UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to          

Commission File No. 1-15371

iSTAR FINANCIAL INC.

(Exact name of registrant as specified in its charter)

Maryland	95-6881527
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
1114 Avenue of the Americas, 27th Floor New York, NY	10036
(Address of principal executive offices)	(Zip code)

 

Registrant’s telephone number, including area code: (212) 930-9400

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant: (i) 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 (ii) has been subject to such filing requirements for the past 90 days. Yes x   No o

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

As of August 3, 2005, there were 112,712,288 shares of common stock of iStar Financial Inc. $0.001/par value per share outstanding (“Common Stock”).

iStar Financial Inc.

Index to Form 10-Q

				Page
Part I.		Consolidated Financial Information			2
Item 1.		Financial Statements:
		Consolidated Balance Sheets at June 30, 2005 and December 31, 2004			2
		Consolidated Statements of Operations—For each of the three and six months ended June 30, 2005 and 2004			3
		Consolidated Statements of Changes in Shareholders' Equity—For the six months ended June 30, 2005			4
		Consolidated Statements of Cash Flows—For each of the three and six months ended June 30, 2005 and 2004			5
		Notes to Consolidated Financial Statements			6
Item 2.		Management's Discussion and Analysis of Financial Condition and the Results of Operations			48
Item 4.		Controls and Procedures			66
Part II.		Other Information			67
Item 1.		Legal Proceedings			67
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			67
Item 3.		Defaults Upon Senior Securities			67
Item 4.		Submission of Matters to a Vote of Security Holders			67
Item 5.		Other Information			67
Item 6.		Exhibits			67
SIGNATURES					68

 

Part I.   Consolidated Financial Information

Item 1.   Financial Statements

iStar Financial Inc.

Consolidated Balance Sheets

(In thousands, except per share data)

(unaudited)

		As of June 30, 2005			As of December 31, 2004*
ASSETS
Loans and other lending investments, net		$	4,509,309			$	3,946,189
Corporate tenant lease assets, net		2,997,395				2,877,042
Other investments		292,715				75,092
Investments in joint ventures		205,301				5,663
Cash and cash equivalents		116,372				88,422
Restricted cash		38,202				39,568
Accrued interest and operating lease income receivable		30,357				25,633
Deferred operating lease income receivable		70,095				62,092
Deferred expenses and other assets		92,517				100,536
Goodwill		7,746				—
Total assets		$	8,360,009			$	7,220,237
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities		$	154,389			$	140,075
Debt obligations		5,637,584				4,605,674
Total liabilities		5,791,973				4,745,749
Commitments and contingencies		—				—
Minority interest in consolidated entities		27,851				19,246
Shareholders’ equity:
Series D Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 4,000 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively		4				4
Series E Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 5,600 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively		6				6
Series F Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 4,000 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively		4				4
Series G Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 3,200 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively		3				3
Series I Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 5,000 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively		5				5
High Performance Units		8,793				7,828
Common Stock, $0.001 par value, 200,000 shares authorized, 112,704 and 111,432 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively		113				111
Warrants and options		6,458				6,458
Additional paid-in capital		2,870,048				2,840,062
Retained earnings (deficit)		(305,744		)		(349,097		)
Accumulated other comprehensive income (losses) (See Note 14)		(13,233		)		(2,086		)
Treasury stock (at cost)		(26,272		)		(48,056		)
Total shareholders’ equity		2,540,185				2,455,242
Total liabilities and shareholders’ equity		$	8,360,009			$	7,220,237

*   Reclassified to conform to 2005 presentation.

