 7, 1997, the Court
had taken no action on the Amendment.

The Amendment provides for the addition of three new unaffiliated members to
the Company's Board of Directors and sets forth new requirements for the
approval of any transactions with certain affiliates until April 28, 1999. In
addition, the Company, CMET, TCI and their stockholders released the defendants
from any claims relating to the plaintiffs' allegations and matters which were
the subject of the evidentiary hearings. The plaintiffs' allegations of any
breaches of the Modification shall be settled by mutual agreement of the
parties or, lacking such agreement, by an arbitration proceeding.

Under the Amendment, all shares of the Company owned by Mr. Phillips or any of
his affiliates shall be voted at all stockholders' meetings held until April
28, 1999 in favor of all new members of the Company's Board of Directors added
under the Amendment. The Amendment also requires that, until April 28, 1999,
all shares of the Company owned by Mr. Phillips or his affiliates in excess of
forty percent (40%) of the Company's outstanding shares shall be voted in
proportion to the votes cast by all non-affiliated stockholders of the Company.

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

Not applicable.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF COMMON STOCK AND
RELATED SHAREHOLDER MATTERS

The Company's Common Stock is traded on the American Stock Exchange ("AMEX")
under the symbol "IOT". The following table sets forth the high and low prices
for the Company's Common Stock as reported on the AMEX.

<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
- - ------------------ ---------- ---------
<S> <C> <C>
March 31, 1997 (through March 7, 1997)......... $ 12 1/4 $ 11

March 31, 1996................................. 10 2/3* 9 1/4*
June 30, 1996.................................. 10 1/2* 9 3/4*
September 30, 1996............................. 11 9 1/2
December 31, 1996.............................. 11 1/2 9 5/8
</TABLE>

<PAGE> 16

ITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF COMMON STOCK AND
RELATED SHAREHOLDER MATTERS (Continued)

<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
- - ------------------ ---------- ---------
<S> <C> <C>
March 31, 1995................................. $ 10 3/16* $ 9 1/2 *
June 30, 1995.................................. 10 * 9 1/2 *
September 30, 1995............................. 10 3/16* 9 1/2 *
December 31, 1995.............................. 10 * 9 1/2 *
</TABLE>
- - -------------------

* Restated for the two for one forward stock split effected June 14,
1996.

As of March 7, 1997, the closing price of the Company's Common Stock on the
AMEX was $11.50 per share.

As of March 7, 1997, the Company's Common Stock was held by 1,110 holders of
record.

The Company paid quarterly dividends in 1996 and 1995 as follows:

<TABLE>
<CAPTION>
Amount
Per
Date Declared Record Date Payable Date Share
------------- ----------- ------------ -----
<S> <C> <C> <C>
March 1, 1996 March 15, 1996 March 31, 1996 $ .10*
June 3, 1996 June 14, 1996 June 28, 1996 .10*
August 23, 1996 September 13, 1996 September 30, 1996 .10
December 2, 1996 December 13, 1996 December 31, 1996 .10

March 3, 1995 March 15, 1995 March 31, 1995 $ .075*
May 22, 1995 June 15, 1995 June 30, 1995 .075*
August 25, 1995 September 15, 1995 September 30, 1995 .075*
November 30, 1995 December 15, 1995 December 31, 1995 .075*
</TABLE>

* Restated for the two for one forward stock split effected June 14,
1996.

The Company reported to the Internal Revenue Service that 100% of the dividends
paid in 1996 and 1995 represented a return of capital.

On December 5, 1989, the Company's Board of Directors approved a share
repurchase program. The Company's Board of Directors has authorized the Company
to repurchase a total of 200,000 shares of its Common Stock pursuant to such
program. Through March 7, 1997, the Company has repurchased a total of 198,904
shares pursuant to such program at a cost to the Company of $1.8 million. In
1996 the Company repurchased 63,000 shares of its Common Stock at a cost to the
Company of $621,000. The Company has repurchased none of its Common Stock in
1997.

On March 24, 1989, the Company distributed one share purchase right for each
outstanding share of Common Stock of the Company. On February 10, 1992, the
rights were redeemed, the Company's Board of Directors having determined that
the rights were no longer necessary to protect the Company from coercive tender
offers. In connection with such redemp-

<PAGE> 17

ITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF COMMON STOCK AND
RELATED SHAREHOLDER MATTERS (Continued)

tion, Messrs. Phillips and Friedman and their affiliates, who owned
approximately 12% of the Company's outstanding Common Stock at the time, agreed
not to acquire more than 40% of the Company's outstanding Common Stock without
the prior action of the Company's Board of Directors to the effect that they do
not object to such increased ownership.

In August 1994, Mr. Phillips and his affiliates, primarily ART and TCI, owned
approximately 39.8% of the Company's outstanding shares of Common Stock. This
stockholder group desired to purchase additional shares of Common Stock of the
Company and requested that the Company's Board of Directors consider the
elimination of the limitation on the percentage of Common Stock which may be
acquired by the stockholder group. The Company's Board of Directors reviewed
the limitation and determined that, due to the fact that Mr. Friedman was no
longer affiliated with the stockholder group, and had disposed of any shares of
the Company which he or his affiliates may have owned, the limitation should no
longer apply to Mr. Friedman or his affiliates. The Company's Board of
Directors also determined that there was no reason to object to the purchase of
additional shares of Common Stock of the Company by the stockholder group and
on August 23, 1994, the Company's Board of Directors adopted a resolution to
the effect that they do not object to the acquisition of up to 49% of the
Company's outstanding shares of Common Stock by Mr. Phillips and his
affiliates. In determining total ownership, Common Stock of the Company owned
by Mr. Friedman and his affiliates are no longer to be included. Pursuant to
this action, Mr. Phillips and his affiliates could not acquire more than 49% of
the Company's outstanding Common Stock without the prior action of the
Company's Board of Directors to the effect that they did not object to such
increased ownership.

On March 21, 1996, the Company's Board of Directors reconsidered the share
ownership limitation and determined that there was no reason to object to the
purchase by Mr. Phillips and his affiliates of additional Common shares in
excess of 49% of the Company's outstanding shares of Common Stock. Accordingly,
there is no longer any limitation on the percentage of Common shares of the
Company which may be acquired by Mr. Phillips and his affiliates. At March 7,
1997, Mr. Phillips and his affiliates, primarily ART and TCI, owned
approximately 55.5% of the Company's outstanding shares of Common Stock.

[THIS SPACE INTENTIONALLY LEFT BLANK.]

<PAGE> 18

ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ----------- ----------- -----------
(dollars in thousands, except per share)
<S> <C> <C> <C> <C> <C>
EARNINGS DATA
Revenues ................ $ 9,005 $ 7,919 $ 6,852 $ 7,113 $ 6,593
Expenses ................ 9,658 8,081 7,225 7,247 7,037
----------- ----------- ----------- ----------- -----------

(Loss) from operations .. (653) (162) (373) (134) (444)
Equity in income (loss)
of partnerships ........ 85 (744) 86 203 (26)
(Loss) on sale of real
estate ............... -- -- -- -- (81)
Extraordinary gain ...... -- -- -- 806 --
----------- ----------- ----------- ----------- -----------

Net income (loss) ....... $ (568) $ (906) $ (287) $ 875 $ (551)
=========== =========== =========== =========== ===========

PER SHARE DATA
Income (loss) before
extraordinary gain ... $ (.37) $ (.57) $ (.18) $ .04 $ (.32)
Extraordinary gain ...... -- -- -- .50 --
----------- ----------- ----------- ----------- -----------

Net income (loss) ....... $ (.37) $ (.57) $ (.18) $ .54 $ (.32)
=========== =========== =========== =========== ===========

Distributions per share . $ .40 $ .30 $ .30 $ .25 $ --

Weighted average
shares outstanding ... 1,530,008 1,582,888 1,582,888 1,609,432 1,728,642

<CAPTION>
December 31,
-----------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ----------- ----------- -----------
(dollars in thousands, except per share)
BALANCE SHEET DATA
Notes and interest
receivable, net ...... $ 1,998 $ 1,986 $ 1,974 $ 2,983 $ 2,922
Real estate held for
sale, net
Foreclosed ........... 914 845 15,878 15,121 15,387
Other ................ 5,709 -- 25,157 25,710 26,259
Real estate held for
investment, net ...... 46,693 39,480 -- -- --
Total assets ............ 63,593 49,169 49,035 50,127 51,275
Notes and interest
payable .............. 38,957 22,682 20,717 21,354 22,447
Stockholders' equity .... 22,381 24,191 25,572 26,334 26,380

Book value per share .... $ 14.63 $ 15.28 $ 16.16 $ 16.36 $ 15.26
</TABLE>

The Company acquired two properties in 1996 for a total of $13.1 million.
See ITEM 2. "PROPERTIES - REAL ESTATE" and ITEM 8. "FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA."

Shares and per share data have been restated for the two for one forward shares
split effected June 14, 1996.

<PAGE> 19

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Introduction

Income Opportunity Realty Investors, Inc. (the "Company") invests in equity
interests in real estate through acquisitions, leases and partnerships and in
mortgage loans on real estate, including first, wraparound and junior mortgage
loans. The Company is the successor to a California business trust organized on
December 14, 1984 which commenced operations on April 10, 1985.

Liquidity and Capital Resources

Cash and cash equivalents at December 31, 1996 aggregated $3.2 million compared
with $3.0 million at December 31, 1995. The Company's principal sources of cash
have been and will continue to be property operations, proceeds from property
sales and refinancings, collection of its mortgage note receivable and
partnership distributions. The Company anticipates that it will have sufficient
cash in 1997 to meet its various cash requirements including the payment of
dividends, debt service obligations and property renovation and/or improvement
costs.

Scheduled principal payments on notes payable of $4.1 million are due in 1997.

The Company owns a 36.3% general partner interest and Transcontinental Realty
Investors, Inc. ("TCI") owns a 63.7% combined general and limited partner
interest in the Tri-City Limited Partnership ("Tri-City"). In 1996, the Company
received $303,000 in distributions from Tri-City's operating cash flow and made
advances of $65,000 to Tri-City. In 1996, the Company also received $5,000 in
distributions from and made $17,000 in contributions to Nakash Income
Associates ("NIA"). The Company owns a 40% general partner interest and TCI
owns a 60% general partner interest in NIA.

The Company has paid quarterly dividends since the first quarter of 1993. In
1996 and 1995, the Company paid dividends to its stockholders totaling $621,000
($.40 per share) and $475,000 ($.30 per share), respectively.

In March, 1997, the Company completed the sale of the Plumtree Apartments, a
116 unit apartment complex in Martinez, California, that was under contract for
sale for at December 31, 1996. The apartment complex was sold for $7.8 million
in cash. The Company received net cash of $1.6 million after the payoff of $5.7
million in existing mortgage debt and the payment of various closing costs
associated with the sale.

The Company has contracted to purchase the LaMesa Village Plaza, a 92,611
square foot office/retail center in LaMesa, California for $8.1 million. The
Company expects to obtain mortgage financing of $6.0 million to complete the
purchase.

<PAGE> 20

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

The Company's management reviews the carrying values of the Company's
properties and mortgage note receivable at least annually and whenever events
or a change in circumstances indicate that impairment may exist. Impairment is
considered to exist if, in the case of a property, the future cash flow from
the property (undiscounted and without interest) is less than the carrying
amount of the property. For notes receivable impairment is considered to exist
if it is probable that all amounts due under the terms of the note will not be
collected. In those instances where impairment is found to exist, a provision
for loss is recorded by a charge against earnings. The Company's mortgage note
receivable review includes an evaluation of the collateral property securing
such note. The property review generally includes selective property
inspections, a review of the property's current rents compared to market rents,
a review of the property's expenses, a review of maintenance requirements, a
review of the property's cash flow, discussions with the manager of the
property and a review of properties in the surrounding area.

Results of Operations

1996 compared to 1995. For the year 1996, the Company incurred a net loss of
$568,000 as compared with a net loss of $906,000 in 1996. The primary factor
contributing to the Company's decreased net loss in 1996 was an improvement in
equity in income (loss) of partnerships of $829,000.

Rents in 1996, were $8.7 million compared to $7.7 million in 1995. Of this
increase, $466,000 is attributable to the two commercial properties purchased
in 1996, $170,000 is attributable to a full year of operations of an apartment
complex foreclosed in 1995 and $302,000 is attributable to increased occupancy
and rental rates at one of the Company's commercial properties and two of its
apartment complexes. Rents are expected to increase in 1997 due to a full year
of operations of the commercial properties acquired in 1996 and from completed
and anticipated 1997 property acquisitions.

Property operations expense for 1996 was $4.4 million, compared to $4.0 million
for 1995. Of the increase, $141,000 is attributable to the two commercial
properties purchased in 1996, $27,000 is attributable to a full year of
operations of an apartment complex foreclosed in 1995, and $164,000 is due to
increased repairs and maintenance at two of the Company's apartment complexes.

Equity in income (loss) of partnerships was income of $85,000 in 1996 as
compared to a loss of $744,000 in 1995. The 1995 equity loss is primarily due
to the modification of a wraparound note receivable and underlying note payable
by Nakash Income Associates ("NIA"), a partnership in which the Company has a
40% general partner interest and to the writedown of a wraparound mortgage note
receivable to the balance of the underlying mortgage payable also by NIA. The
Company's equity share of the loss on the note modification was $85,000 and its
equity share of the note writedown was $601,000. See NOTE 5. "INVESTMENT IN

<PAGE> 21

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

EQUITY METHOD PARTNERSHIPS." Excluding the effect of the NIA transactions,
equity earnings would have been comparable in each year. Equity earnings are
not expected to be significant in 1997.

Interest income increased to $339,000 in 1996 from $231,000 in 1995 due to an
increase in short-term investment income. Interest income in 1997 is expected
to approximate that in 1995, the Company having invested the net cash proceeds
from financing two previously unencumbered commercial properties in two
commercial property acquisitions.

Interest expense increased to $2.6 million in 1996 compared to $2.0 million in
1995. Of this increase $537,000 is attributable to the refinancing of two
previously unencumbered commercial properties in March 1996 and in September
1996 and $100,000 is due to the purchase of two commercial properties in 1996.
Interest expense will increase in 1997 due to a full year's effect of the above
transaction as well as completed and anticipated property acquisitions in 1997.

Depreciation expense of $1.1 million in 1996 compared to the $1.1 million in
1995. Depreciation expense will increase in 1997 due to a full year's affect of
the two commercial properties purchased in 1996, as well as completed and
anticipated leverage property acquisitions in 1997.

Advisory fee expense decreased to $227,000 in 1996 compared to $316,000
in 1995. Such decrease is attributable to the operating expense
limitation in the Company's Advisory Agreement. See NOTE 9. "ADVISORY
AGREEMENT."

General and administrative expenses for 1996 increased to $1.3 million as
compared to $699,000 in 1995. Of this increase, $399,000 is attributable to an
increase in legal fees related to the Olive litigation (See NOTE 14.
"COMMITMENTS AND CONTINGENCIES."), $101,000 is attributable to consulting and
engineering fees related to potential property acquisitions and financings and
$96,000 is attributable to the preparation of proxy material and registration
statement relating to the Company's incorporation, which is nonrecurring in
nature.

1995 COMPARED TO 1994. For the year 1995, the Company incurred a net loss of
$906,000, compared with a net loss of $287,000 in 1994. The primary factor
contributing to the Company's net loss was an increase in equity in losses of
partnerships of $830,000, as discussed in detail below.

Rents in 1995 were $7.7 million, compared to $6.6 million in 1994. Of this
increase, $567,000 is due to the March 2, 1995 foreclosure of an apartment
complex securing a mortgage note receivable, $360,000 is due to an increase in
occupancy at one of the Company's office buildings from 92% to 100% and
$115,000 is due to an increase in occupancy at one of the Company's apartment
complexes from 91% to 94%.

<PAGE> 22

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

Property operations expense for 1995 was $4.0 million, compared to $3.4 million
for 1994. This increase is primarily due to the property foreclosure described
above.

Equity in income (loss) of partnerships was a loss of $744,000 in 1995 compared
to income of $86,000 in 1994. The equity loss for 1995 is primarily
attributable to a modification of a wraparound mortgage note receivable and
underlying note payable by NIA and to the writedown of a wraparound mortgage
note receivable to the balance of the underlying mortgage payable also by NIA.
The Company's equity share of the loss on the note modification was $85,000 and
its equity share of the note writedown was $601,000. See NOTE 5. "INVESTMENT IN
EQUITY METHOD PARTNERSHIPS."

Interest income decreased from $294,000 in 1994 to $231,000 in 1995. This
decrease is attributable to the foreclosure of an apartment complex securing a
mortgage note receivable. See NOTE 2. "NOTES AND INTEREST RECEIVABLE". Interest
expense and depreciation in 1995 approximated that of 1994.

Advisory fee expense decreased from $367,000 in 1994 to $316,000 in 1995. The
decrease is attributable to the refund of a portion of the advisory fee due to
the operating expenses of the Company exceeding the limitation as provided in
the Company's Advisory Agreement. See NOTE 9.
"ADVISORY AGREEMENT."

General and administrative expenses for 1995 increased to $699,000 from
$555,000 in 1994. The increase is primarily due to legal fees incurred in the
preparation of proxy materials and registration statement relating to the
proposal to convert the Company into a corporation, and to increased Trustee
fees.

Environmental Matters

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

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

Inflation

The effects of inflation on the Company's operations are not quantifiable.
Revenues from property operations fluctuate proportion-

<PAGE> 23

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)

Inflation (Continued)

ately with inflationary increases and decreases in housing costs. Fluctuations
in the rate of inflation also affect the sale values of properties and,
correspondingly, the ultimate realizable value of the Company's real estate and
notes receivable portfolios. Inflation also has an effect on the Company's
earnings from short-term investments.

Taxes

For the years 1994, 1995 and 1996, the Company elected and in the opinion of
the Company's management qualified, to be taxed as a Real Estate Investment
Trust ("REIT") as defined under Sections 856 through 860 of the Internal
Revenue Code of 1986, as amended (the "Code"). To continue to qualify for
federal taxation as a REIT under the Code, the Company is required to hold at
least 75% of the value of its total assets in real estate assets, government
securities, cash and cash equivalents at the close of each quarter of each
taxable year. The Code also requires a REIT to distribute at least 95% of its
REIT taxable income plus 95% of its net income from foreclosure property, all
as defined in Section 857 of the Code, on an annual basis to stockholders.

Recent Accounting Pronouncements

In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 121 - "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of."
The statement requires that long-lived assets be considered impaired "...if the
sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset." If impairment exists,
an impairment loss shall be recognized, by a charge against earnings, equal to
"...the amount by which the carrying amount of the asset exceeds the fair value
of the asset." If impairment of a long-lived asset is recognized, the carrying
amount of the asset shall be reduced by the amount of the impairment, shall be
accounted for as the asset's "new cost" and such new cost shall be depreciated
over the asset's remaining useful life.

SFAS No. 121 further requires that long-lived assets held for sale "...be
reported at the lower of carrying amount or fair value less cost to sell." If a
reduction in a held for sale asset's carrying amount to fair value less cost to
sell is required, a provision for loss shall be recognized by a charge against
earnings. Subsequent revisions, either upward or downward, to a held for sale
asset's estimated fair value less cost to sell shall be recorded as an
adjustment to the asset's carrying amount, but not in excess of the asset's
carrying amount when originally classified as held for sale. A corresponding
charge against or credit to earnings is to be recognized. Long-lived assets
held for sale are not to be depreciated. The Company adopted SFAS No. 121
effective January 1, 1996.

The effect of adopting SFAS No. 121 was the discontinuance of depreciation on
the Company's property held for sale of $20,000 and a corresponding
reduction in the Company's reported net loss.

<PAGE> 24

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

INCOME OPPORTUNITY REALTY INVESTORS, INC.

Report of Independent Certified Public Accountants.............. 25

Consolidated Balance Sheets -
December 31, 1996 and 1995.................................. 26

Consolidated Statements of Operations -
Years Ended December 31, 1996, 1995 and 1994................ 27

Consolidated Statements of Stockholders' Equity -
Years Ended December 31, 1996, 1995 and 1994................ 28

Consolidated Statements of Cash Flows -
Years Ended December 31, 1996, 1995 and 1994................ 29

Notes to Consolidated Financial Statements...................... 31

Schedule III - Real Estate and Accumulated Depreciation......... 44

Schedule IV - Mortgage Loans on Real Estate.................... 46

TRI-CITY LIMITED PARTNERSHIP

Report of Independent Certified Public Accountants.............. 48

Balance Sheets - December 31, 1996 and 1995..................... 49

Statements of Operations -
Years ended December 31, 1996, 1995 and 1994................ 50

Statements of Partners' Equity -
Years ended December 31, 1996, 1995 and 1994................ 51

Statements of Cash Flows -
Years ended December 31, 1996, 1995 and 1994................ 52

Notes to Financial Statements................................... 53

Schedule III - Real Estate and Accumulated Depreciation......... 56
</TABLE>

All other schedules are omitted because they are not required, are not
applicable or the information required is included in the Financial Statements
or the notes thereto.

<PAGE> 25

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors of
Income Opportunity Realty Investors, Inc.

We have audited the accompanying consolidated balance sheets of Income
Opportunity Realty Investors, Inc. and Subsidiaries as of December 31, 1996 and
1995 and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1996. We have also audited the schedules listed in the accompanying index.
These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.

We conducted our audits 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 and schedules are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedules. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedules. We believe our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Income
Opportunity Realty Investors, Inc. and Subsidiaries as of December 31, 1996 and
1995, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.

Also, in our opinion, the schedules referred to above present fairly, in all
material respects, the information set forth therein.

BDO SEIDMAN, LLP

Dallas, Texas
March 7, 1997

<PAGE> 26

INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
December 31,
-----------------
1996 1995
------- -------
(dollars in thousands)
<S> <C> <C>
Assets

Notes and interest receivable
Performing ............................................ $ 1,998 $ 1,986

Foreclosed real estate held for sale, net of
accumulated depreciation ($20 in 1996 and 1995 ........ 914 966

Real estate under contract for sale, net of
accumulated depreciation ($1,904 in 1996) ............. 5,709 --

Less - allowance for estimated losses .................... -- (121)
------- -------
6,623 845

Real estate held for investment, net of accumulated
depreciation ($5,311 in 1996 and $6,087 in 1995) ...... 46,693 39,480

Investment in partnerships ............................... 2,331 2,472
Cash and cash equivalents ................................ 3,186 2,988
Other assets (including $256 in 1996 and $90 in
1995 from affiliates) ................................. 2,762 1,398
------- -------
$63,593 $49,169
======= =======

Liabilities and Stockholders' Equity

Liabilities
Notes and interest payable ............................... $38,957 $22,682
Other liabilities (including $243
in 1995 to affiliates) ................................ 2,255 2,296
------- -------
41,212 24,978

Commitments and contingencies

Stockholders' equity
Common Stock, $.01 par value;
authorized 10,000,000 shares; issued and
outstanding 1,519,888 shares in 1996 and
1,582,888 shares in 1995 .............................. 15 3,347
Paid-in capital .......................................... 64,804 62,093
Accumulated distributions in excess of accumulated
earnings .............................................. (42,438) (41,249)
------- -------
22,381 24,191
------- -------
$63,593 $49,169
======= =======
</TABLE>

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

<PAGE> 27

INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------
1996 1995 1994
---------- ---------- ----------
(dollars in thousands, except per share)

<S> <C> <C> <C>
Revenues
Rents ..................................... $ 8,666 $ 7,688 $ 6,558
Interest .................................. 339 231 294
---------- ---------- ----------

9,005 7,919 6,852
<CAPTION>

Expenses
Property operations (including $209
in 1996, $156 in 1995 and $146 in
1994 to affiliates) .................... 4,358 4,035 3,425
Interest .................................. 2,629 1,979 1,911
Depreciation .............................. 1,128 1,052 967
Advisory fee to affiliate ................. 227 316 367
General and administrative
(including $175 in 1996, $140 in
1995 and $158 in 1994 to
affiliate) ............................. 1,316 699 555
---------- ---------- ----------

9,658 8,081 7,225
---------- ---------- ----------

(Loss) from operations ....................... (653) (162) (373)

Equity in income (loss) of
partnerships .............................. 85 (744) 86
---------- --------- ---------
Net (loss) ................................... $ (568) $ (906) $ (287)
========== ========= =========

Earnings per share
Net (loss) ................................... $ (.37) $ (.57) $ (.18)
========== ========== ==========

Weighted average shares of
Common Stock used in
computing earnings per share .............. 1,530,008 1,582,888 1,582,888
========== ========== ==========
</TABLE>

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

<PAGE> 28

INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
Accumulated
Distributions
Common Stock in Excess of
-------------------- Paid-in Accumulated Stockholders'
Shares Amount Capital Earnings Equity
---------- ---------- ---------- ------------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>

Balance, December 31,
1993 .................... 1,582,888 3,347 62,093 (39,106) 26,334

Distributions ($.30 per
share) .................. -- -- -- (475) (475)

Net (loss) ................. -- -- -- (287) (287)
---------- ---------- ---------- ------------- ----------

Balance, December 31,
1994 .................... 1,582,888 3,347 62,093 (39,868) 25,572

Distributions ($.30 per
share) .................. -- -- -- (475) (475)

Net (loss) ................. -- -- -- (906) (906)
---------- ---------- ---------- ------------- ----------

Balance, December 31,
1995 .................... 1,582,888 3,347 62,093 (41,249) 24,191

Change in par value ........ -- (3,332) 3,332 -- --

Repurchase of Common
Stock ..................... (63,000) -- (621) -- (621)

Dividends ($.40 per
share) .................. -- -- -- (621) (621)

Net (loss) ................. -- -- -- (568) (568)
---------- ---------- ---------- ------------- ----------

Balance, December 31,
1996 .................... 1,519,888 $ 15 $ 64,804 $ (42,438) $ 22,381
========== ========== ========== ============= ==========
</TABLE>

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

<PAGE> 29

INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1996 1995 1994
-------- -------- --------
(dollars in thousands)

<S> <C> <C> <C>
Cash Flows from Operating Activities
Rents collected ............................... $ 8,673 $ 7,685 $ 6,694
Interest collected ............................ 327 219 282
Interest paid ................................. (2,281) (1,816) (1,828)
Payments for property operations
(including $209 in 1996, $156 in 1995
and $146 in 1994 to affiliate) ............. (5,203) (3,776) (2,973)
Advisory fee paid to affiliate ................ (386) (316) (371)
General and administrative expenses paid
(including $175 in 1996, $140 in 1995
and $158 in 1994 to affiliates) ............ (1,151) (851) (792)
Distributions from equity partnerships'
operating cash flow ........................ 308 298 408
Escrow funding ................................ (69) (131) --
Other ......................................... (161) 88 (331)
-------- -------- --------
Net cash provided by operating
activities ........................... 57 1,400 1,089

Cash Flows from Investing Activities
Funding of equity partnerships ................ (82) (20) (145)
Real estate improvements ...................... (290) (341) (184)
Acquisition of real estate .................... (13,829) -- --
-------- -------- --------
Net cash (used in) investing activities .... (14,201) (361) (329)

Cash Flows from Financing Activities
Proceeds from notes payable ................... 16,511 6,300 --
Payments on notes payable ..................... (439) (4,300) (635)
Debt issue costs .............................. (488) (294) --
Distributions from equity partnerships'
financing cash flow ........................ -- 486 --
Dividends to stockholders ..................... (621) (475) (475)
Repurchase of Common Stock .................... (621) -- --
-------- -------- --------
Net cash provided by (used in)
financing activities ................. 14,342 1,717 (1,110)

Net increase (decrease) in cash and
cash equivalents .............................. 198 2,756 (350)
Cash and cash equivalents, beginning of year ..... 2,988 232 582
-------- -------- --------

Cash and cash equivalents, end of year ........... $ 3,186 $ 2,988 $ 232
======== ======== ========
</TABLE>

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

<PAGE> 30

INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1996 1995 1994
------- ------- --------
(dollars in thousands)

<S> <C> <C> <C>
Reconciliation of net (loss) to net
cash provided by operating activities
Net (loss) ......................................... $ (568) $ (906) $ (287)

Adjustments to reconcile net (loss)
to net cash provided by operating
activities
Depreciation and amortization ................ 1,261 1,238 955
Equity in loss (income) of partnerships ...... (85) 744 (86)
Distributions from equity
partnerships' operating cash flow ......... 308 298 408
(Increase) in other assets ................... (215) (287) (198)
Increase (decrease) in interest
payable ................................... 203 (35) (3)
Increase (decrease) in other
liabilities ............................... (847) 348 300
------- ------- -------
Net cash provided by operating
activities .......................... $ 57 $ 1,400 $ 1,089
======= ======= =======

Schedule of noncash investing and financing
activities

Notes payable from purchase of
real estate ..................................... $ 3,500 $ -- $ --

Carrying value of real estate obtained through
insubstance foreclosure in satisfaction of note
receivable with a carrying value of $990 ........... -- -- 990

</TABLE>

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

<PAGE> 31

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements of Income Opportunity Realty
Investors, Inc. and consolidated entities (the "Company") have been prepared in
conformity with generally accepted accounting principles, the most significant
of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES."
These, along with the remainder of the Notes to Consolidated Financial
Statements, are an integral part of these Consolidated Financial Statements.
The data presented in the Notes to Consolidated Financial Statements are as of
December 31 of each year and for the year then ended, unless otherwise
indicated. Dollar amounts in tables are in thousands, except per share amounts.

Certain balances for 1995 and 1994 have been reclassified to conform to the
1996 presentation.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Company Business. Income Opportunity Realty Investors, Inc.
("IORI"), is the successor to a California business trust organized on December
14, 1984, which commenced operations on April 10, 1985. The Company may hold
interests in real estate through direct ownership, leases and partnerships and
it may also invest in mortgage loans on real estate, including first,
wraparound and junior mortgage loans.

Basis of consolidation. The Consolidated Financial Statements include the
accounts of IORI and subsidiaries and partnerships which it controls. All
intercompany transactions and balances have been eliminated.

Accounting estimates. In the preparation of the Company's Consolidated
Financial Statements in conformity with generally accepted accounting
principles it was necessary for the Company's management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the Consolidated
Financial Statements and the reported amounts of revenues and expenses for the
year then ended. Actual results could differ from these estimates.

Interest recognition on notes receivable. It is the Company's policy to cease
recognizing interest income on notes receivable that have been delinquent for
60 days or more. In addition, accrued but unpaid interest income is only
recognized to the extent that the net realizable value of the underlying
collateral exceeds the carrying value of the receivable.

Allowance for estimated losses. Valuation allowances are provided for estimated
losses on notes receivable considered to be impaired. Impairment is considered
to exist when it is probable that all amounts due under the terms of the note
will not be collected. Valuation allowances are provided for estimated losses
on notes receivable to the

<PAGE> 32

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

extent that the Company's investment in the note exceeds the Company's estimate
of net realizable value of the collateral securing such note, or fair value of
the collateral if foreclosure is probable.

Real Estate Held for Investment and Depreciation. Real estate held for
investment is carried at cost. Statement of Financial Accounting Standards No.
121 ("SFAS No. 121") requires that a property be considered impaired, if the
sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the property. If impairment
exists, an impairment loss is recognized, by a charge against earnings, equal
to the amount by which the carrying amount of the property exceeds the fair
value of the property. If impairment of a property is recognized, the carrying
amount of the property is reduced by the amount of the impairment, and a new
cost for the property is established. Such new cost is depreciated over the
property's remaining useful life. Depreciation is provided by the straight-line
method over estimated useful lives, which range from 3 to 40 years.

Real Estate Held for Sale. Foreclosed real estate is initially recorded at new
cost, defined as the lower of original cost or fair value minus estimated costs
of sale. SFAS No. 121 also requires that properties held for sale be reported
at the lower of carrying amount or fair value less costs of sale. If a
reduction in a held for sale property's carrying amount to fair value less
costs of sale is required, a provision for loss shall be recognized by a charge
against earnings. Subsequent revisions, either upward or downward, to a held
for sale property's estimated fair value less costs of sale is recorded as an
adjustment to the property's carrying amount, but not in excess of the
property's carrying amount when originally classified as held for sale. A
corresponding charge against or credit to earnings is recognized. Properties
held for sale are not to be depreciated.

Present value discounts. The Company provides for present value discounts on
notes receivable that have interest rates that differ substantially from
prevailing market rates and amortizes such discounts by the interest method
over the lives of the related notes. The factors considered in determining a
market rate for notes receivable include the borrower's credit standing, nature
of the collateral and payment terms of the note.

Revenue recognition on the sale of real estate. Sales of real estate are
recognized when and to the extent permitted by Statement of Financial
Accounting Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS No.
66"). Until the requirements of SFAS No. 66 for full profit recognition have
been met, transactions are accounted for using either the deposit, the
installment sale, the cost recovery or the financing method, whichever is
appropriate.

<PAGE> 33

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Investment in noncontrolled partnerships. The Company uses the equity method to
account for investments in partnerships which it does not control. Under the
equity method, the Company's initial investment, recorded at cost, is increased
by the Company's proportionate share of the partnership's operating income and
additional advances and decreased by the Company's proportionate share of the
partnership's operating losses and distributions received.

Fair value of financial instruments. The Company used the following assumptions
in estimating the fair value of its note receivable and notes payable. For its
note receivable, which is performing, the fair value was estimated by
discounting future cash flows using current interest rates for similar loans.
The estimated fair value presented does not purport to represent the amount to
be ultimately realized by the Company. The amount ultimately realized may vary
significantly from the estimated fair value presented. For notes payable the
fair value was estimated using year end interest rates for mortgages with
similar terms and maturities.

Cash equivalents. For purposes of the Consolidated Statements of Cash Flows,
the Company considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.

Earnings per share. (Loss) per share is computed based upon the weighted
average number of shares of Common Stock outstanding during each year, adjusted
for the two for one stock split effective June 14, 1996.

NOTE 2. NOTES AND INTEREST RECEIVABLE

Notes and interest receivable consisted of the following:

1996 1995
------------------ ------------------
Estimated Estimated
Fair Book Fair Book
Value Value Value Value
------- ------- ------- -------

Note Receivable
Performing ........... $ 2,020 $ 2,000 $ 2,028 $ 2,000
======= =======

Accrued interest ........ 17 17
Unamortized discount .... (19) (31)
------- -------
$ 1,998 $ 1,986
======= =======

The Company does not recognize interest income on nonperforming notes
receivable. For the years 1995 and 1994, unrecognized interest income on
nonperforming notes receivable aggregated $121,000 and $86,000, respectively.
The Company's single note receivable was performing throughout 1996, bears
interest at 10.0% per annum and matures in 1998.