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

2

iStar Financial Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
(unaudited)

		For the  Three Months Ended  June 30,						For the  Six Months Ended  June 30,
		2005			2004*			2005			2004*
Revenue:
Interest income		$	106,287		$	92,112		$	198,285		$	174,996
Operating lease income		78,523			71,493			155,534			137,367
Other income		13,847			9,993			26,072			22,107
Total revenue		198,657			173,598			379,891			334,470
Costs and expenses:
Interest expense		81,654			59,043			150,605			111,529
Operating costs—corporate tenant lease assets		5,715			4,271			11,470			8,985
Depreciation and amortization		18,180			15,928			36,021			30,757
General and administrative		14,166			12,511			29,527			25,870
General and administrative—stock-based compensation expense		641			568			1,283			108,109
Provision for loan losses		—			2,000			2,250			5,000
Loss on early extinguishment of debt		—			1,006			—			13,178
Total costs and expenses		120,356			95,327			231,156			303,428
Income before equity in earnings from joint ventures, minority interest and other items		78,301			78,271			148,735			31,042
Equity in earnings (loss) from joint ventures		(5		)	(855		)	(165		)	5,393
Minority interest in consolidated entities		(74		)	(128		)	(280		)	(261		)
Income from continuing operations		78,222			77,288			148,290			36,174
Income from discontinued operations		110			5,731			361			11,593
Gain from discontinued operations		407			—			407			136
Net income		78,739			83,019			149,058			47,903
Preferred dividend requirements		(10,580		)	(10,580		)	(21,160		)	(30,180		)
Net income allocable to common shareholders and HPU holders(1)		$	68,159		$	72,439		$	127,898		$	17,723
Basic earnings per common share(2)		$	0.59		$	0.64		$	1.11		$	0.16
Diluted earnings per common share(3)(4)		$	0.58		$	0.64		$	1.10		$	0.16

 

*   Reclassified to conform to 2005 presentation.

Explanatory Notes:

(1)             HPU holders are Company employees who purchased high performance common stock units under the Company’s High Performance Unit Program.

(2)             For the three months ended June 30, 2005 and 2004, excludes $1,675 and $1,163 of net income allocable to HPU holders, respectively. For the six months ended June 30, 2005 and 2004, excludes $3,159 and $259 of net income allocable to HPU holders, respectively.

(3)             For the three months ended June 30, 2005 and 2004, excludes $1,659 and $1,148 of net income allocable to HPU holders, respectively. For the six months ended June 30, 2005 and 2004, excludes $3,126 and $243 of net income allocable to HPU holders, respectively.

(4)             For the three months ended June 30, 2005 and 2004, includes $0 and $41 of joint venture income, respectively. For the six months ended June 30, 2005 and 2004, includes $0 and $3 of joint venture income respectively.

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

3

iStar Financial Inc.
Consolidated Statements of Changes in Shareholders’ Equity
(In thousands)
(unaudited)

Series D Preferred Stock

Series E Preferred Stock

Series F Preferred Stock

Series G Preferred Stock

Series I Preferred Stock

HPU’s

Common Stock at Par

Warrants & Options

Additional  Paid-In Capital

Retained Earnings (Deficit)

Accumulated Other Comprehensive Income (Losses)

Treasury Stock

Total

Balance at December 31, 2004			$   4				$   6				$   4				$   3				$   5			$7,828			$111				$6,458			$2,840,062		$(349,097	)		$   (2,086	)		$(48,056	)		$2,455,242
Exercise of options			—				—				—				—				—			—			1				—			1,227		—			—			—			1,228
Dividends declared- preferred			—				—				—				—				—			—			—				—			—		(21,160	)		—			—			(21,160	)
Dividends declared- common			—				—				—				—				—			—			—				—			—		(82,481	)		—			—			(82,481	)
Dividends declared- HPU			—				—				—				—				—			—			—				—			—		(2,064	)		—			—			(2,064	)
Restricted stock units granted to employees			—				—				—				—				—			—			—				—			1,546		—			—			—			1,546
High performance units sold to employees			—				—				—				—				—			965			—				—			—		—			—			—			965
Issuance of stock held in treasury			—				—				—				—				—			—			1				—			26,169		—			—			21,784			47,954
Issuance of stock DRIP/Stock purchase plan			—				—				—				—				—			—			—				—			1,044		—			—			—			1,044
Net income for the period			—				—				—				—				—			—			—				—			—		149,058			—			—			149,058
Change in accumulated other comprehensive income (losses)			—				—				—				—				—			—			—				—			—		—			(11,147	)		—			(11,147	)
Balance at June 30, 2005			$   4				$   6				$   4				$   3				$   5			$8,793			$113				$6,458			$2,870,048		$(305,744	)		$(13,233	)		$(26,272	)		$2,540,185