<PAGE> 34

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)

In April 1992, the Company sold the Spanish Trace Apartments in Irving, Texas
with the Company providing $1.1 million of purchase money financing in the form
of a wraparound mortgage note. In November 1993, the Company placed the
wraparound mortgage note on nonperforming, nonaccrual status. In December 1993,
the borrower filed for bankruptcy protection. The Company recorded the property
as an insubstance foreclosure as of December 31, 1994. The Company accepted a
deed in lieu of foreclosure on March 2, 1995. The Company did not incur a loss
on foreclosure as the fair value of the property, less estimated costs of sale,
exceeded the principal balance of the note receivable.

NOTE 3. REAL ESTATE AND DEPRECIATION

In November 1996, the Company purchased the Olympic Building, a 57,000 square
foot office building in Los Angeles, California, for $6.0 million. The Company
paid $1.5 million in cash and obtained new mortgage financing of $4.5 million.
The mortgage bears interest at a variable rate, currently 9.25% per annum,
requires monthly payments of principal and interest of $38,531 and matures in
November 2003.

NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES

Activity in the allowance for estimated losses was as follows:

<TABLE>
<CAPTION>
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Balance January 1, ....... $ 121 $ 121 $ 121
Amounts charged off ... (121) -- --
----- ----- -----
Balance December 31, ..... $-- $ 121 $ 121
===== ===== =====
</TABLE>

NOTE 5. INVESTMENT PARTNERSHIPS

The Company's investments in equity method partnerships consisted of the
following:

<TABLE>
<CAPTION>
1996 1995
------ ------
<S> <C> <C>
Tri-City Limited Partnership ("Tri-City") ... $2,072 $2,226
Nakash Income Associates ("NIA") ............ 259 246
------ ------
$2,331 $2,472
====== ======
</TABLE>

The Company uses the equity method to account for its 36.3% general
partner interest in Tri-City, which owns five properties in Texas.
Transcontinental Realty Investors, Inc. ("TCI") owns a combined 63.7%

<PAGE> 35

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 5. INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)

general and limited partner interest in Tri-City. As of March 7, 1997, TCI
owned approximately 22.5% of the Company's outstanding shares of Common Stock.

In July 1995, Tri-City obtained first mortgage financing of $1.4 million,
secured by a previously unencumbered office building in Dallas, Texas. The
Company received $486,000 of the net financing proceeds.

The Company also uses the equity method to account for its 40% general partner
interest in NIA. TCI owns the remaining 60% general partner interest in NIA.

At December 31, 1995, NIA owned two wraparound mortgage notes receivable, one
of which was secured by a shopping center in Onandaga, New York. In July 1995,
the owner of the shopping center informed NIA that it had determined that
further investment in the shopping center was not justified and further that it
had offered to deed the property back to the first lien holder in lieu of
foreclosure making the wraparound note receivable held by NIA uncollectible.
NIA recorded a provision for loss of $1.5 million to write its wraparound note
receivable down to the balance of the first lien mortgage. The Company's equity
portion of the loss was $601,000. The property was returned to the lender in
March 1996.

In September 1995, the Company received notice from NIA that the other of its
wraparound notes receivable had been modified in conjunction with the
modification of the underlying note payable. NIA recorded a provision for loss
of $212,000 on such modification of which the Company's equity share was
$85,000. This notes remains outstanding.

Set forth below are summarized financial data for the partnerships the Company
accounts for using the equity method:

<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Notes receivable .......................................... $ 902 $ 2,597
Real estate, net of accumulated
depreciation ($3,896 in 1996 and $3,395
in 1995) ............................................... 9,906 10,363
Other assets .............................................. 148 307
Notes payable ............................................. (2,422) (4,143)
Other liabilities ......................................... (384) (569)
-------- --------
Partners' capital ......................................... $ 8,150 $ 8,555
======== ========

<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Rents .......................................... $ 2,643 $ 2,478 $ 2,380
Interest income ................................ 121 319 349
Interest expense ............................... (249) (259) (283)
Property operations expense .................... (1,768) (1,587) (1,656)
Depreciation ................................... (501) (607) (605)
Provision for losses ........................... -- (1,714) --
-------- -------- --------
Net (loss) income .............................. $ 246 $ (1,370) $ 185
======== ======== ========
</TABLE>

<PAGE> 36

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 5. INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)

The Company's equity share of the above net income (loss) for 1996, 1995 and
1994 was $89,000, $(552,000) and $102,000, respectively, before amortization of
property acquisition costs discussed below.

The Company's share of the above partnership's capital was $3.0 million in 1996
and $3.1 million in 1995.

The excess of the Company's investment over its respective share of the equity
in the underlying net assets of Tri-City relates principally to the remaining
unamortized property acquisition costs of $176,000 in 1996 and $180,000 in
1995. These amounts are being amortized over the remaining estimated useful
lives of the properties.

NOTE 6. NOTES AND INTEREST PAYABLE

Notes and interest payable consisted of the following:

<TABLE>
<CAPTION>
1996 1995
-------------------- ------------------
Estimated Estimated
Fair Book Fair Book
Value Value Value Value
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Notes payable................... $ 38,612 $ 38,652 $ 22,289 $ 22,580
Interest payable................ ======== 305 ======== 102
-------- --------
$ 38,957 $ 22,682
======== ========
</TABLE>

Scheduled notes payable principal payments are due as follows:

<TABLE>
<S> <C>
1997.................................... $ 4,069
1998.................................... 6,082
1999.................................... 809
2000.................................... 9,518
2001.................................... 314
Thereafter.............................. 17,860
-------
$38,652
=======
</TABLE>

Mortgage notes payable at December 31, 1996, bear interest at rates ranging
from 6% to 9.75% and mature between 1997 and 2006. These notes are
collateralized by deeds of trust on real estate with a net carrying value of
$52.4 million.

In September 1996, the Company obtained mortgage financing of $1.2 million
secured by the previously unencumbered Town Center Plaza Office

<PAGE> 37

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6. NOTES AND INTEREST PAYABLE (Continued)

Building in Boca Raton, Florida. The Company received net cash of $1.0 million
after funding required tax and insurance escrows and the payment of various
closing costs associated with the financing. The mortgage bears interest at
9.16% per annum, requires monthly payments of principal and interest of $10,296
and matures in October 2006.

In December 1995, the Company refinanced the mortgage debt secured by the
Treehouse Apartments in San Antonio, Texas and the Eastpoint Apartments in
Mesquite, Texas in the aggregate amount of $6.3 million. The Company received
net cash of $2.3 million after the payoff of $3.8 million in existing mortgage
debt, and the payment of various closing costs associated with the
refinancings. The new mortgages bear interest at 7.75% per annum, require
monthly payments of principal and interest and mature in January 2006.

NOTE 7. DIVIDENDS

The Company has paid regular quarterly dividends to its stockholders since the
first quarter of 1993. The Company paid dividends of $.40 per share in 1996 and
$.30 per share in 1995 and 1994 totaling $621,000, $475,000 and $475,000,
respectively.

The Company reported to the Internal Revenue Service that 100% of the dividends
paid in 1996, 1995 and 1994 represented a return on capital.

NOTE 8. RENTS UNDER OPERATING LEASES

The Company's operations include the leasing of office buildings. The leases
thereon expire at various dates through 2001. The following is a schedule of
minimum future rents on non-cancelable operating leases as of December 31,
1996:

1997............................................... $ 3,035
1998............................................... 2,189
1999............................................... 1,910
2000............................................... 640
2001............................................... 145
-------
$ 7,919
=======

NOTE 9. ADVISORY AGREEMENT

Basic Capital Management, Inc. ("BCM" or the "Advisor") has served as
advisor to the Company since March 28, 1989. BCM is a company owned by
a trust for the benefit of the children of Gene E. Phillips. Mr.
Phillips served as a Director of the Company until December 31, 1992,
and as a director of BCM until December 22, 1989, and as Chief Executive
Officer of BCM until September 1, 1992. Mr. Phillips serves as a
representative of his children's trust which owns BCM and, in such
capacity, has substantial contact with the management of BCM and input
with respect to its performance of advisory services to the Company.

<PAGE> 38

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9. ADVISORY AGREEMENT (Continued)

At the Company's annual meeting of stockholders held on May 31, 1996, the
renewal of the Company's Advisory Agreement with BCM through the next annual
meeting of the Company's stockholders was approved. Subsequent renewals of the
Company's Advisory Agreement with BCM do not require the approval of the
Company's stockholders, but do require approval of the Company's Board of
Directors.

Under the Advisory Agreement, the Advisor is required to formulate and submit
annually for approval by the Company's Board of Directors a budget and business
plan for the Company containing a twelve-month forecast of operations and cash
flow, a general plan for asset sales and acquisitions, lending foreclosure and
borrowing activity and other investments. The Advisor is required to report
quarterly to the Company's Board of Directors on the Company's performance
against the business plan. In addition, all transactions by the Company shall
require prior approval by the Company's Board of Directors, unless they are
explicitly provided for in the approved business plan or are made pursuant to
authority expressly delegated to the Advisor by the Company's Board of
Directors.

The Advisory Agreement also requires prior approval of the Company's Board of
Directors for the retention of all consultants and third party professionals,
other than legal counsel. The Advisory Agreement provides that the Advisor
shall be deemed to be in a fiduciary relationship to the Company's stockholders
and contains a broad standard governing the Advisor's liability for losses by
the Company.

The Advisory Agreement provides for BCM to be responsible for the day-to-day
operations of the Company and to receive an advisory fee comprised of a gross
asset fee of .0625% per month (.75% per annum) of the average of the gross
asset value of the Company (total assets less allowance for amortization,
depreciation or depletion and valuation reserves) and an annual net income fee
equal to 7.5% per annum of the Company's net income.

The Advisory Agreement also provides for BCM to receive an annual incentive
sales fee. BCM or an affiliate of BCM is to receive an acquisition commission
for supervising the acquisition, purchase or long-term lease of real estate for
the Company. BCM or an affiliate of BCM is to receive a mortgage or loan
acquisition fee with respect to the acquisition or purchase of any existing
mortgage loan by the Company. BCM or an affiliate of BCM is also to receive a
mortgage brokerage and equity refinancing fee for obtaining loans to the
Company or refinancing on the Company's properties and BCM is to receive
reimbursement of certain expenses incurred by it, in the performance of
advisory services to the Company.

The Advisory Agreement requires BCM or any affiliate of BCM to pay to the
Company one-half of any compensation received from third parties with respect
to the origination, placement or brokerage of any loan made by the Company.

<PAGE> 39

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9. ADVISORY AGREEMENT (Continued)

Under the Advisory Agreement all or a portion of the annual advisory fee must
be refunded by the Advisor to the Company if the Operating Expenses of the
Company (as defined in the Advisory Agreement) exceed certain limits specified
in the Advisory Agreement. The effect of this limitation was to require that
BCM refund 191,000, $44,000 and $6,000, of the 1996, 1995 and 1994 annual
advisory fee, respectively.

Additionally, if the Company were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an
affiliate of BCM will be separately compensated for such additional services on
terms to be agreed upon from time to time. As discussed in NOTE 10. "PROPERTY
MANAGEMENT," the Company has hired Carmel Realty Services, Ltd. ("Carmel,
Ltd."), an affiliate of BCM, to provide property management for the Company's
properties and, as discussed in NOTE 11. "REAL ESTATE BROKERAGE," the Company
has engaged Carmel Realty, Inc. ("Carmel Realty"), also an affiliate of BCM, on
a non-exclusive basis, to provide brokerage services for the Company.

BCM may only assign the Advisory Agreement with the prior consent of the
Company.

NOTE 10. PROPERTY MANAGEMENT

Carmel, Ltd. provides property management services to the Company for a
fee of 5% or less of the monthly gross rents collected on the properties
under its management. Carmel, Ltd. subcontracts with other entities for
the property-level management services to the Company at various rates.
The general partner of Carmel, Ltd. is BCM. The limited partners of
Carmel, Ltd. are (i) Syntek West, Inc. ("SWI"), of which Mr. Phillips is
the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the
benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the
property-level management and leasing of four of the Company's office
buildings and the commercial properties owned by Tri-City in which the
Company and TCI are partners to Carmel Realty which is a company owned
by SWI. Carmel Realty is entitled to receive property and construction
management fees and leasing commissions in accordance with the terms of
its property-level management agreement with Carmel, Ltd.

NOTE 11. REAL ESTATE BROKERAGE

Carmel Realty, also provides brokerage services to the Company on a
non-exclusive basis. Carmel Realty is entitled to receive a commission for
property acquisitions and sales in accordance with a sliding scale of total
fees to be paid by the Company.

<PAGE> 40

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 12. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.

Fees and cost reimbursements to BCM and its affiliates:

<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Fees
Advisory .......................... $ 227 $ 316 $ 367
Brokerage commissions ............. 532 -- --
Mortgage brokerage and equity
refinancing .................... 85 63 --
Property and construction
management and leasing
commissions* ................... 209 156 146
------ ------ ------
$1,053 $ 535 $ 513
====== ====== ======

Cost reimbursements .................. $ 175 $ 140 $ 160
====== ====== ======
</TABLE>

* Net of property management fees paid to subcontractors, other than Carmel
Realty.

NOTE 13. INCOME TAXES

For the years 1996, 1995 and 1994, the Company has elected and qualified to be
treated as a Real Estate Investment Trust ("REIT"), as defined in Sections 856
through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), and
as such, will not be taxed for federal income tax purposes on that portion of
its taxable income which is distributed to stockholders, provided that at least
95% of its REIT taxable income, plus 95% of its taxable income from foreclosure
property as defined in Section 857 of the Code, is distributed.

The Company had a net loss for federal income tax purposes in 1996, 1995 and
1994; therefore, the Company recorded no provision for income taxes. The
Company's tax basis in its net assets differs from the amount at which its net
assets are reported for financial statement purposes, principally due to the
accounting for gains and losses on property sales, the difference in the
allowance for estimated losses, depreciation on owned properties and
investments in joint venture partnerships. At December 31, 1996, the Company's
tax basis in its net assets exceeded its basis for financial statement purposes
by $3.6 million. As a result, aggregate future income for income tax purposes
will be less than such amount for financial statement purposes and the Company
would be able to maintain its REIT status without distributing 95% of its
financial statement income. Additionally, at December 31, 1996, the Company had
tax net operating loss carryforwards of $18.0 million expiring through the year
2011.

As a result of the Company's election to be treated as a REIT for income tax
purposes and of its intention to distribute its taxable income, if any, in
future years, no deferred tax asset, liability or valuation allowance was
recorded.

<PAGE> 41

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 14. COMMITMENTS AND CONTINGENCIES

Olive Litigation. In February 1990, the Company, together with Continental
Mortgage and Equity Trust ("CMET"), National Income Realty Trust ("NIRT") and
TCI, three real estate entities with, at the time, the same officers, directors
or trustees and advisor as the Company, entered into a settlement of a class
and derivative action entitled Olive et al. v. National Income Realty Trust et
al., relating to the operation and management of each of the entities. On April
23, 1990, the Court granted final approval of the terms of the settlement.

The Modification, among other things, provided for the addition of new
unaffiliated members to the Company's Board of Directors and set forth new
requirements for the approval of certain transactions with affiliates until
April 28, 1999. In addition, BCM, the Company's advisor, Gene E. Phillips and
William S. Friedman, who served as the President and Director of the Company
until February 24, 1994, President of BCM until May 1, 1993 and director of BCM
until December 22, 1989, agreed to pay a total of $1.2 million to the Company,
CMET, NIRT and TCI, of which the Company's share was $150,000.

<PAGE> 42

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 14. COMMITMENTS AND CONTINGENCIES (Continued)

Separately, in 1996, legal counsel for the plaintiffs notified the Company's
Board of Directors that he intends to assert that certain actions taken by the
Board of Directors breached the terms of the Modification. On January 27, 1997,
the parties entered into an Amendment to the Modification effective January 9,
1997 (the "Amendment"), which was submitted to the Court for approval on
January 29, 1997. The Amendment provides for the settlement of all matters
raised at the evidentiary hearings and by plaintiffs' counsel in his notices to
the Company's Board of Directors. As of March 7, 1997, the Court had taken no
action on the Amendment.

The Amendment provides for the addition of three new unaffiliated members to
the Company's Board of Directors and sets forth new requirements for the
approval of any transactions with certain

<PAGE> 43

INCOME OPPORTUNITY REALTY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 14. COMMITMENTS AND CONTINGENCIES (Continued)

affiliates until April 28, 1999. In addition, the Company, CMET, TCI and their
stockholders released the defendants from any claims relating to the
plaintiffs' allegations and matters which were the subject of the evidentiary
hearings. The plaintiffs' allegations of any breaches of the Modification shall
be settled by mutual agreement of the parties or, lacking such agreement, by an
arbitration proceeding.

Other Litigation. The Company is also involved in various other lawsuits
arising in the ordinary course of business. The Company's management is of the
opinion that the outcome of these lawsuits will have no material impact on the
Company's financial condition, results of operations or liquidity.

NOTE 15. SUBSEQUENT EVENTS

In January 1997, the Company purchased the Chuck Yeager Building, a 60,060
square foot industrial/office building in Chantilly, Virginia, for $5.1
million. The Company paid $2.0 million in cash and obtained new mortgage
financing of $3.1 million. The mortgage bears interest at a variable rate,
currently 10.75% per annum, requires monthly payments of principal and interest
of $72,017, and matures in January 1999.

In March 1997, the Company completed the sale of the Plumtree Apartments, a 116
unit complex in Martinez, California, that was under contract for sale at
December 31, 1996. The apartment complex was sold for $7.8 million in cash, the
Company receiving net cash of $1.6 million after the payoff of $5.7 million in
existing mortgage debt and the payment of various closing costs associated with
the sale. The Company will recognize a gain on the sale of approximately $1.8
million.

<PAGE> 44
SCHEDULE III
INCOME OPPORTUNITY REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1996

<TABLE>
<CAPTION>
Cost
Capitalized
Subsequent to Gross Amounts of Which Carried
Initial Cost Acquisition at End of Year
------------------ ------------ -------------------------------
Building & Building & (1)
Property/Location Encumbrances Land Improvements Improvements Land Improvements Total
----------------- ------------ ---- ------------ ------------ ---- ------------ -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Properties Held For Investment
APARTMENTS

Eastpoint ................................... $ 3,373 $ 1,181 $ 2,749 $ 386 $ 1,181 $ 3,135 $ 4,316
Mesquite, TX

Porticos .................................... 9,619 2,897 11,588 179 2,897 11,767 14,664
Milwaukee, WI

Treehouse ................................... 2,864 375 2,124 218 375 2,342 2,717
San Antonio, TX

OFFICE BUILDINGS

Daley Plaza Corporate
Center ..................................... 3,500 1,502 6,008 -- 1,502 6,008 7,510
San Diego, CA

Olympic Building ............................ 4,500 1,264 5,055 -- 1,264 5,055 6,319
Los Angeles, CA

Saratoga .................................... 7,246 2,577 10,306 686 2,583 10,986 13,569
Saratoga, CA

Town Center Plaza ........................... 1,208 554 2,214 141 554 2,355 2,909
Boca Raton, FL

Properties Held for Sale

APARTMENTS

Plumtree .................................... 5,684 1,751 5,038 824 1,751 5,862 7,613
Martinez, CA

Spanish Trace ............................... -- 198 792 (56)(2) 168 766 934
Irving, TX ............................... -- -- -- -- -- -- --

------- ------- ------- ------ ------- ------- -------
$37,994 $12,299 $45,874 $2,378 $12,275 $48,276 $60,551
======= ======= ======= ====== ======= ======= =======
<CAPTION>
Life on Which
Depreciation
In Latest
Statement
Accumulated Date of Date of Operation
Property/Location Depreciation Construction Acquired is Computed
----------------- ------------ ------------ -------- --------------
(dollars in thousands)
<S> <C> <C> <C> <C>

Properties Held For Investment
APARTMENTS

Eastpoint ................................... $1,157 1985 01/86 5 - 40 years
Mesquite, TX

Porticos .................................... 1,556 1973 11/91 40 years
Milwaukee, WI

Treehouse ................................... 482 1975 09/89 5 - 40 years
San Antonio, TX

OFFICE BUILDINGS

Daley Plaza Corporate
Center ..................................... 50 1987 09/96 5 - 40 years
San Diego, CA

Olympic Building ............................ 20 1990 11/96 5 - 40 years
Los Angeles, CA

Saratoga .................................... 1,648 1986 12/91 3 - 40 years
Saratoga, CA

Town Center Plaza ........................... 398 1985 03/91 5 - 40 years
Boca Raton, FL

Properties Held for Sale

APARTMENTS

Plumtree .................................... 1,904 1986 02/86 5 - 40 years
Martinez, CA

Spanish Trace ............................... 20 1964 12/94 40 years
Irving, TX --
------
$7,235
======
</TABLE>

(1) The aggregate cost for Federal income tax purposes is $60,636.
(2) Writedown of property to estimated net realizable value.

44
<PAGE> 45

SCHEDULE III
(Continued)

INCOME OPPORTUNITY REALTY INVESTORS, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION

<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(dollars in thousands)

<S> <C> <C> <C>
Reconciliation of Real Estate

Balance at January 1, .................. $ 46,553 $ 46,211 $ 45,040

Additions

Acquisitions and Improvements ..... 14,119 342 184
Foreclosure ....................... -- -- 990

Deductions

Writedown due to permanent
impairment of property,
previously reserved ............ (121) -- --
Other ............................. -- -- (3)
-------- -------- --------

Balance at December 31, ................ $ 60,551 $ 46,553 $ 46,211
======== ======== ========

Reconciliation of Accumulated
Depreciation

Balance at January 1, .................. $ 6,107 $ 5,055 $ 4,088

Additions

Depreciation ...................... 1,128 1,052 967
-------- -------- --------

Balance at December 31, ................ $ 7,235 $ 6,107 $ 5,055
======== ======== ========
</TABLE>

<PAGE> 46

SCHEDULE IV

INCOME OPPORTUNITY REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE
December 31, 1996

<TABLE>
<CAPTION>
Principal amount
of loans subject
Final Carrying to delinquent
Interest maturity Prior Face amount amounts principal
Description rate date Periodic payment terms liens of mortgage of mortgage(1) or interest
- - ------------------------- ----- -------- --------------------------------- --------- ----------- -------------- ----------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
WRAPAROUND MORTGAGE NOTE

Twin Oaks................ 10.00% 08/98 Monthly interest - only payments $ 739 $ 2,000 $ 2,000 $ -
due through maturity, at which ======== ========= =========
Secured by shopping time the entire principal balance
center in Joliet, IL. and all accrued and unpaid
interest are due.

Accrued interest 17

Unamortized discount (19)
----------
$ 1,998
==========
</TABLE>

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

(1) The aggregate cost for Federal income tax purposes is $2.0 million.

<PAGE> 47

SCHEDULE IV
(Continued)

INCOME OPPORTUNITY REALTY INVESTORS, INC.
MORTGAGE LOANS ON REAL ESTATE

<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
(dollars in thousands)

<S> <C> <C> <C>
Balance at January 1, ...... $ 2,000 $ 2,000 $ 3,050

Deductions

Foreclosure ........... -- -- (1,050)
------- ------- -------

Balance at December 31, .... $ 2,000 $ 2,000 $ 2,000
======= ======= =======
</TABLE>

<PAGE> 48

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Partners of
Tri-City Limited Partnership
Dallas, Texas

We have audited the accompanying balance sheets of Tri-City Limited Partnership
as of December 31, 1996 and 1995, and the related statements of operations,
partners' equity, and cash flows for the three years ended December 31, 1996. We
have also audited the schedule listed in the accompanying index. These financial
statements and schedule are the responsibility of the Partnership's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.

We conducted our audits 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 and schedule are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedule. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedule. We believe that our
audits provide 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 Tri-City Limited Partnership at
December 31, 1996 and 1995, and the results of its operations its cash flows for
the three years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles.

Also in our opinion the schedule referred to above presents fairly in all
material respects the information set forth therein.

BDO SEIDMAN, LLP

Dallas, Texas
March 7, 1997

<PAGE> 49
TRI-CITY LIMITED PARTNERSHIP
BALANCE SHEETS

<TABLE>
<CAPTION>
December 31,
----------------------
1996 1995
----------- ---------
(dollars in thousands)

Assets

<S> <C> <C>
Real estate held for investment, net of accumulated
depreciation ($3,896 in 1996 and $3,395 in 1995) ........ $ 9,793 $10,250

Cash and cash equivalents ................................. 102 175

Other assets (including $6 in 1996 to affiliates) ......... 141 132
------- -------
$10,036 $10,557
======= =======

Liabilities and Partners' Equity

Notes and interest payable ................................ $ 1,406 $ 1,421

Other liabilities (including $222 in
1995 to affiliates) ..................................... 372 464
------- -------
1,778 1,885

Partners' equity
Limited Partner ......................................... 6,698 6,698
General Partners ........................................ 1,560 1,974
------- -------
8,258 8,672
------- -------

$10,036 $10,557
======= =======
</TABLE>

The accompanying notes are an integral part of these financial statements.

49
<PAGE> 50
TRI-CITY LIMITED PARTNERSHIP
STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1996 1995 1994
------ ------ -------
(dollars in thousands)
<S> <C> <C> <C>
Revenues
Rents ................................. $ 2,643 $ 2,478 $ 2,380

Expenses
Property operations (including
$110 in 1996, $91 in 1995 and
$86 in 1994 to affiliates)........... 1,753 1,565 1,572
Interest .............................. 139 62 --
Depreciation .......................... 501 607 654
General and administrative ............ 10 18 14
-------- ------- -------
2,403 2,252 2,240
-------- ------- -------

Net income .............................. $ 240 $ 226 $ 140
======== ======= =======
</TABLE>

The accompanying notes are an integral part of these financial statements.

<PAGE> 51

TRI-CITY LIMITED PARTNERSHIP
STATEMENT OF PARTNERS' EQUITY

<TABLE>
<CAPTION>
Limited General
Partner Partners Total
------- -------- -----
(Dollars in thousands)
<S> <C> <C> <C>
Balance, January 1, 1994 ........... $ 6,698 $ 4,246 $ 10,944

Distributions ...................... -- (700) (700)

Net income ......................... -- 140 140
-------- -------- --------

Balance, December 31, 1994 ......... 6,698 3,686 10,384

Distributions ...................... -- (1,938) (1,938)

Net income ......................... -- 226 226
-------- -------- --------

Balance, December 31, 1995 ......... 6,698 1,974 8,672

Contributions ...................... -- 181 181

Distributions ...................... (835) (835)

Net income ......................... -- 240 240
-------- -------- --------

Balance, December 31, 1996 ......... $ 6,698 $ 1,560 $ 8,258
======== ======== ========
</TABLE>

The accompanying notes are an integral part of these financial statements.

<PAGE> 52

TRI-CITY LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------
1996 1995 1994
-------- ------- ------
(dollars in thousands)
<S> <C> <C> <C>
Cash Flows from Operating Activities
Rents collected ............................ $ 2,653 $ 2,480 $ 2,428
Interest paid ............................... (131) (48) --
Payments for property operations (including
$110 in 1996, $91 in 1995 and $86 in 1994
to affiliates) ............................ (1,612) (1,785) (1,541)
Distributions ............................... (835) (1,938) (700)
Other ....................................... (16) 7 (10)
------- ------- -------
Net cash provided by (used in)
operating activities ................... 59 (1,284) 177

Cash flows from Investing Activities
Real estate improvements .................... (44) (213) (278)
Contributions ............................... 181 -- --
------- ------- -------
Net cash provided by (used in) investing
activities ............................. 137 (213) (278)

Cash Flows from Financing Activities
Proceeds from notes payable ................. -- 1,415 --
Payments on notes payable ................... (15) (5) --
Debt issue costs ............................ -- (79) --
Advance (to) from affiliate ................. (254) 322 (108)

Net cash provided by (used in)
financing activities ................... (269) 1,653 (108)

Net increase (decrease) in cash and cash
equivalents ................................. (73) 156 (209)
Cash and cash equivalents, beginning of period 175 19 228
------- ------- -------

Cash and cash equivalents, end of period ...... $ 102 $ 175 $ 19
======= ======= =======

Reconciliation of net income to net cash
provided by (used in) operating activities
Net income .................................. $ 240 $ 226 $ 140
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization .......... 501 610 654
Distributions .......................... (835) (1,938) (700)
(Increase) decrease in other assets .... (6) 20 41
Increase in interest payable ........... 8 11 --
Increase (decrease) in other liabilities 151 (213) 42
------- ------- -------
Net cash provided by (used in)
operating activities .............. $ 59 $(1,284) $ 177
======= ======= =======
</TABLE>

The accompanying notes are an integral part of these financial statements.

<PAGE> 53

TRI-CITY LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS

The accompanying Financial Statements of Tri-City Limited Partnership (the
"Partnership") have been prepared in conformity with generally accepted
accounting principles, the most significant of which are described in NOTE 1.
"SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES." These, along with the remainder
of the Notes to Financial Statements, are an integral part of these Financial
Statements. The data presented in the Notes to Financial Statements are as of
December 31 of each year and for the year then ended, unless otherwise
indicated. Dollar amounts in tables are in thousands.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and purpose. Tri-City Limited Partnership, a Texas partnership,
was organized on June 29, 1989. The purpose of the Partnership is to acquire,
hold for investment, improve, lease, operate, and sell or otherwise dispose of
real estate, and to engage in any and all activities related or incidental
thereto.

Income Opportunity Realty Investors, Inc. ("IORI") and Transcontinental Realty
Investors, Inc. ("TCI") are partners in the Partnership. IORI is a publicly
held real estate investment trust ("REIT") whose shares are traded on the
American Stock Exchange. TCI is also a publicly held REIT whose shares are
traded on the New York Stock Exchange. Basic Capital Management, Inc. ("BCM")
serves as advisor to IORI and TCI.

The percentages of ownership of the Partnership are as follows:

<TABLE>
<CAPTION>
General Limited
Partner Partner Total
------- ------- -----
<S> <C> <C> <C>
TCI........................................ 23.59% 40.11% 63.70%
IORI....................................... 36.30% -- 36.30%
----- ----- ------
59.89% 40.1l% 100.00%
===== ===== ======
</TABLE>

Allocations of profits and distributions are made in accordance with the
partnership agreement.

Accounting estimates. In the preparation of the Partnership's Financial
Statements in conformity with generally accepted accounting principles it was
necessary for the Partnership's management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the Financial Statements and
the reported amounts of revenues and expenses for the year then ended. Actual
results could differ from these estimates.

Real estate and depreciation. Real estate is carried at cost. Depreciation is
provided using the straight-line method over the estimated useful lives of the
assets, which range from four to forty years.

<PAGE> 54
TRI-CITY LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS - Continued

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Fair values of financial instruments. The Partnership estimated the fair value
of its note payable using year end interest rates for mortgages with similar
terms and maturities.

Cash and cash equivalents. The Partnership considers all highly liquid debt
instruments purchased with an original maturity of three months or less to be
cash equivalents.

Income taxes. The Partnership is taxed as such for federal income tax
purposes. The Partnership has no current year income tax expense or deferred
taxes. Taxable income is included in the respective tax returns of the
partners.

NOTE 2. NOTES AND INTEREST PAYABLE

Note and interest payable consisted of the following:

<TABLE>
<CAPTION>
1996 1995
------------------ ------------------
Estimated Estimated
Fair Book Fair Book
Value Value Value Value
------------------ ------------------
<S> <C> <C> <C> <C>
Note payable ............. $1,444 $1,395 $1,497 $1,410
======
Interest payable ......... 11 11
------ ------
$1,406 $1,421
====== ======
</TABLE>

Scheduled principal payments are due as follows:

1997 ............................... $ 19
1998 ............................... 20
1999 ............................... 22
2000 ............................... 25
2001 ............................... 27
Thereafter ......................... 1,282
-------
$ 1,395
=======

In July 1995, the Partnership obtained mortgage financing of $1.4 million
secured by the previously unencumbered MacArthur Mills Office Park in Dallas,
Texas. The mortgage bears interest at 9.32% per annum, requires monthly
payments of principal and interest of $12,186 and matures August 1, 2005.

NOTE 3. RELATED PARTY TRANSACTIONS

Property Management Fees. Carmel Realty Services, Ltd. ("Carmel, Ltd."), an
affiliate of BCM, provides property management services for a fee of 5% of the
monthly gross rents collected on the properties under its management. Carmel,
Ltd. subcontracts with other entities for

<PAGE> 55

TRI-CITY LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS - Continued

NOTE 3. RELATED PARTY TRANSACTIONS (Continued)

property level management services to the Partnership's apartment complexes at
various rates. Carmel, Ltd. subcontracts the property-level management and
leasing of the Partnership's commercial properties to Carmel Realty, Inc.,
also an affiliate of BCM.

Leasing commissions. As compensation for providing leasing and rent-up services
to a Partnership property, Carmel, Ltd. or an affiliate shall be paid a
reasonable leasing commission.

Construction supervision. As compensation for oversight of major renovations
and refurbishments, Carmel, Ltd. or an affiliate shall be paid a construction
supervision fee.

Mortgage brokerage and equity refinancing fees. As compensation for obtaining
loans for the Partnership, BCM or an affiliate of BCM is to receive a mortgage
brokerage and equity refinancing fee.

Fees to BCM, Carmel, Ltd. and their affiliates are as follows:

<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Property management fees* ........ $ 82 $ 77 $ 75
Leasing commissions .............. 19 7 3
Constructions supervision fees.... 9 7 8
Mortgage brokerage and equity
refinancing fee ................ -- 14 --
---- ---- ----
$110 $105 $ 86
==== ==== ====
</TABLE>

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

* Net of property management fees paid to subcontractors, other than Carmel,
Ltd.