 

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

 

iStar Financial Inc.
Consolidated Statements of Cash Flows
(In thousands)
(unaudited)

		For the  Three Months Ended  June 30,						For the  Six Months Ended  June 30,
		2005			2004			2005			2004
Cash flows from operating activities:
Net income		$	78,739		$	83,019		$	149,058		$		47,903
Adjustments to reconcile net income (loss) to cash flows provided by operating activities:
Minority interest in consolidated entities		74			128			280			261
Non-cash expense for stock-based compensation		698			625			1,411			52,791
Depreciation, depletion and amortization		18,506			15,928			36,757			30,757
Depreciation and amortization from discontinued operations		20			1,235			53			2,456
Amortization of deferred financing costs		7,975			7,853			15,501			15,618
Amortization of discounts/premiums, deferred interest and costs on lending investments		(13,008		)	(13,592		)	(31,727		)	(29,457				)
Discounts, loan fees and deferred interest received		3,026			3,127			42,418			13,767
Equity in earnings (loss) from joint ventures		5			855			165			(5,393				)
Distributions from operations of joint ventures		—			70			—			143
Loss on early extinguishment of debt		—			1,006			—			13,178
Deferred operating lease income receivable		(3,961		)	(6,330		)	(7,948		)	(11,795				)
Gain from discontinued operations		(407		)	—			(407		)	(136				)
Provision for loan losses		—			2,000			2,250			5,000
Changes in assets and liabilities:
Changes in accrued interest and operating lease income receivable		1,701			(990		)	(2,842		)	(762				)
Changes in deferred expenses and other assets		(4,205		)	13,963			5,705			21,248
Changes in accounts payable, accrued expenses and other liabilities		24,135			(58,778		)	5,276			(16,031				)
Cash flows from operating activities		113,298			50,119			215,950			139,548
Cash flows from investing activities:
New investment originations		(817,142		)	(614,273		)	(1,658,789		)	(1,325,108				)
Net investments in and advances to unconsolidated joint ventures		(151,851		)	—			(151,851		)	—
Cash paid for acquisition of Falcon Financial		—			—			(113,696		)	—
Add-on fundings under existing loan commitments		(62,531		)	(68,649		)	(155,736		)	(85,297				)
Net proceeds from sale of corporate tenant lease assets		5,998			—			5,998			2,822
Repayments of and principal collections on loans and other lending investments(1)		554,323			394,165			976,451			539,045
Capital improvements for build-to-suit facilities		(4,249		)	—			(4,249		)	—
Capital improvement projects on corporate tenant lease assets		(648		)	(1,174		)	(4,502		)	(2,547				)
Other capital expenditures on corporate tenant lease assets		(1,497		)	(5,343		)	(3,636		)	(7,896				)
Cash flows from investing activities		(477,597		)	(295,274		)	(1,110,010		)	(878,981				)
Cash flows from financing activities:
Borrowings under secured revolving credit facilities		617,000			329,081			1,127,000			1,360,416
Repayments under secured revolving credit facilities		(631,710		)	(582,491		)	(1,192,262		)	(1,779,561				)
Borrowings under unsecured revolving credit facilities		1,286,000			1,178,000			2,440,000			1,178,000
Repayments under unsecured revolving credit facilities		(1,341,000		)	(395,000		)	(2,722,000		)	(525,000				)
Borrowings under term loans		1,617			—			5,431			198,771
Repayments under term loans		(2,296		)	(61,271		)	(5,186		)	(316,353				)
Borrowings under unsecured bond offerings		494,640			24,726			1,585,117			1,032,301
Repayments under unsecured notes		(47		)	—			(47		)	(110,000				)
Repayments under secured bond offerings		(130,368		)	(141,545		)	(217,203		)	(212,059				)
Repayments under other debt obligations		—			—			—			(10,148				)
Contribution from minority interest partner		4,644			—			5,682			—
Changes in restricted cash held in connection with debt obligations		7,500			(14,591		)	1,366			(24,299				)
Prepayment penalty on early extinguishment of debt		—			—			—			(9,625				)
Payments for deferred financing costs		(715		)	(6,961		)	(1,846		)	(8,209				)
Distributions to minority interest in consolidated entities		(1,184		)	(40		)	(1,557		)	(247				)
Net proceeds from preferred offering/exchange		—			—			—			203,048
Redemption of preferred stock		—			—			—			(165,000				)
Common dividends paid		(82,481		)	(77,569		)	(82,481		)	(77,569				)
Preferred dividends paid		(10,580		)	(10,971		)	(21,160		)	(20,748				)
Dividends on HPUs		(2,064		)	(1,253		)	(2,064		)	(1,253				)
HPUs issued		19			50			965			2,302
Contribution from significant shareholder		—			—			—			1,935
Proceeds from exercise of options and issuance of DRIP/Stock purchase shares		1,193			13,431			2,255				38,714
Cash flows from financing activities		210,168			253,596			922,010				755,416
Changes in cash and cash equivalents		(154,131		)	8,441			27,950				15,983
Cash and cash equivalents at beginning of period		270,503			87,632			88,422				80,090
Cash and cash equivalents at end of period		$	116,372		$	96,073		$	116,372			$		96,073
Supplemental disclosure of cash flow information:
Cash paid during the period for interest, net of amount capitalized		$	53,159		$	39,592		$	118,094			$		85,557

 

Explanatory Note:

(1)                Does not include approximately $99.9 million of loan repayments in escrow during the period ended June 30, 2005 for which cash was received by the Company on July 7, 2005.

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

5

iStar Financial Inc.
Notes to Consolidated Financial Statements

Note 1—Business and Organization

Business—iStar Financial Inc. (the “Company”) is the leading publicly-traded finance company focused on the commercial real estate industry. The Company provides custom-tailored financing to high-end private and corporate owners of real estate, including senior and junior mortgage debt, senior and mezzanine corporate capital, and corporate net lease financing. The Company, which is taxed as a real estate investment trust (“REIT”), seeks to deliver strong dividends and superior risk-adjusted returns on equity to shareholders by providing the highest quality financing to its customers.

The Company’s primary product lines include:

·       Structured Finance.   The Company provides senior and subordinated loans that typically range in size from $20 million to $100 million. These loans may be either fixed or variable rate and are structured to meet the specific financing needs of the borrowers, including the acquisition or financing of large, quality real estate. The Company offers borrowers a wide range of structured finance options, including first mortgages, second mortgages, partnership loans, participating debt and interim facilities. The Company’s structured finance transactions have maturities generally ranging from three to ten years. As of June 30, 2005, based on gross carrying values, the Company’s structured finance assets represented 28.8% of its assets.

·       Portfolio Finance.   The Company provides funding to regional and national borrowers who own multiple facilities in geographically diverse portfolios. Loans are cross-collateralized to give the Company the benefit of all available collateral and underwritten to recognize inherent portfolio diversification. Property types include multifamily, suburban office, hotels and other property types where individual property values are less than $20 million on average. Loan terms are structured to meet the specific requirements of the borrower and typically range in size from $25 million to $150 million. The Company’s portfolio finance transactions have maturities generally ranging from three to ten years. As of June 30, 2005, based on gross carrying values, the Company’s portfolio finance assets represented 11.6% of its assets.

·       Corporate Finance. The Company provides senior and subordinated capital to corporations engaged in real estate or real estate-related businesses. Financings may be either secured or unsecured and typically range in size from $20 million to $150 million. The Company’s corporate finance transactions have maturities generally ranging from five to ten years. As of June 30, 2005, based on gross carrying values, the Company’s corporate finance assets represented 8.1% of its assets.

·       Loan Acquisition.   The Company acquires whole loans and loan participations which present attractive risk-reward opportunities. Loans are generally acquired at a small discount to the principal balance outstanding. Loan acquisitions typically range in size from $5 million to $100 million and are collateralized by all major property types. The Company’s loan acquisition transactions have maturities generally ranging from three to ten years. As of June 30, 2005, based on gross carrying values, the Company’s loan acquisition assets represented 6.0% of its assets.