NOTE 4. RENTS UNDER OPERATING LEASES

The Partnership's operations include the leasing of an office building and two
shopping centers. The leases thereon expire at various dates through 2001. The
following is a schedule of future minimum rents on noncancelable operating
leases as of December 31, 1996:

1997......... $ 1,017
1998......... 737
1999......... 560
2000......... 483
2001......... 339
Thereafter... 830
-------
$ 3,966
=======

<PAGE> 56
SCHEDULE III

TRI-CITY LIMITED PARTNERSHIP
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1996

<TABLE>
<CAPTION>
Cost
Capitalized
Initial Cost to Subsequent to Gross Amounts of Which Carried
the Partnership Acquisition at End of Year
------------------- ------------- --------------------------------
Building & Building &
Property/Location Encumbrances Land Improvements Improvements Land Improvements Total(1)
----------------- ------------ ------- ------------ ------------ ---- ------------ -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>

APARTMENTS

Oaks of Inwood .............................. $ - $ 522 $ 1,486 $ (120)(2) $ 493 $ 1,395 $ 1,888
Inwood Greens ............................... - 319 957 (152)(2) 286 838 1,124

SHOPPING CENTERS

Chelsea Square .............................. - 562 3,185 719 562 3,904 4,466
Summit at Bridgewood ........................ - 408 2,314 795 408 3,109 3,517

OFFICE BUILDING

MacArthur Mills ............................. 1,395 239 1,353 1,102 264 2,430 2,694
------- ------- ------- ------ ------- ------- -------
$ 1,395 $ 2,050 $ 9,295 $2,344 $ 2,013 $11,676 $13,689
======= ======= ======= ====== ======= ======= =======

Live on Which
Depreciated
In Latest
Statement
Accumulated Date of Date of Operation
Property/Location Depreciation Construction Acquired is Computed
----------------- ------------ ------------ -------- ------------
(dollars in thousands)
<S> <C> <C> <C> <C>

APARTMENTS

Oaks of Inwood .............................. $ 281 1979 06/89 40 years
Inwood Greens ............................... 179 1980 06/89 40 years

SHOPPING CENTERS

Chelsea Square .............................. 1,102 1985 06/89 5 - 40 years
Summit at Bridgewood ........................ 1,146 1985 06/89 5 - 40 years

OFFICE BUILDING

MacArthur Mills ............................. 1,188 1986 06/89 4 - 40 years
------
$3,896
======
</TABLE>

- - -----------------------------
(1) The aggregate cost for federal income tax purposes is approximately
$13.6 million.
(2) Writedown of property to estimated net realizable value.

<PAGE> 57

SCHEDULE III
(Continued)

TRI-CITY LIMITED-PARTNERSHIP
REAL ESTATE AND ACCUMULATED DEPRECIATION

<TABLE>
<CAPTION>
1996 1995 1994
------- ------- ---------
(dollars in thousands)
<S> <C> <C> <C>
Reconciliation of Real Estate
Balance at January 1, .................... $13,645 $13,432 $13,154
Additions
Improvements ....................... 44 213 278
------- ------- -------
Balance at December 31, .................. $13,689 $13,645 $13,432
======= ======= =======

Reconciliation of Accumulated Depreciation
Balance at January 1, .................... $ 3,395 $ 2,788 $ 2,134
Additions
Depreciation ....................... 501 607 654
------- ------- -------
Balance at December 31, .................. $ 3,896 $ 3,395 $ 2,788
======= ======= =======
</TABLE>

57
<PAGE> 58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT

Directors

The affairs of Income Opportunity Realty Investors, Inc. (the "Company" or the
"Registrant") are managed by a Board of Directors. The Directors are elected at
the annual meeting of stockholders or appointed by the incumbent Board of
Directors and serve until the next annual meeting of stockholders or until a
successor has been elected or approved.

The Directors of the Company are listed below, together with their ages, terms
of service, all positions and offices with the Company or its advisor, Basic
Capital Management, Inc. ("BCM" or the "Advisor"), their principal occupations,
business experience and directorships with other companies during the last five
years or more. The designation "Affiliated", when used below with respect to a
Director, means that the Director is an officer, director or employee of the
Advisor or an officer of the Company. The designation "Independent" when used
below with respect to a Director, means that the Director is neither an officer
of the Company nor a director, officer or employee of the Advisor, although the
Company may have certain business or professional relationships with such
Director as discussed in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS -Certain Business Relationships."

TED P. STOKELY: Age 63, Director (Independent) (since April 1990)
and Chairman of the Board (since January 1995).

General Manager (since January 1995) of ECF Senior Housing Corporation, a
nonprofit corporation; General Manager (since January 1993) of Housing
Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid
Consultant (since January 1993) and paid Consultant (April 1992 to
December 1992) of Eldercare Housing Foundation ("Eldercare"), a nonprofit
corporation engaged in the acquisition of low income and elderly housing;
President (April 1992 to April 1994) of PSA Group (real estate management
and consulting); Executive Vice President (1987 to 1991) of Key Companies
Inc., a publicly traded company that develops, acquires and sells water
and minerals; Trustee (since April 1990) and Chairman of the Board (since
January 1995) of Continental Mortgage and Equity Trust ("CMET"); Director
(since April 1990) and Chairman of the Board (since January 1995) of
Transcontinental Realty Investors, Inc. ("TCI"); and Trustee (April 1990
to August 1994) of National Income Realty Trust ("NIRT").

<PAGE> 59

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

Directors (Continued)

EDWARD L. TIXIER: Age 67, Director (Independent) (since July 1996).

Executive Vice President (since 1996) of Tasa American Homes; Vice
Chairman Planning and Zoning Commission (since 1996) of Dripping Springs,
Texas; Director (since 1995) of Ryokachi Corporation, a Japanese company;
Cattle Rancher (since 1988); President (1988 to 1994) of Tixier, Inc., an
Austin, Texas based corporation; Senior Executive Advisor (1988 to 1994)
to the President of Regency International Trading Company, a Japanese
company; Commander (1984 to 1988) of U.S. Forces, Japan and Commander,
5th Air Force; Retired (1988) Lt. General, United States Air Force;
Trustee (since July 1996) of CMET; and Director (since July 1996) of TCI.

MARTIN L. WHITE: Age 57, Director (Independent) (since January 1995).

Chairman and Chief Executive Officer (since 1993) of North American
Trading Company Ltd.; President and Chief Operating Officer (since 1992)
of Community Based Developers, Inc.; Development Officer and Loan Manager
(1986 to 1992) of the City of San Jose, California; Vice President and
Director of Programs (1967 to 1986) of Arpact, Inc., a government
contractor for small business development and trade; Trustee (since
January 1995) of CMET; and Director (since January 1995) of TCI.

EDWARD G. ZAMPA: Age 62, Director (Independent) (since January 1995).

General Partner (since 1976) of Edward G. Zampa and Company; Trustee
(since January 1995) of CMET; and Director (since January 1995) of TCI.

Board Committees

The Company's Board of Directors held thirteen meetings during 1996. For such
year, no incumbent Director attended fewer than 75% of the aggregate of (i) the
total number of meetings held by the Company's Board of Directors during the
period for which he had been a Director and (ii) the total number of meetings
held by all committees of the Board of Directors on which he served during the
period that he served.

The Company's Board of Directors has an Audit Committee, the function of
which is to review the Company's operating and accounting procedures.
The current members of the Audit Committee, all of whom are Independent
Directors, are Messrs. Stokely, Tixier and White. The Audit Committee
met twice during 1996.

The Company's Board of Directors has a Relationship with Advisor
Committee and a Board Development Committee. The current members of the
Relationship with Advisor Committee are Messrs. Stokely and Zampa. The
Relationship with Advisor Committee reviews and reports to the Company's
Board of Directors on the services provided to the Company by the

<PAGE> 60

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

Board Committees (Continued)

Advisor and its affiliates and the terms of any engagement or compensation of
the Advisor or its affiliates. The Relationship with Advisor Committee met
twice in 1996. The Board Development Committee reviews and reports to the
Company's Board of Directors on the membership, compensation and functions of
the Board of Directors. The current member of the Board Development Committee
is Mr. White. The Board Development Committee met twice in 1996.

The Company's Board of Directors does not have Nominating or
Compensation Committees.

Executive Officers

The following persons currently serve as executive officers of the Company:
Randall M. Paulson, President; Bruce A. Endendyk, Executive Vice President; and
Thomas A. Holland, Executive Vice President and Chief Financial Officer. Their
positions with the Company are not subject to a vote of stockholders. Their
ages, terms of service, all positions and offices with the Company or BCM,
other principal occupations, business experience and directorships with other
companies during the last five years or more are set forth below.

RANDALL M. PAULSON: Age 50, President (since August 1995) and Executive
Vice President (January 1995 to August 1995).

President (since August 1995) and Executive Vice President (January 1995
to August 1995) of CMET, TCI and Syntek Asset Management, Inc. ("SAMI"),
the managing general partner of Syntek Asset Management, L.P. ("SAMLP"),
which is the general partner of National Realty, L.P. ("NRLP") and
National Operating, L.P. ("NOLP") and (October 1994 to August 1995) of
BCM; Director (since August 1995) of SAMI; Executive Vice President
(since January 1995) of American Realty Trust, Inc. ("ART"); Vice
President (1993 to 1994) of GSSW, LP, a joint venture of Great Southern
Life and Southwestern Life; Vice President (1990 to 1993) of Property
Company of America Realty, Inc.; President (1990) of Paulson Realty
Group; President (1983 to 1989) of Johnstown Management Company; and Vice
President (1979 to 1982) of Lexton-Ancira.

[This space intentionally left blank.]

<PAGE> 61

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

Executive Officers (Continued)

BRUCE A. ENDENDYK: Age 48, Executive Vice President (since January
1995).

President (since January 1995) of Carmel Realty, Inc. ("Carmel Realty"),
a company owned by Syntek West, Inc. ("SWI"); Executive Vice President
(since January 1995) of BCM, SAMI, ART, CMET and TCI; Management
Consultant (November 1990 to December 1994); Executive Vice President
(January 1989 to November 1990) of Southmark Corporation ("Southmark");
President and Chief Executive Officer (March 1988 to January 1989) of
Southmark Equities Corporation; and Vice President/Resident Manager
(December 1975 to March 1988) of Coldwell Banker Commercial/Real Estate
Services in Houston, Texas.

THOMAS A. HOLLAND: Age 54, Executive Vice President and Chief Financial
Officer (since August 1995); Secretary (since February 1997) and Senior
Vice President and Chief Accounting Officer (July 1990 to August 1995).

Executive Vice President and Chief Financial Officer (since August 1995)
and Senior Vice President and Chief Accounting Officer (July 1990 to
August 1995) of BCM, SAMI, ART, CMET and TCI; Secretary (since February
1997) of CMET and TCI; Senior Vice President and Chief Accounting Officer
(July 1990 to February 1994) of NIRT and Vinland Property Trust ("VPT");
Vice President and Controller (December 1986 to June 1990) of Southmark;
Vice President-Finance (January 1986 to December 1986) of Diamond
Shamrock Chemical Company; Assistant Controller (May 1976 to January
1986) of Maxus Energy Corporation (formerly Diamond Shamrock
Corporation); Trustee (August 1989 to June 1990) of Arlington Realty
Investors; and Certified Public Accountant (since 1970).

Officers

Although not executive officers of the Company, the following persons currently
serve as officers of the Company: Mark W. Branigan, Senior Vice President -
Residential Asset Management; Lynn W. Humphries, Senior Vice President -
Commercial Asset Management; Robert A. Waldman, Senior Vice President and
General Counsel; and Drew D. Potera, Vice President and Treasurer. Their
positions with the Company are not subject to a vote of stockholders. Their
ages, terms of service, all positions and offices with the Company or BCM,
other principal occupations, business experience and directorships with other
companies during the last five years or more are set forth below.

<PAGE> 62

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

Officers (Continued)

MARK W. BRANIGAN: Age 42, Senior Vice President - Residential Asset
Management (since December 1996) and Vice President (February 1994 to
December 1996).

Senior Vice President - Residential Asset Management (since December
1996) and Vice President (February 1994 to December 1996) of ART, CMET,
TCI and SAMI; Executive Vice President (since May 1995) and Real Estate
Analyst (January 1992 to May 1995) of BCM; Executive Vice President (1984
to 1991) of Byron Investments, Inc.; Director (May 1989 to August 1990)
and Manager of Treasury Services (May 1981 to 1983) of Southmark; and
Director (1977 to April 1981) of Investor Relations for Syntek Corp.

LYNN W. HUMPHRIES: Age 46, Senior Vice President - Commercial Asset
Management (since May 1996).

Senior Vice President - Commercial Asset Management (since May 1996) of
BCM, ART, CMET, TCI and SAMI; Vice President (January 1994 to May 1996)
of the Amend Group; Vice President (1980 to 1993) of Equitable Real
Estate Investment Management, Inc.; and Senior Vice President (1975 to
1980) of
Sanders Campbell & Company.

ROBERT A. WALDMAN: Age 44, Senior Vice President and General Counsel
(since January 1995); Vice President (December 1990 to January 1995) and
Secretary (December 1993 to February 1997).

Senior Vice President and General Counsel (since January 1995), Vice
President (December 1990 to January 1995) and Secretary (December 1993 to
February 1997) of CMET and TCI; Senior Vice President and General Counsel
(since January 1995), Vice President (January 1993 to January 1995) and
Secretary (since December 1989) of ART; Senior Vice President and General
Counsel (since November 1994), Vice President and Corporate Counsel
(November 1989 to November 1994), and Secretary (since November 1989) of
BCM; Senior Vice President and General Counsel (since January 1995), Vice
President (April 1990 to January 1995) and Secretary (since December
1990) of SAMI; Vice President (December 1990 to February 1994) and
Secretary (December 1993 to February 1994) of NIRT and VPT; and Director
(February 1987 to October 1989) and General Counsel and Secretary (1985
to October 1989) of Red Eagle Resources Corporation (oil and gas).

<PAGE> 63

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

Officers (Continued)

DREW D. POTERA: Age 37, Vice President (since December 1996) and
Treasurer (since December 1990).

Vice President (since December 1996) and Treasurer (since December 1990)
of CMET and TCI; Vice President (since December 1996) and Treasurer
(since August 1991) and Assistant Treasurer (December 1990 to August
1991) of ART; Vice President, Treasurer and Securities Manager (since
July 1990) of BCM; Vice President and Treasurer (since February 1992) of
SAMI; Treasurer (December 1990 to February 1994) of NIRT and VPT; and
Financial Consultant with Merrill Lynch, Pierce, Fenner & Smith
Incorporated (June 1985 to June 1990).

In addition to the foregoing officers, the Company has several vice presidents
and assistant secretaries who are not listed herein.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

Under the securities laws of the United States, the Company's Directors,
executive officers, and any persons holding more than ten percent of the
Company's shares of Common Stock are required to report their ownership of the
Company's shares and any changes in that ownership to the Securities and
Exchange Commission (the "Commission"). Specific due dates for these reports
have been established and the Company is required to report any failure to file
by these dates during 1996. All of these filing requirements were satisfied by
its Directors and executive officers and ten percent holders. In making these
statements, the Company has relied on the written representations of its
incumbent Directors and executive officers and its ten percent holders and
copies of the reports that they have filed with the Commission.

The Advisor

Although the Company's Board of Directors is directly responsible for managing
the affairs of the Company and for setting the policies which guide it, the
day-to-day operations of the Company are performed by a contractual advisor
under the supervision of the Company's Board of Directors. The duties of the
advisor include, among other things, locating, investigating, evaluating and
recommending real estate and mortgage note investment and sales opportunities
as well as financing and refinancing sources for the Company. The advisor also
serves as a consultant to the Company's Board of Directors in connection with
the business plan and investment policy decisions.

BCM has served as the Company's advisor since March 1989. BCM is a
company of which Messrs. Paulson, Endendyk and Holland serve as
executive officers. BCM is owned by a trust for the benefit of the
children of Gene E. Phillips. Mr. Phillips served as a director of BCM
until December 22, 1989, and as Chief Executive Officer of BCM until
September 1, 1992. Mr. Phillips serves as a representative of his

<PAGE> 64

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

The Advisor (Continued)

children's trust which owns BCM and, in such capacity, has substantial contact
with the management of BCM and input with respect to BCM's performance of
advisory services to the Company.

At the Company's annual meeting of stockholders held on May 31, 1996, the
Company's stockholders approved the renewal of the Company's Advisory Agreement
with BCM through the next annual meeting of the Company's stockholders.
Subsequent renewals of the Company's Advisory Agreement with BCM do not require
the approval of the Company's stockholders, but do require approval of the
Company's Board of Directors.

Under the Advisory Agreement, the Advisor is required to formulate and submit
annually for approval by the Company's Board of Directors a budget and business
plan for the Company containing a twelve month forecast of operations and cash
flow, a general plan for asset sales and acquisitions, lending foreclosure and
borrowing activity, and other investments. The Advisor is required to report
quarterly to the Company's Board of Directors on the Company's performance
against the business plan. In addition, all transactions by the Company shall
require prior approval by the Company's Board of Directors, unless they are
explicitly provided for in the approved business plan or are made pursuant to
authority expressly delegated to the Advisor by the Company's Board of
Directors.

The Advisory Agreement also requires prior approval of the Company's Board of
Directors for the retention of all consultants and third party professionals,
other than legal counsel. The Advisory Agreement provides that the Advisor
shall be deemed to be in a fiduciary relationship to the Company's
stockholders; contains a broad standard governing the Advisor's liability for
losses by the Company; and contains guidelines for the Advisor's allocation of
investment opportunities as among itself, the Company and other entities it
advises.