·       Corporate Tenant Leasing.   The Company provides capital to corporations and borrowers who control facilities leased to single creditworthy customers. The Company’s net leased assets are generally mission-critical headquarters or distribution facilities that are subject to long-term leases with public companies, many of which are rated corporate credits and which provide for all expenses at the facility to be paid by the corporate customer on a triple net lease basis. Corporate tenant lease (“CTL”) transactions have terms generally ranging from ten to 20 years and typically

6

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 1—Business and Organization (Continued)

range in size from $20 million to $150 million. As of June 30, 2005, based on gross carrying values, the Company’s CTL assets (including investments in joint ventures) represented 42.0% of its assets.

The Company’s investment strategy targets specific sectors of the real estate credit markets in which it believes it can deliver the highest quality, flexible financial solutions to its customers, thereby differentiating its financial products from those offered by other capital providers.

The Company has implemented its investment strategy by:

·       Focusing on the origination of large, structured mortgage, corporate and lease financings where customers require flexible financial solutions and “one-call” responsiveness post-closing.

·       Avoiding commodity businesses in which there is significant direct competition from other providers of capital such as conduit lending and investment in commercial or residential mortgage-backed securities.

·       Developing direct relationships with borrowers and corporate customers in addition to sourcing transactions through intermediaries.

·       Adding value beyond simply providing capital by offering borrowers and corporate customers expertise in multiple markets, flexibility, certainty and long-term relationships.

·       Taking advantage of market anomalies in the real estate and corporate financing markets when the Company believes credit is mispriced by other providers of capital.

Organization—The Company began its business in 1993 through private investment funds formed to capitalize on inefficiencies in the real estate finance market. In March 1998, these funds contributed their approximately $1.1 billion of assets to the Company’s predecessor in exchange for a controlling interest in that company. Since that time, the Company has grown by originating new lending and leasing transactions, as well as through corporate acquisitions.

Specifically, in September 1998, the Company acquired the loan origination and servicing business of a major insurance company, and in December 1998, the Company acquired the mortgage and mezzanine loan portfolio of its largest private competitor. Additionally, in November 1999, the Company acquired TriNet Corporate Realty Trust, Inc. (“TriNet”), then the largest publicly-traded company specializing in corporate sale/leaseback transactions for office and industrial facilities (the “TriNet Acquisition”). The TriNet Acquisition was structured as a stock-for-stock merger of TriNet with a subsidiary of the Company.

In March 2005, in connection with the amendment of certain covenants in the 7.95% TriNet Notes due 2006, the Company merged TriNet into the Company. As of March 31, 2005, TriNet no longer exists.

Note 2—Basis of Presentation

The accompanying unaudited Consolidated Financial Statements have been prepared in conformity with the instructions to Form 10-Q and Article 10-01 of Regulation S-X for interim financial statements. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles in the United States of America (“GAAP”) for complete financial statements. The Consolidated Financial Statements include the accounts of the Company, its qualified REIT subsidiaries,

7

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 2—Basis of Presentation (Continued)

its majority-owned and controlled partnerships and other entities that are consolidated under the provisions of FASB Interpretation No. 46 (“FIN 46”) (see Note 6).

Certain other investments in partnerships or joint ventures which the Company does not control are accounted for under the equity method (see Note 6). All significant intercompany balances and transactions have been eliminated in consolidation.

In the opinion of management, the accompanying Consolidated Financial Statements contain all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the Company’s consolidated financial position at June 30, 2005 and December 31, 2004 and the results of its operations, changes in shareholders’ equity and its cash flows for the three and six months ended June 30, 2005 and 2004, respectively. Such operating results may not be indicative of the expected results for any other interim periods or the entire year.

Note 3—Summary of Significant Accounting Policies

Loans and other lending investments—As described in Note 4, “Loans and Other Lending Investments” includes the following investments: senior mortgages, subordinate mortgages, corporate/partnership loans, other lending investments-loans and other lending investments-securities. Management considers nearly all of its loans and other lending investments to be held-to-maturity, although a small number of investments may be classified as available-for-sale. Items classified as held-to-maturity are reflected at amortized historical cost. Items classified as available-for-sale are reported at fair values with unrealized gains and losses included in “Accumulated other comprehensive income (losses)” on the Company’s Consolidated Balance Sheets and are not included in the Company’s net income.

Corporate tenant lease assets and depreciation—CTL assets are generally recorded at cost less accumulated depreciation. Certain improvements and replacements are capitalized when they extend the useful life, increase capacity or improve the efficiency of the asset. Repairs and maintenance items are expensed as incurred. Depreciation is computed using the straight-line method of cost recovery over the shorter of estimated useful lives or 40.0 years for facilities, five years for furniture and equipment, the shorter of the remaining lease term or expected life for tenant improvements and the remaining life of the facility for facility improvements.

CTL assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell and are included in “Assets held for sale” on the Company’s Consolidated Balance Sheets. The Company also periodically reviews long-lived assets to be held and used for an impairment in value whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. In management’s opinion, CTL assets to be held and used are not carried at amounts in excess of their estimated recoverable amounts.

Regarding the Company’s acquisition of facilities, purchase costs are allocated to the tangible and intangible assets and liabilities acquired based on their estimated fair values. The value of the tangible assets, consisting of land, buildings, building improvements and tenant improvements, are determined as if vacant, that is, at replacement cost. Intangible assets including the above-market or below-market value of leases, the value of in-place leases and the value of customer relationships are recorded at their relative fair values.

8

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 3—Summary of Significant Accounting Policies (Continued)

Above-market and below-market in-place lease values for owned CTL assets are recorded based on the present value (using a discount rate reflecting the risks associated with the leases acquired) of the difference between: (1) the contractual amounts to be paid pursuant to the leases negotiated and in-place at the time of acquisition of the facilities; and (2) management’s estimate of fair market lease rates for the facility or equivalent facility, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market (or below-market) lease value is amortized as a reduction of (or, increase to) operating lease income over the remaining non-cancelable term of each lease plus any renewal periods with fixed rental terms that are considered to be below-market. The Company generally engages in sale/leaseback transactions and typically executes leases simultaneously with the purchase of the CTL asset at market-rate rents. Because of this, no above-market or below-market lease value is ascribed to these transactions.

The total amount of other intangible assets are allocated to in-place lease values and customer relationship intangible values based on management’s evaluation of the specific characteristics of each customer’s lease and the Company’s overall relationship with each customer. Characteristics to be considered in allocating these values include the nature and extent of the existing relationship with the customer, prospects for developing new business with the customer, the customer’s credit quality and the expectation of lease renewals among other factors. Factors considered in management’s analysis include the estimated carrying costs of the facility during a hypothetical expected lease-up period, current market conditions and costs to execute similar leases. Management also considers information obtained about a property in connection with its pre-acquisition due diligence. Estimated carrying costs include real estate taxes, insurance, other property operating costs and estimates of lost operating lease income at market rates during the hypothetical expected lease-up periods, based on management’s assessment of specific market conditions. Management estimates costs to execute leases including commissions and legal costs to the extent that such costs are not already incurred with a new lease that has been negotiated in connection with the purchase of the facility. Management’s estimates are used to determine these values. These intangible assets are included in “Other investments” on the Company’s Consolidated Balance Sheets (see Note 5).

The value of above-market or below-market in-place leases are amortized to expense over the remaining initial term of each lease. The value of customer relationship intangibles are amortized to expense over the initial and renewal terms of the leases, but no amortization period for intangible assets will exceed the remaining depreciable life of the building. In the event that a customer terminates its lease, the unamortized portion of each intangible, including market rate adjustments, lease origination costs, in-place lease values and customer relationship values, would be charged to expense.

Timber and timberlands—Timber and timberlands, including logging roads, are stated at cost less accumulated depletion for timber previously harvested and accumulated road amortization. The Company capitalizes timber and timberland purchases and reforestation costs and other costs associated with the planting and growing of timber, such as site preparation, growing or purchases of seedlings, planting, silviculture, herbicide application and the thinning of tree stands to improve growth. The cost of timber and timberlands typically is allocated between the timber and the land acquired, based on estimated relative fair values.