The Advisory Agreement also provides for BCM to receive an annual incentive
sales fee equal to 10% of the amount, if any, by which the aggregate sales
consideration for all real estate sold by the Company during such fiscal year
exceeds the sum of: (i) the cost of each such property as originally recorded
in the Company's books for tax purposes (without deduction for depreciation,
amortization or reserve for losses), (ii) capital improvements made to such
assets during the period

<PAGE> 65

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

The Advisor (Continued)

owned by the Company, and (iii) all closing costs, (including real estate
commissions) incurred in the sale of such real estate; provided, however, no
incentive fee shall be paid unless (a) such real estate sold in such fiscal
year, in the aggregate, has produced an 8% simple annual return on the
Company's net investment including capital improvements, calculated over the
Company's holding period before depreciation and inclusive of operating income
and sales consideration and (b) the aggregate net operating income from all
real estate owned by the Company for each of the prior and current fiscal years
shall be at least 5% higher in the current fiscal year than in the prior fiscal
year.

Additionally, pursuant to the Advisory Agreement BCM or an affiliate of BCM is
to receive an acquisition commission for supervising the acquisition, purchase
or long-term lease of real estate for the Company equal to the lesser of (i) up
to 1% of the cost of acquisition, inclusive of commissions, if any, paid to
nonaffiliated brokers or (ii) the compensation customarily charged in
arm's-length transactions by others rendering similar property acquisition
services as an ongoing public activity in the same geographical location and
for comparable property, provided that the aggregate purchase price of each
property (including acquisition fees and real estate brokerage commissions) may
not exceed such property's appraised value at acquisition.

The Advisory Agreement requires BCM or any affiliate of BCM to pay to the
Company, one-half of any compensation received from third parties with respect
to the origination, placement or brokerage of any loan made by the Company;
provided, however, that the compensation retained by BCM or any affiliate of
BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed
by the Company or (ii) a loan brokerage and commitment fee which is reasonable
and fair under the circumstances.

The Advisory Agreement also provides that BCM or an affiliate of BCM is to
receive a mortgage or loan acquisition fee with respect to the acquisition or
purchase of any existing mortgage loan by the Company equal to the lesser of
(i) 1% of the amount of the loan purchased or (ii) a brokerage or commitment
fee which is reasonable and fair under the circumstances. Such fee will not be
paid in connection with the origination or funding by the Company of any
mortgage loan.

Under the Advisory Agreement, BCM or an affiliate of BCM is also to receive a
mortgage brokerage and equity refinancing fee for obtaining loans to the
Company or refinancing on Company properties equal to the lesser of (i) 1% of
the amount of the loan or the amount refinanced or (ii) a brokerage or
refinancing fee which is reasonable and fair under the circumstances; provided,
however, that no such fee shall be paid on loans from BCM or an affiliate of
BCM without the approval of the Company's Board of Directors. No fee shall be
paid on loan extensions.

Under the Advisory Agreement, BCM is to receive reimbursement of certain
expenses incurred by it, in the performance of advisory services to the
Company.

<PAGE> 66

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

The Advisor (Continued)

Under the Advisory Agreement all or a portion of the annual advisory fee must
be refunded by the Advisor to the Company if the Operating Expenses of the
Company (as defined in the Advisory Agreement) exceed certain limits specified
in the Advisory Agreement based on the book value, net asset value and net
income of the Company during such fiscal year. The effect of this limitation
was to require that BCM refund $191,000, of the 1996 annual advisory fee.

Additionally, if the Company were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an
affiliate of BCM will be separately compensated for such additional services on
terms to be agreed upon from time to time. As discussed below, under "Property
Management", the Company has hired Carmel Realty Services, Ltd. ("Carmel,
Ltd."), an affiliate of BCM, to provide management for the Company's properties
and, as discussed below, under "Real Estate Brokerage" the Company has engaged
Carmel Realty, also an affiliate of BCM, on a non-exclusive basis to provide
brokerage services for the Company.

BCM may only assign the Advisory Agreement with the prior consent of the
Company.

The directors and principal officers of BCM are set forth below.

MICKEY N. PHILLIPS: Director

RYAN T. PHILLIPS: Director

RANDALL M. PAULSON: President

MARK W. BRANIGAN: Executive Vice President - Residential Asset
Management

BRUCE A. ENDENDYK: Executive Vice President

THOMAS A. HOLLAND: Executive Vice President and Chief Financial
Officer

COOPER B. STUART: Executive Vice President

CLIFFORD C. TOWNS, JR: Executive Vice President - Finance

DAN S. ALLRED Senior Vice President - Land Development

LYNN W. HUMPHRIES: Senior Vice President - Commercial Asset
Management

ROBERT A. WALDMAN: Senior Vice President, Secretary and General
Counsel

DREW D. POTERA: Vice President, Treasurer and Securities
Manager

<PAGE> 67

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
(Continued)

The Advisor (Continued)

Mickey N. Phillips is Gene E. Phillips' brother and Ryan T. Phillips is Gene E.
Phillips' son. Gene E. Phillips serves as a representative of the trust
established for the benefit of his children which owns BCM and, in such
capacity, has substantial contact with the management of BCM and input with
respect to its performance of advisory services to the Company.

Property Management

Since February 1, 1990, affiliates of BCM have provided property
management services to the Company. Currently, Carmel, Ltd. provides
such property management services for a fee of 5% or less of the monthly
gross rents collected on the properties under its management. Carmel,
Ltd. subcontracts with other entities for the provision of the
property-level management services to the Company at various rates. The
general partner of Carmel, Ltd. is BCM. The limited partners of Carmel,
Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii)
Mr. Phillips and (iii) a trust for the benefit of the children of Mr.
Phillips. Carmel, Ltd. subcontracts the property-level management and
leasing of four of the Company's office buildings and the commercial
properties owned by a real estate partnership in which the Company and
TCI are partners to Carmel Realty which is a company owned by SWI.
Carmel Realty is entitled to receive property and construction
management fees and leasing commissions in accordance with its property-
level management agreement with Carmel, Ltd.

Real Estate Brokerage

Since December 1, 1992, Carmel Realty has been engaged, on a non-exclusive
basis, to provide brokerage services for the Company. Carmel Realty is entitled
to receive a real estate brokerage commission for property acquisitions and
sales by the Company in accordance with the following sliding scale of total
fees to be paid by the Company: (i) maximum fee of 5% on the first $2.0 million
of any purchase or sale transaction of which no more than 4% would be paid to
Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction amounts
between $2.0 million - $5.0 million of which no more than 3% would be paid to
Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction amounts
between $5.0 million - $10.0 million of which no more than 2% would be paid to
Carmel Realty or affiliates; and, (iv) maximum fee of 2% on transaction amounts
in excess of $10.0 million of which no more than 1 1/2% would be paid to Carmel
Realty or affiliates.

ITEM 11. EXECUTIVE COMPENSATION

The Company has no employees, payroll or benefit plans and pays no compensation
to the executive officers of the Company. The executive officers of the Company
who are also officers or employees of BCM, the Company's Advisor, are
compensated by the Advisor. Such executive officers of the Company perform a
variety of services for the Advisor and the amount of their compensation is
determined solely by the

<PAGE> 68

ITEM 11. EXECUTIVE COMPENSATION (Continued)

Advisor. BCM does not allocate the cash compensation of its officers among the
various entities for which it serves as advisor. See ITEM 10. "DIRECTORS,
EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor" for a more
detailed discussion of the compensation payable to BCM by the Company.

The only remuneration paid by the Company is to the Directors who are not
officers or directors of BCM or its affiliated companies. The Independent
Directors (i) review the business plan of the Company to determine that it is
in the best interest of the Company's stockholders, (ii) review the Company's
contract with the advisor, (iii) supervise the performance of the Company's
advisor and review the reasonableness of the compensation which the Company
pays to its advisor in terms of the nature and quality of services performed,
(iv) review the reasonableness of the total fees and expenses of the Company
and (v) select, when necessary, a qualified independent real estate appraiser
to appraise properties acquired by the Company. Each Independent Director
receives compensation in the amount of $15,000 per year, plus reimbursement for
expenses, and the Chairman of the Board receives an additional fee of $1,500
per year for serving in such position. In addition, each Independent Director
receives an additional fee of $1,000 per day for any special services rendered
by him to the Company outside of his ordinary duties as Director, plus
reimbursement of expenses.

During 1996, $124,274 was paid to the Independent Directors in total Directors'
fees for all services including the annual fee for service during the period
January 1, 1996 through December 31, 1996, and 1996 special service fees, as
follows: Geoffrey C. Etnire, $20,833; John P. Parsons, $23,363; Bennett B.
Sims, $20,410; Ted P. Stokely, $18,167; Edward L. Tixier, $8,167; Martin L.
White, $16,667; and Edward G. Zampa, $16,667.

[This space intentionally left blank.]

<PAGE> 69

ITEM 11. EXECUTIVE COMPENSATION (Continued)

Performance Graph

The following performance graph compares the cumulative total stockholder
return on the Company's shares of Common Stock with the Standard & Poor's 500
Stock Index ("S&P 500 Index") and the National Association of Real Estate
Investment Trusts, Inc. Hybrid REIT Total Return Index ("REIT Index"). The
comparison assumes that $100 was invested on December 31, 1991 in the Company's
shares of Common Stock and in each of the indices and further assumes the
reinvestment of all distributions. Past performance is not necessarily an
indicator of future performance.

COMPARISON OF FIVE YEAR

CUMULATIVE TOTAL RETURN

[GRAPH]

<TABLE>
<CAPTION>
=================================================
1991 1992 1993 1994 1995 1996
- - -------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
The Company 100 114 286 383 394 460
- - -------------------------------------------------
S&P 500 Index 100 108 118 120 165 203
- - -------------------------------------------------
REIT Index 100 117 141 147 181 234
=================================================
</TABLE>

<PAGE> 70
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security Ownership of Certain Beneficial Owners. The following table sets forth
the ownership of the Company's shares of Common Stock, both beneficially and of
record, both individually and in the aggregate for those persons or entities
known by the Company to be beneficial owners of more than 5% of its shares of
Common Stock as of the close of business on March 7, 1997.

<TABLE>
<CAPTION>
Amount and Nature
Name and Address of of Beneficial Percent of
Beneficial Owner Ownership Class (1)
------------------- ----------------- ----------

<S> <C> <C>
American Realty Trust, Inc. 450,102 29.6%
10670 N. Central Expressway
Suite 300
Dallas, Texas 75231

Transcontinental Realty
Investors, Inc. 341,500 22.5%
10670 N. Central Expressway
Suite 300
Dallas, Texas 75231
</TABLE>

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

(1) Percentages are based upon 1,519,888 shares of Common Stock outstanding at
March 7, 1997.

Security Ownership of Management. The following table sets forth the ownership
of the Company's shares of Common Stock, both beneficially and of record, both
individually and in the aggregate for the Directors and executive officers of
the Company as of the close of business on March 7, 1996.

<TABLE>
<CAPTION>
Amount and Nature
of Beneficial Percent of
Name of Beneficial Owner Ownership Class (1)
- - ------------------------ ------------------ ----------

<S> <C> <C>
All Directors and Executive 844,352 (2) 55.5%
Officers as a group
(7 individuals)
</TABLE>

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

(1) Percentage is based upon 1,519,888 shares of Common Stock outstanding at
March 7, 1997.

(2) Includes 341,500 shares owned by TCI of which the Directors may be deemed
to be beneficial owners by virtue of their positions as directors of TCI
and 450,102 shares owned by ART and 52,750 owned by BCM, of which the
executive officers of the Company may be deemed to be beneficial owners by
virtue of their positions as executive officers of ART and BCM. The
Company's Directors and executive officers disclaim beneficial ownership
of such shares. Each of the directors of ART may be deemed to be
beneficial owners

<PAGE> 71

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(Continued)

of the shares owned by ART by virtue of their positions as directors
of ART. Each of the directors of BCM may be deemed to be beneficial
owners of the shares owned by BCM by virtue of their positions as
directors of BCM. The directors of ART and BCM disclaim such
beneficial ownership.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Certain Business Relationships

In February 1989, the Company's Board of Directors voted to retain BCM as the
Company's advisor. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF
THE REGISTRANT - The Advisor." BCM is a company of which Messrs. Paulson,
Endendyk and Holland serve as executive officers. Gene E. Phillips served as a
director of BCM until December 22, 1989, and as Chief Executive Officer of BCM
until September 1, 1992. BCM is owned by a trust for the benefit of the
children of Mr. Phillips. Mr. Phillips serves as a representative of his
children's trust which owns BCM and, in such capacity, has substantial contact
with the management of BCM and input with respect to BCM's performance of
advisory services to the Company.

Since February 1, 1991, affiliates of BCM have provided property management
services to the Company. Currently, Carmel, Ltd. provides such property
management services. The general partner of Carmel, Ltd. is BCM. The limited
partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole
shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the
children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level
management and leasing of four of the Company's office buildings and the
commercial properties owned by a real estate partnership in which the Company
and TCI are partners to Carmel Realty, which is a company owned by SWI.

Prior to December 1, 1992, affiliates of BCM provided brokerage services to the
Company and received brokerage commissions in accordance with the advisory
agreement. Since December 1, 1992, the Company has engaged, on a non-exclusive
basis, Carmel Realty to perform brokerage services for the Company. Carmel
Realty is a company owned by SWI.

The Directors and officers of the Company also serve as trustees or directors
and officers of CMET and TCI. The Directors owe fiduciary duties to such
entities as well as to the Company under applicable law. CMET and TCI have the
same relationship with BCM as the Company. Mr. Phillips is a general partner
of SAMLP, the general partner of NRLP and NOLP. BCM performs certain
administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM
also serves as advisor to ART. Mr. Phillips served as Chairman of the Board
and as a director of ART until November 16, 1992. Messrs. Paulson, Endendyk
and Holland serve as executive officers of ART.

From April 1992 to December 31, 1992, Mr. Stokely was employed as a paid Real
Estate Consultant and since January 1993 as a part-time unpaid Consultant for
Eldercare, a nonprofit corporation engaged in the

<PAGE> 72

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)

Certain Business Relationships (Continued)

acquisition of low income and elderly housing. Eldercare filed for bankruptcy
protection in July 1993 and was dismissed from bankruptcy in October 1994.
Eldercare again filed for bankruptcy protection in May 1995 and was dismissed
from bankruptcy in February 1996.

Related Party Transactions

Historically, the Company has engaged in and may continue to engage in business
transactions, including real estate partnerships, with related parties. The
Company's management believes that all of the related party transactions
represented the best investments available at the time and were at least as
advantageous to the Company as could have been obtained from unrelated third
parties.

As more fully described in ITEM 2. "PROPERTIES - Real Estate," the Company is a
partner with TCI in the Tri-City Limited Partnership and Nakash Income
Associates.

In 1996, the Company paid BCM and its affiliates $430,000 in advisory fees,
$532,000 in real estate brokerage commissions, $85,000 in mortgage brokerage
and equity refinancing fees, and $209,000 in property management and
construction supervision fees (net of property management fees paid to
subcontractors, other than Carmel Realty). In addition, as provided in the
Advisory Agreement, BCM received cost reimbursements from the Company of
$175,000 in 1996.

Restrictions on Related Party Transactions

Article FOURTEENTH of the Company's Articles of Incorporation provides that the
Company shall not, directly or indirectly, contract or engage in any
transaction with (i) any director, officer or employee of the Company, (ii) any
director, officer or employee of the advisor, (iii) the advisor or (iv) any
affiliate or associate (as such terms are defined in Rule 12b-2 under the
Securities Exchange Act of 1934, as amended) of any of the aforementioned
persons, unless (a) the material facts as to the relationship among or
financial interest of the relevant individuals or persons and as to the
contract or transaction are disclosed to or are known by the Company's Board of
Directors or the appropriate committee thereof and (b) the Company's Board of
Directors or committee thereof determines that such contract or transaction is
fair to the Company and simultaneously authorizes or ratifies such contract or
transaction by the affirmative vote of a majority of independent directors of
the Company entitled to vote thereon.

Article FOURTEENTH defines an "Independent Director" as one who is neither an
officer or employee of the Company nor a director, officer or employee of the
Company's advisor.

Pursuant to the terms of the Modification of Stipulation of Settlement (the
"Modification") in the Olive Litigation, as more fully discussed in ITEM 3.
"LEGAL PROCEEDINGS - Olive Litigation," which became effective on January 11,
1995, certain related party transactions which the

<PAGE> 73

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)

Restrictions on Related Party Transactions (Continued)

Company may enter into prior to April 28, 1999, require the unanimous approval
of the Company's Board of Directors. In addition, such related party
transactions are to be discouraged and may only be entered into in exceptional
circumstances and after a determination by the Company's Board of Directors
that the transaction is in the best interests of the Company and that no other
opportunity exists that is as good as the opportunity presented by such
transaction.

The Modification requirements for related party transactions do not apply to
direct contractual agreements for services between the Company and the Advisor
or one of its affiliates, (including the Advisory Agreement, the Brokerage
Agreement and the property management contracts). These agreements, pursuant to
the specific terms of the Modification, require the prior approval by
two-thirds of the Directors of the Company, and if required, approval by a
majority of the Company's stockholders. The Modification requirements for
related party transactions also do not apply to joint ventures between or among
the Company and CMET, NIRT or TCI or any of their affiliates or subsidiaries
and a third party having no prior or intended future business or financial
relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of
such parties. Such joint ventures may be entered into on the affirmative vote
of a majority of the Directors of the Company. See ITEM 3. "LEGAL PROCEEDINGS -
Olive Litigation."

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
FORM 8-K

(a) The following documents are filed as part of this Report:

1. Consolidated Financial Statements

INCOME OPPORTUNITY REALTY INVESTORS, INC.