Timber carrying costs, such as real estate taxes, insect and wildlife control and timberland management fees, are expensed as incurred. Net carrying value of the timber and timberlands is used to

9

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 3—Summary of Significant Accounting Policies (Continued)

compute the gain or loss in connection with timberland sales. Timber and timberlands are included in “Other investments” on the Company’s Consolidated Balance Sheets (see Note 7).

Capitalized interest—The Company capitalizes interest costs incurred during the construction periods for qualified build-to-suit projects for corporate tenants, including investments in joint ventures accounted for under the equity method. Capitalized interest during the three and six months ended June 30, 2005 and 2004 was approximately $19,500 and $0, respectively.

Cash and cash equivalents—Cash and cash equivalents include cash held in banks or invested in money market funds with original maturity terms of less than 90 days.

Restricted cash—Restricted cash represents amounts required to be maintained in escrow under certain of the Company’s debt obligations, leasing and derivative transactions.

Variable interest entities—In accordance with FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of ARB 51 (“FIN 46”), the Company identifies entities for which control is achieved through means other than through voting rights (a “variable interest entity” or “VIE”), and determines when and which business enterprise should consolidate the VIE. In addition, the Company discloses information pertaining to both the primary beneficiary and all other enterprises with a significant variable interest in a VIE. Beginning January 31, 2003, the Company consolidated all VIEs entered into or modified after February 1, 2003 in which the Company is deemed the primary beneficiary. Beginning January 1, 2004, the Company consolidated all VIEs entered into prior to February 1, 2003. FIN 46 applies when either: (1) the equity investors (if any) lack one or more of the essential characteristics of controlling financial interest; (2) the equity investment at risk is insufficient to finance that entity’s activities without additional subordinated financial support; or (3) the equity investors have voting rights that are not proportionate to their economic interest.

Identified intangible assets and goodwill—Upon the acquisition of a business the Company records intangible assets acquired at their estimated fair value separate and apart from goodwill. The Company amortizes identified intangible assets that are determined to have finite lives based on the period over which the assets are expected to contribute directly or indirectly to the future cash flows of the business acquired. Intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its estimated fair value.

The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed is recorded as goodwill. Goodwill is not amortized but is tested for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test is done at a level of reporting referred to as a reporting unit. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than its carrying value.

Fair values for goodwill and other intangible assets are determined based on discounted cash flows or appraised values, as appropriate.

10

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 3—Summary of Significant Accounting Policies (Continued)

During the first quarter 2005, the Company acquired Falcon Financial Investment Trust (“Falcon Financial”) in a business combination and identified intangible assets of approximately $2.0 million and goodwill of $7.7 million (see Note 4 for further discussion). These identified intangible assets are included in “Deferred expenses and other assets” on the Company’s Consolidated Balance Sheets.

Revenue recognition—The Company’s revenue recognition policies are as follows:

Loans and other lending investments:   Management considers nearly all of its loans and other lending investments to be held-to-maturity, although a small number of investments may be classified as available-for-sale. The Company reflects held-to-maturity investments at historical cost adjusted for allowance for loan losses, unamortized acquisition premiums or discounts and unamortized deferred loan fees. Unrealized gains and losses on available-for-sale investments are included in “Accumulated other comprehensive income (losses)” on the Company’s Consolidated Balance Sheets and are not included in the Company’s net income. On occasion, the Company may acquire loans at generally small premiums or discounts based on the credit characteristics of such loans. These premiums or discounts are recognized as yield adjustments over the lives of the related loans. Loan origination or exit fees, as well as direct loan origination costs, are also deferred and recognized over the lives of the related loans as a yield adjustment. If loans with premiums, discounts, loan origination or exit fees are prepaid, the Company immediately recognizes the unamortized portion as a decrease or increase in the prepayment gain or loss which is included in “Other income” in the Company’s Consolidated Statements of Operations. Interest income is recognized using the effective interest method applied on a loan-by-loan basis.

A small number of the Company’s loans provide for accrual of interest at specified rates that differ from current payment terms. Interest is recognized on such loans at the accrual rate subject to management’s determination that accrued interest and outstanding principal are ultimately collectible, based on the underlying collateral and operations of the borrower.