Report of Independent Certified Public Accountants

Consolidated Balance Sheets - December 31, 1996 and 1995

Consolidated Statements of Operations -
Years Ended December 31, 1996, 1995 and 1994

Consolidated Statements of Stockholders' Equity -
Years Ended December 31, 1996, 1995 and 1994

Consolidated Statements of Cash Flows Years Ended December 31, 1996, 1995
and 1994

Notes to Consolidated Financial Statements

<PAGE> 74

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
FORM 8-K (Continued)

TRI-CITY LIMITED PARTNERSHIP

Report of Independent Certified Public Accountants

Balance Sheets - December 31, 1996 and 1995

Statements of Operations -
Years Ended December 31, 1996, 1995 and 1994

Statements of Partners' Equity -
Years Ended December 31, 1996, 1995 and 1994

Statements of Cash Flows -
Years Ended December 31, 1996, 1995 and 1994

Notes to Financial Statements

2. Financial Statement Schedules

INCOME OPPORTUNITY REALTY INVESTORS, INC.

Schedule III - Real Estate and Accumulated Depreciation

Schedule IV - Mortgage Loans on Real Estate

TRI-CITY LIMITED PARTNERSHIP

Schedule III - Real Estate and Accumulated Depreciation

All other schedules are omitted because they are not applicable or because the
required information is shown in the Financial Statements or the Notes thereto.

3. Exhibits

The following documents are filed as Exhibits to this Report:

Exhibit
Number Description
- - ------ -----------

3.0 Articles of Incorporation of Income Opportunity Realty
Investors, Inc. (incorporated by reference to Appendix C to the
Registrant's Registration Statement on Form S-4 dated February
12, 1996).

3.1 Bylaws of Income Opportunity Realty Investors, Inc.
(incorporated by reference to Appendix D to the Registrant's
Registration Statement on Form S-4 dated February 12, 1996).

<PAGE> 75

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
FORM 8-K (Continued)

Exhibit
Number Description
- - ------ -----------

10.0 Advisory Agreement dated as of March 7, 1995, between Income
Opportunity Realty Trust and Basic Capital Management, Inc.
(incorporated by reference to Exhibit No. 10.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1994).

10.1 Advisory Agreement dated as of March 15, 1996, between Income
Opportunity Realty Investors, Inc. and Basic Capital
Management, Inc., filed herewith.

27.0 Financial Data Schedule, filed herewith.

(b) Reports on Form 8-K:

A current report on Form 8-K, dated November 13, 1996, was
filed with respect to Item 2. "Acquisition or Disposition of
Assets," and Item 7. "Financial Statements and Exhibits," which
reports the acquisition of the Olympic Office Building, which
was amended on Form 8-K/A, filed January 15, 1997.

<PAGE> 76

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

INCOME OPPORTUNITY REALTY INVESTORS,
INC.

Dated: March 13, 1997 By: /s/ Randall M. Paulson
------------------------------- ----------------------------------
Randall M. Paulson
President

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.

By: /s/ Ted P. Stokely By: /s/ Martin L. White
------------------------------- ----------------------------------
Ted P. Stokely Martin L. White
Chairman of the Board Director
and Director

By: /s/ Edward L. Tixier By: /s/ Edward G. Zampa
------------------------------- ----------------------------------
Edward L. Tixier Edward G. Zampa
Director Director

By: /s/ Thomas A. Holland
----------------------------------
Thomas A. Holland
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)

Dated: March 13, 1997
----------------------------------

<PAGE> 77

INCOME OPPORTUNITY REALTY INVESTORS, INC.

EXHIBITS TO
ANNUAL REPORT ON FORM 10-K

For the Year Ended December 31, 1996

Exhibit
Number Description Page
- - ------- ----------- ----

10.1 Advisory Agreement dated as of March 15, 78
1997, between Income Opportunity Realty
Investors, Inc. and Basic Capital
Management, Inc.

27.0 Financial Data Schedule. 102

<PAGE> 1
EXHIBIT 10.1

ADVISORY AGREEMENT

BETWEEN

INCOME OPPORTUNITY REALTY INVESTORS, INC.

AND

BASIC CAPITAL MANAGEMENT, INC.

THIS AGREEMENT dated as of March 15, 1996, between Income Opportunity
Realty Investors, Inc., a Nevada corporation (the "Company"), and Basic Capital
Management, Inc. (the "Advisor"), a Nevada corporation.

W I T N E S S E T H:

1. The Company owns a portfolio of real estate and mortgages.

2. The Advisor and its employees have extensive experience in
the administration of real estate assets and the origination, structuring and
evaluation of real estate and mortgage investments.

NOW THEREFORE, in consideration of the premises and of the mutual
covenants herein contained, the parties agree as follows:

1. DUTIES OF THE ADVISOR. Subject to the supervision of the Board
of Directors, the Advisor will be responsible for the day-to-day operations of
the Company and, subject to Section 17 hereof, shall provide such services and
activities relating to the assets, operations and business plan of the Company
as may be appropriate, including:

(a) preparing and submitting an annual budget and
business plan for approval by the Board of the Company (the
"Business Plan");

<PAGE> 2

(b) using its best efforts to present to the Company a
continuing and suitable investment program consistent with the
investment policies and objectives of the Company as set forth in the
Business Plan;

(c) using its best efforts to present to the Company investment
opportunities consistent with the Business Plan and such investment
program as the Directors may adopt from time to time;

(d) furnishing or obtaining and supervising the performance of
the ministerial functions in connection with the administration of the
day-to-day operations of the Company including the investment of
reserve funds and surplus cash in short-term money market investments;

(e) serving as the Company's investment and financial advisor
and providing research, economic, and statistical data in connection
with the Company's investments and investment and financial policies;

(f) on behalf of the Company, investigating, selecting and
conducting relations with borrowers, lenders, mortgagors, brokers,
investors, builders, developers and others; provided however, that the
Advisor shall not retain on the Company's behalf any consultants or
third party professionals, other than legal counsel, without prior
Board approval;

(g) consulting with the Directors and furnishing the Directors
with advice and recommendations with respect to the making, acquiring
(by purchase, investment, exchange or otherwise), holding and
disposition (through sale, exchange, or otherwise) of investments
consistent with the Business Plan of the Company;

<PAGE> 3

(h) obtaining for the Directors such services as may be
required in acquiring and disposing of investments, disbursing and
collecting the funds of the Company, paying the debts and fulfilling
the obligations of the Company, and handling, prosecuting, and
settling any claims of the Company, including foreclosing and
otherwise enforcing mortgage and other liens securing investments;

(i) obtaining for and at the expense of the Company such
services as may be required for property management, loan
disbursements, and other activities relating to the investments of the
Company, provided, however, the compensation for such services shall
be agreed to by the Company and the service provider;

(j) advising the Company in connection with public or private
sales of shares or other securities of the Company, or loans to the
Company, but in no event in such a way that the Advisor could be
deemed to be acting as a broker dealer or underwriter;

(k) quarterly and at any time requested by the Directors,
making reports to the Directors regarding the Company's performance to
date in relation to the Company's approved Business Plan and its
various components, as well as the Advisor's performance of the
foregoing services;

(l) making or providing appraisal reports, where appropriate,
on investments or contemplated investments of the Company;

(m) assisting in preparation of reports and other documents
necessary to satisfy the reporting and other requirements of any
governmental bodies or agencies and to maintain effective
communications with stockholders of the Company; and

<PAGE> 4

(n) doing all things necessary to ensure its ability to render
the services contemplated herein, including providing office space and
office furnishings and personnel necessary for the performance of the
foregoing services as Advisor, all at its own expense, except as
otherwise expressly provided for herein.

2. NO PARTNERSHIP OR JOINT VENTURE. The Company and the Advisor
are not partners or joint venturers with each other, and nothing herein shall
be construed so as to make them such partners or joint venturers or impose any
liability as such on either of them.

3. RECORDS. At all times, the Advisor shall keep proper books of
account and records of the Company's affairs which shall be accessible for
inspection by the Company at any time during ordinary business hours.

4. ADDITIONAL OBLIGATIONS OF THE ADVISOR. The Advisor shall
refrain from any action (including, without limitation, furnishing or rendering
services to tenants of property or managing or operating real property) that
would (a) adversely affect the status of the Company as a real estate
investment trust, as defined and limited in Sections 856-860 of the Internal
Revenue Code, (b) violate any law, rule, regulation, or statement of policy of
any governmental body or agency having jurisdiction over the Company or over
its securities, (c) cause the Company to be required to register as an
investment company under the Investment Company Act of 1940, or (d) otherwise
not be permitted by the Articles of Incorporation of the Company.

5. BANK ACCOUNTS. The Advisor may establish and maintain one
or more bank accounts in its own name, and may collect and deposit into any
such account or accounts, and disburse from any such account or accounts, any
money on behalf of the Company, under such

<PAGE> 5

terms and conditions as the Directors may approve, provided that no funds in
any such account shall be commingled with funds of the Advisor; and the Advisor
shall from time to time render appropriate accounting of such collections and
payments to the Directors and to the auditors of the Company.

6. BOND. The Advisor shall maintain a fidelity bond with a
responsible surety company in such amount as may be required by the Directors
from time to time, covering all directors, officers, employees, and agents of
the Advisor handling funds of the Company and any investment documents or
records pertaining to investments of the Company. Such bond shall inure to the
benefit of the Company in respect to losses of any such property from acts of
such directors, officers, employees, and agents through theft, embezzlement,
fraud, negligence, error, or omission or otherwise, the premium for said bond
to be at the expense of the Company.

7. INFORMATION FURNISHED ADVISOR. The Directors shall have the
right to change the Business Plan at any time, effective upon receipt by the
Advisor of notice of such change. The Company shall furnish the Advisor with a
certified copy of all financial statements, a signed copy of each report
prepared by independent certified public accountants, and such other
information with regard to the Company's affairs as the Advisor may from time
to time reasonably request.

8. CONSULTATION AND ADVICE. In addition to the described above,
the Advisor shall consult with the Directors, and shall, at the request of the
Directors or the officers of the Company, furnish advice and recommendations
with respect to any aspect of the business and affairs of the Company,
including any factors that in the Advisor's best judgment should influence the
policies of the Company.

<PAGE> 6

9. ANNUAL BUSINESS PLAN AND BUDGET. No later than January 15th of
each year, the Advisor shall submit to the Directors a written Business Plan
for the current Fiscal Year of the Company. Such Business Plan shall include a
twelve-month forecast of operations and cash flow with explicit assumptions and
a general plan for asset sales or acquisitions, lending, foreclosure and
borrowing activity, other investments or ventures and proposed securities
offerings or repurchases or any proposed restructuring of the Company. To the
extent possible, the Business Plan shall set forth the Advisor's
recommendations and the basis therefor with respect to all material investments
of the Company. Upon approval by the Board of Directors, the Advisor shall be
authorized to conduct the business of the Company in accordance with the
explicit provisions of the Business Plan, specifically including the borrowing,
leasing, maintenance, capital improvements, renovations and sale of investments
set forth in the Business Plan. Any transaction or investment not explicitly
provided for in the approved Business Plan shall require the prior approval of
the Board of Directors unless made pursuant to authority expressly delegated to
the Advisor. Within sixty (60) days of the end of each calendar quarter, the
Advisor shall provide the Board of Directors with a report comparing the
Company's actual performance for such quarter against the Business Plan.

10. DEFINITIONS. As used herein, the following terms shall have
the meanings set forth below:

(a) "Affiliate" shall mean, as to any Person, any
other Person who owns beneficially, directly, or indirectly, 1% or more
of the outstanding capital stock, shares or equity interests of such
Person or of any other Person which controls, is controlled by, or is
under common control with such Person or is an officer, retired officer,
director,

<PAGE> 7

employee, partner, or trustee (excluding noninterested trustees not
otherwise affiliated with the entity) of such Person or of any other
Person which controls, is controlled by, or is under common control
with, such Person.

(b) "Appraised Value" shall mean the value of a Real Property
according to an appraisal made by an independent qualified appraiser
who is a member in good standing of the American Institute of Real
Estate Appraisers and is duly licensed to perform such services in
accordance with the applicable state law, or, when pertaining to
Mortgage Loans, the value of the underlying property as determined by
the Advisor.

(c) "Book Value" of an asset or assets shall mean the value of
such asset or assets on the books of the Company, before provision for
amortization, depreciation, depletion or valuation reserves and before
deducting any indebtedness or other liability in respect thereof,
except that no asset shall be valued at more than its fair market
value as determined by the Directors.

(d) "Book Value of Invested Assets" shall mean the Book Value
of the Company's total assets (without deduction of any liabilities),
but excluding (i) goodwill and other intangible assets, (ii) cash, and
(iii) cash equivalent investments with terms which mature in one year
or less.

(e) "Business Plan" shall mean the Company's investment
policies and objectives and the capital and operating budget based
thereon, approved by the Board as thereafter modified or amended.

(f) "Fiscal Year" shall mean any period for which an income tax
return is submitted to the Internal Revenue Service

<PAGE> 8

and which is treated by the Internal Revenue Service as a
reporting period.

(g) "Gross Asset Value" shall mean the total assets of the
Company after deduction of allowance for amortization, depreciation or
depletion and valuation reserves.

(h) "Mortgage Loans" shall mean notes, debentures, bonds, and
other evidences of indebtedness or obligations, whether negotiable or
non-negotiable, and which are secured or collateralized by mortgages,
including first, wraparound, construction and development, and junior
mortgages.

(i) "Net Asset Value" shall mean the Book Value of all
the assets of the Company minus all the liabilities of the
Company.

(j) "Net Income" for any period shall mean the Net Income of
the Company for such period computed in accordance with generally
accepted accounting principles after deduction of the Gross Asset Fee,
but before deduction of the Net Income Fee, as set forth in Sections
11(a) and 11(b), respectively, herein, and inclusive of gain or loss
of the sale of assets.

(k) "Net Operating Income" shall mean rental income less
property operating expenses.

(l) "Operating Expenses" shall mean the aggregate annual
expenses regarded as operating expenses in accordance with generally
accepted accounting principles as determined by the independent
auditors selected by the Directors and including the Gross Asset Fee
payable to the Advisor and fees and expenses paid to the Directors who
are not employees or Affiliates of the Advisor.

<PAGE> 9

(m) The operating expenses shall exclude, however, the
following:

(i) the cost of money borrowed by the Company;

(ii) income taxes, taxes and assessments on real
property and all other taxes applicable to the Company;

(iii) expenses and taxes incurred in connection with
the issuance, distribution, transfer, registration and stock
exchange listing of the Company's securities (including legal,
auditing, accounting, underwriting, brokerage, printing,
engraving and other fees);

(iv) fees and expenses paid to independent mortgage
servicers, contractors, consultants, managers and other agents
retained by or on behalf of the Company;

(v) expenses directly connected with the purchase,
origination, ownership and disposition of Real Properties or
Mortgage Loans (including the costs of foreclosure, insurance,
legal, protective, brokerage, maintenance, repair and property
improvement services) other than expenses with respect thereto
of employees of the Advisor, except legal, internal auditing,
foreclosure and transfer agent services performed by employees
of the Advisor;

(vi) expenses of maintaining and managing real estate
equity interests and processing and servicing mortgage and
other loans;

(vii) expenses connected with payments of dividends,
interest or distributions by the Company to shareholders;

(viii) expenses connected with communications to
shareholders and bookkeeping and clerical expenses for

<PAGE> 10

maintaining shareholder relations, including the cost of
printing and mailing share certificates, proxy
solicitation materials and reports;

(ix) transfer agent's, registrar's and indenture
trustee's fees and charges; and

(x) the cost of any accounting, statistical,
bookkeeping or computer equipment necessary for the
maintenance of books and records of the Company.

Additionally, the following expenses of the Advisor shall
be excluded:

(i) employment expenses of the Advisor's personnel
(including Directors, officers and employees of the Company who
are directors, officers or employees of the Advisor or its
Affiliates), other than the expenses of those employee services
listed at (v) above.

(ii) rent, telephone, utilities and office furnishings and
other office expenses of the Advisor (except those relating to
a separate office, if any, maintained by the Company); and

(iii) the Advisor's overhead directly related to
performance of its functions under this Agreement.

(n) "Person" shall mean and include individuals, corporations,
limited partnerships, general partnerships, joint stock companies or
associations, joint ventures, associations, companies, trusts, banks,
trust companies, land trusts, business trusts, or other entities and
governments and agencies and political subdivisions thereof.

(o) "Real Property" shall mean and include land, rights in
land, leasehold interests (including but not limited to interests of a
lessor or lessee therein), and any buildings, structures,
improvements, fixtures, and equipment located on

<PAGE> 11

or used in connection with land, leasehold interests, and
rights in land or interests therein.

All calculations made pursuant to this Agreement shall be
based on statements (which may be unaudited, except as provided herein)
prepared on an accrual basis consistent with generally accepted accounting
principles, regardless of whether the Company may also prepare statements on a
different basis. All other terms shall have the same meaning as set forth in
the Company's Articles of Incorporation and Bylaws.

11. ADVISORY COMPENSATION.

(a) Gross Asset Fee. On or before the twenty-eighth day of each
month during the term hereof, the Company shall pay to the Advisor, as
compensation for the basic management and advisory services rendered
to the Company hereunder, a fee at the rate of .0625% per month of the
average of the Gross Asset Value of the Company at the beginning and
at the end of the next preceding calendar month. Without negating the
provisions of Sections 18, 19, 22 and 23 hereof, the annual rate of
the Gross Asset Fee shall be .75% per annum.

(b) Net Income Fee. As an incentive for successful investment
and management of the Company's assets, the Advisor will be entitled
to receive a fee equal to 7.5% per annum of the Company's Net Income
for each Fiscal Year or portion thereof for which the Advisor provides
services. To the extent the Company has Net Income in a quarter, the
7.5% Net Income fee is to be paid quarterly on or after the third
business day following the filing of the report on Form 10-Q with the
Securities and Exchange Commission, except for the payment for the
fourth quarter, ended December 31, which is to

<PAGE> 12

be paid on or after the third business day following the filing of the
report on Form 10-K with the Securities and Exchange Commission.

The 7.5% Net Income Fee is to be cumulative within any Fiscal
Year, such that if the Company has a loss in any quarter during the
Fiscal Year, each subsequent quarter's payment during such Fiscal Year
shall be adjusted to maintain the 7.5% per annum rate, with final
settlement being made with the fourth quarter payment and in
accordance with audited results for the Fiscal Year. The 7.5% Net
Income Fee is not cumulative from year to year.

(c) Acquisition Commission. For supervising the acquisition,
purchase or long term lease of Real Property for the Company, the
Advisor is to receive an Acquisition Commission equal to the lesser of
(i) up to 1% of the cost of acquisition, inclusive of commissions, if
any, paid to nonaffiliated brokers; or (ii) the compensation
customarily charged in arm's-length transactions by others rendering
similar property acquisition services as an ongoing public activity in
the same geographical location and for comparable property. The
aggregate of each purchase price of each property (including the
Acquisition Commissions and all real estate brokerage fees) may not
exceed such property's Appraised Value at acquisition.

(d) Incentive Sales Compensation. To encourage periodic sales
of appreciated Real Property at optimum value and to reward the
Advisor for improved performance of the Company's Real Property, the
Company shall pay to the Advisor, on or before the 45th day after the
close of each Fiscal Year, an incentive fee equal to 10% of the
amount, if any, by which the aggregate sales consideration for all
Real Property sold by

<PAGE> 13

the Company during such Fiscal Year exceeds the sum of: (i) the cost
of each such Real Property as originally recorded in the Company's
books for tax purposes (without deduction for depreciation,
amortization or reserve for losses), (ii) capital improvements made to
such assets during the period owned by the Company, and (iii) all
closing costs, (including real estate commissions) incurred in the
sale of such Real Property; provided however, no incentive fee shall
be paid unless (a) such Real Property sold in such Fiscal Year, in the
aggregate, has produced an 8% simple annual return on the Company's
net investment, including capital improvements, calculated over the
Company's holding period before depreciation and inclusive of
operating income and sales consideration and (b) the aggregate Net
Operating Income from all Real Property owned by the Company for all
of the prior Fiscal Year and the current Fiscal Year shall be at least
5% higher in the current Fiscal Year than in the prior Fiscal Year.

(e) Mortgage or Loan Acquisition Fees. For the acquisition or
purchase from an unaffiliated party of any existing mortgage or loan
by the Company, the Advisor or an Affiliate is to receive a Mortgage
or Loan Acquisition Fee equal to the lesser of (a) 1% of the amount of
the mortgage or loan purchased by the Company or (b) a brokerage or
commitment fee which is reasonable and fair under the circumstances.
Such fee will not be paid in connection with the origination or
funding by the Company of any mortgage loan.

(f) Mortgage Brokerage and Equity Refinancing Fees. For
obtaining loans to the Company or refinancing on Company properties,
the Advisor or an Affiliate is to receive a Mortgage Brokerage and
Equity Refinancing Fee equal to the

<PAGE> 14

lesser of (a) 1% of the amount of the loan or the amount refinanced or
(b) a brokerage or refinancing fee which is reasonable and fair under
the circumstances; provided, however that no such fee shall be paid on
loans from the Advisor or an Affiliate without the approval of the
Board of Directors. No fee shall be paid on loan extensions.

12. LIMITATION ON THIRD PARTY MORTGAGE PLACEMENT FEES. The Advisor
or any of its Affiliates shall pay to the Company, one-half of any compensation
received by the Advisor or any such Affiliate from third parties with respect
to the origination, placement or brokerage of any loan made by the Company,
provided, however, the compensation retained by the Advisor or Affiliate shall
not exceed the lesser of (a) 2% of the amount of the loan committed by the
Company or (b) a loan brokerage and commitment fee which is reasonable and fair
under the circumstances.

13. STATEMENTS. The Advisor shall furnish to the Company not later
than the tenth day of each calendar month, beginning with the second calendar
month of the term of this Agreement, a statement showing the computation of the
fees, if any, payable in respect to the next preceding calendar month (or, in
the case of incentive compensation, for the preceding Fiscal Year, as
appropriate) under the Agreement. The final settlement of incentive
compensation for each Fiscal Year shall be subject to adjustment in accordance
with, and upon completion of, the annual audit of the Company's financial
statements; any payment by the Company or repayment by the Advisor that shall
be indicated to be necessary in accordance therewith shall be made promptly
after the completion of such audit and shall be reflected in the audited
statements to be published by the Company.

<PAGE> 15

14. COMPENSATION FOR ADDITIONAL SERVICES. If and to the extent that
the Company shall request the Advisor or any director, officer, partner, or
employee of the Advisor to render services for the Company other than those
required to be rendered by the Advisor hereunder, such additional services, if
performed, will be compensated separately on terms to be agreed upon between
such party and the Company from time to time. In particular, but without
limitation, if the Company shall request that the Advisor perform property
management, leasing, loan disbursement or similar functions, the Company and
the Advisor shall enter into a separate agreement specifying the obligations of
the parties and providing for reasonable additional compensation to the Advisor
for performing such services.

15. EXPENSES OF THE ADVISOR. Without regard to the amount of
compensation or reimbursement received hereunder by the Advisor,
the Advisor shall bear the following expenses:

(a) employment expenses of the personnel employed by the
Advisor (including Directors, officers, and employees of the Company
who are directors, officers, or employees of the Advisor or of any
company that controls, is controlled by, or is under common control
with the Advisor), including, but not limited to, fees, salaries,
wages, payroll taxes, travel expenses, and the cost of employee
benefit plans and temporary help expenses except for those personnel
expenses described in Sections 16(e) and (p);

(b) advertising and promotional expenses incurred in
seeking investments for the Company;

(c) rent, telephone, utilities, office furniture and
furnishings, and other office expenses of the Advisor and the
Company, except as any of such expenses relates to an office

<PAGE> 16

maintained by the Company separate from the office of the
Advisor; and

(d) miscellaneous administrative expenses relating to
performance by the Advisor of its functions hereunder.

16. Expenses of the Company. The Company shall pay all of its
expenses not assumed by the Advisor, including without limitation,
the following expenses:

(a) the cost of money borrowed by the Company;

(b) income taxes, taxes and assessments on real property,
and all other taxes applicable to the Company;

(c) legal, auditing, accounting, underwriting, brokerage,
listing, registration and other fees, printing, and engraving and
other expenses, and taxes incurred in connection with the issuance,
distribution, transfer, registration, and stock exchange listing of
the Company's securities:

(d) fees, salaries, and expenses paid to officers, and
employees of the Company who are not directors, officers or employees
of the Advisor, or of any company that controls, is controlled by, or
is under common control with the Advisor;

(e) expenses directly connected with the origination or
purchase of Mortgage Loans and with the acquisition, disposition and
ownership of real estate equity interests or other property (including
the costs of foreclosure, insurance, legal, protective, brokerage,
maintenance, repair, and property improvement services) and including
all compensation, traveling expenses, and other direct costs
associated with the Advisor's employees or other personnel engaged in
(i) real estate transaction legal services, (ii) internal auditing,
(iii) foreclosure and other mortgage finance services, (iv)

<PAGE> 17

sale or solicitation for sale of mortgages, (v) engineering and
appraisal services, and (vi) transfer agent services.

(f) expenses of maintaining and managing real estate
equity interests;

(g) insurance, as required by the Directors (including
Directors' liability insurance);

(h) the expenses of organizing, revising, amending,
converting, modifying, or terminating the Company;

(i) expenses connected with payments of dividends or
interest or distributions in cash or any other form made or caused to
be made by the Directors to holders of securities of the Company;

(j) all expenses connected with communications to holders
of securities of the Company and the other bookkeeping and clerical
work necessary in maintaining relations with holders of securities,
including the cost of printing and mailing certificates for securities
and proxy solicitation materials and reports to holders of the
Company's securities;

(k) the cost of any accounting, statistical, bookkeeping or
computer equipment or computer time necessary for maintaining the
books and records of the Company and for preparing and filing Federal,
State and Local tax returns;

(l) transfer agent's, registrar's, and indenture
trustee's fees and charges;

(m) legal, accounting, investment banking, and auditing
fees and expenses charged by independent parties performing these
services not otherwise included in clauses (c) and (e) of this Section
16;

<PAGE> 18

(n) expenses incurred by the Advisor, arising from the
sales of Company properties, including those expenses related
to carrying out foreclosure proceedings;

(o) commercially reasonable fees paid to the Advisor for
efforts to liquidate mortgages before maturity, such as the
solicitation of offers and negotiation of terms of sale;

(p) costs and expenses connected with computer services,
including but not limited to employee or other personnel compensation,
hardware and software costs, and related development and installation
costs associated therewith;

(q) costs and expenses associated with risk management
(i.e. insurance relating to the Company's assets);

(r) loan refinancing compensation; and

(s) expenses associated with special services requested
by the Directors pursuant to Section 14 hereof.

17. Other Activities of Advisor. The Advisor, its officers,
directors, or employees or any of its Affiliates may engage in other business
activities related to real estate investments or act as advisor to any other
person or entity (including another real estate investment trust), including
those with investment policies similar to the Company, and the Advisor and its
officers, directors, or employees and any of its Affiliates shall be free from
any obligation to present to the Company any particular investment opportunity
that comes to the Advisor or such persons, regardless of whether such
opportunity is in accordance with the Company's Business Plan. However, to
minimize any possible conflict, the Advisor shall consider the respective
investment objectives of, and the appropriateness of a particular investment to
each such entity in determining to which entity a particular investment
opportunity should be presented. If appropriate to more

<PAGE> 19

than one entity, the Advisor shall present the investment opportunity to the
entity that has had sufficient uninvested funds for the longest period of time.

18. LIMITATION ON OPERATING EXPENSES. To the extent that the
Operating Expenses of the Company for any Fiscal Year exceed the lesser of (a)
1.5% of the average of the Book Values of Invested Assets of the Company at the
end of each calendar month of such Fiscal Year, or (b) the greater of 1.5% of
the average of the Net Asset Value of the Company at the end of each calendar
month of such Fiscal Year or 25% of the Company's Net Income, the Advisor shall
refund to the Company from the fees paid to the Advisor the amount, if any, by
which the Operating Expenses so exceed the applicable amount, provided,
however, that the Advisor shall not be required to refund to the Company, with
respect to any Fiscal Year, any amount which exceeds the aggregate of the Gross
Asset Fees paid to the Advisor under this Agreement with respect to such Fiscal
Year.

19. TERM; TERMINATION OF AGREEMENT. This Agreement shall continue
in force until the next Annual Meeting of Stockholders of the Company, and,
thereafter, it may be renewed from year to year, subject to any required
approval of the Stockholders of the Company and, if any Director is an
Affiliate of the Advisor, the approval of a majority of the Directors who are
not so affiliated. Notice of renewal shall be given in writing by the Directors
to the Advisor not less than 60 days before the expiration of this Agreement or
of any extension thereof. This Agreement may be terminated for any reason
without penalty upon 60 days' written notice by the Company to the Advisor or
120 days' written notice by the Advisor to the Company, in the former case by
the vote of a majority of the Directors who are not Affiliates of the Advisor
or by the vote of holders of a majority of the outstanding shares of the
Company.

<PAGE> 20

Notwithstanding the foregoing, however, in the event of any material change in
the ownership, control or management of the Advisor, the Company may terminate
this Agreement without penalty and without advance notice to the Advisor.

20. AMENDMENTS. This Agreement shall not be changed, modified,
terminated or discharged in whole or in part except by an instrument in writing
signed by both parties hereto, or their respective successors or assigns, or
otherwise as provided herein.

21. ASSIGNMENT. This Agreement shall not be assigned by the Advisor
without the prior consent of the Company. The Company may terminate this
Agreement in the event of its assignment by the Advisor without the prior
consent of the Company. Such an assignment or any other assignment of this
Agreement shall bind the assignee hereunder in the same manner as the Advisor
is bound hereunder. This Agreement shall not be assignable by the Company
without the consent of the Advisor, except in the case of assignment by the
Company to a corporation, association, trust, or other organization that is a
successor to the Company. Such successor shall be bound hereunder and by the
terms of said assignment in the same manner as the Company is bound hereunder.

22. DEFAULT, BANKRUPTCY, ETC. At the option solely of the Directors,
this Agreement shall be and become terminated immediately upon written notice
of termination from the Directors to the Advisor if any of the following events
shall occur:

(a) If the Advisor shall violate any provision of this
Agreement, and after notice of such violation shall not cure such
default within 30 days; or

(b) If the Advisor shall be adjudged bankrupt or insolvent
by a court of competent jurisdiction, or an order shall be made by a
court of competent jurisdiction for the appointment of a receiver,
liquidator, or trustee of the

<PAGE> 21

Advisor or of all or substantially all of its property by reason of
the foregoing, or approving any petition filed against the Advisor for
its reorganization, and such adjudication or order shall remain in
force or unstayed for a period of 30 days; or

(c) If the Advisor shall institute proceedings for
voluntary bankruptcy or shall file a petition seeking reorganization
under the Federal bankruptcy laws, or for relief under any law for the
relief of debtors, or shall consent to the appointment of a receiver of
itself or of all or substantially all its property, or shall make a
general assignment for the benefit of its creditors, or shall admit in
writing its inability to pay its debts generally, as they become due.
The Advisor agrees that if any of the events specified in subsections
(b) and (c) of this Section 22 shall occur, it will give written
notice thereof to the Directors within seven days after the occurrence
of such event.

23. ACTION UPON TERMINATION. From and after the effective date of
termination of this Agreement, pursuant to Sections 19, 21 or 22 hereof, the
Advisor shall not be entitled to compensation for further services hereunder
but shall be paid all compensation accruing to the date of termination. The
Advisor shall forthwith upon such termination:

(a) pay over to the Company all monies collected and held
for the account of the Company pursuant to this Agreement;

(b) deliver to the Directors a full accounting, including
a statement showing all payments collected by it and a
statement of any monies held by it, covering the period

<PAGE> 22

following the date of the last accounting furnished to the
Directors; and

24. MISCELLANEOUS. The Advisor shall be deemed to be in a
fiduciary relationship to the stockholders of the Company. The Advisor assumes
no responsibility under this Agreement other than to render the services called
for hereunder in good faith, and shall not be responsible for any action of the
Directors in following or declining to follow any advice or recommendations of
the Advisor. Neither the Advisor nor any of its shareholders, directors,
officers, or employees shall be liable to the Company, the Directors, the
holders of securities of the Company or to any successor or assign of the
Company for any losses arising from the operation of the Company if the Advisor
had determined, in good faith, that the course of conduct which caused the loss
or liability was in the best interests of the Company and the liability or loss
was not the result of negligence or misconduct by the Advisor. However, in no
event will the directors, officers or employees of the Advisor be personally
liable for any act or failure to act unless it was the result of such person's
willful misfeasance, bad faith, gross negligence or reckless disregard of duty.

25. NOTICES. Any notice, report, or other communication required or
permitted to be given hereunder shall be in writing unless some other method of
giving such notice, report, or other communication is accepted by the party to
whom it is given, and shall be given by being delivered at the following
addresses of the parties hereto:

<PAGE> 23

The Directors and/or the Company:

Income Opportunity Realty Investors, Inc.
10670 North Central Expressway
Suite 600
Dallas, Texas 75231
Attention: President

The Advisor:

Basic Capital Management, Inc.
10670 North Central Expressway
Suite 600
Dallas, Texas 75231
Attention: Executive Vice President and Chief
Financial Officer

Either party may at any time give notice in writing to the other party
of a change of its address for the purpose of this Section 25.

26. HEADINGS. The section headings hereof have been inserted for
convenience of reference only and shall not be construed to affect the meaning,
construction, or effect of this Agreement.

27. GOVERNING LAW. This Agreement has been prepared, negotiated and
executed in the State of Texas. The provisions of this Agreement shall be
construed and interpreted in accordance with the laws of the State of Texas
applicable to agreements made and to be performed entirely in the State of
Texas.

28. EXECUTION. This instrument is executed and made on behalf of the
Company by an officer of the Company, not individually but solely as an
Officer, and the obligations under this Agreement are not binding upon, nor
shall resort be had to the private property of, any of the Directors,
stockholders, officers, employees, or agents of the Company personally, but
bind only the Company property.

100

<PAGE> 24

IN WITNESS WHEREOF, INCOME OPPORTUNITY REALTY INVESTORS, INC. and BASIC
CAPITAL MANAGEMENT, INC., by their duly authorized officers, have signed these
presents all as of the day and year first above written.

INCOME OPPORTUNITY REALTY
INVESTORS, INC.

By: /s/ Randall M. Paulson
--------------------------------
Randall M. Paulson
President

BASIC CAPITAL MANAGEMENT, INC.

By: /s/ Thomas A. Holland
--------------------------------
Thomas A. Holland
Executive Vice President

101

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