Prepayment penalties or yield maintenance payments from borrowers are recognized as additional income when received. Certain of the Company’s loan investments provide for additional interest based on the borrower’s operating cash flow or appreciation of the underlying collateral. Such amounts are considered contingent interest and are reflected as income only upon certainty of collection.

Leasing investments:   Operating lease revenue is recognized on the straight-line method of accounting from the later of the date of the origination of the lease or the date of acquisition of the facility subject to existing leases. Accordingly, contractual lease payment increases are recognized evenly over the term of the lease. The cumulative difference between lease revenue recognized under this method and contractual lease payment terms is recorded as “Deferred operating lease income receivable” on the Company’s Consolidated Balance Sheets.

Provision for loan losses—The Company’s accounting policies require that an allowance for estimated loan losses be maintained at a level that management, based upon an evaluation of known and inherent risks in the portfolio, considers adequate to provide for loan losses. In establishing loan loss provisions, management periodically evaluates and analyzes the Company’s assets, historical and industry loss

11

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 3—Summary of Significant Accounting Policies (Continued)

experience, economic conditions and trends, collateral values and quality, and other relevant factors. Specific valuation allowances are established for impaired loans in the amount by which the carrying value, before allowance for estimated losses, exceeds the fair value of collateral less disposition costs on an individual loan basis. Management considers a loan to be impaired when, based upon current information and events, it believes that it is probable that the Company will be unable to collect all amounts due under the loan agreement. Management carries these impaired loans at the fair value of the loans’ underlying collateral less estimated disposition costs. Impaired loans may be left on accrual status during the period the Company is pursuing repayment of the loan; however, these loans are placed on non-accrual status at such time as: (1) management determines the borrower is incapable of, or has ceased efforts toward, curing the cause of the impairment; (2) the loans become 90 days delinquent; (3) the loan has a maturity default; or (4) the net realizable value of the loan’s underlying collateral approximates the Company’s carrying value of such loan. While on non-accrual status, interest income is recognized only upon actual receipt. Impairment losses are recognized as direct write-downs of the related loan with a corresponding charge to the provision for loan losses. Charge-offs occur when loans, or a portion thereof, are considered uncollectible and of such little value that further pursuit of collection is not warranted. Management also provides a loan portfolio reserve based upon its periodic evaluation and analysis of the portfolio, historical and industry loss experience, economic conditions and trends, collateral values and quality, and other relevant factors.

The Company’s loans are generally secured by real estate assets or are corporate lending arrangements to entities with significant real estate holdings. While the underlying real estate assets for the corporate lending instruments may not serve as collateral for the Company’s investments in all cases, the Company evaluates the underlying real estate assets when estimating loan loss exposure because the Company’s loans generally have restrictions as to how much senior and/or secured debt the customer may borrow ahead of the Company’s position.

Allowance for doubtful accounts—The Company’s accounting policies require a reserve on the Company’s accrued operating lease income receivable balances and on the deferred operating lease income receivable balances. The reserve covers asset specific problems (e.g., bankruptcy) as they arise, as well as a portfolio reserve based on management’s evaluation of the credit risks associated with these receivables.

Derivative instruments and hedging activity—In accordance with Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities” as amended by Statement of Financial Accounting Standards No. 137 “Accounting for Derivative Instruments and Hedging Activity—Deferral of the Effective date of FASB 133,” Statement of Financial Accounting Standards No. 138 “Accounting for Certain Derivative Instruments and Certain Hedging Activities—an Amendment of FASB Statement 133” and Statement of Financial Accounting Standards No. 149 “Amendment of Statement 133 on Derivative Instrument and Hedging Activities,” the Company recognizes all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as: (1) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment; (2) a hedge of the exposure to variable cash flows of a forecasted transaction; or (3) in certain circumstances, a hedge of a foreign currency exposure.

12

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 3—Summary of Significant Accounting Policies (Continued)

Stock-based compensation—During the third quarter 2002, with retroactive application to the beginning of the year, the Company adopted the fair-value method of accounting for options issued to employees or directors. Accordingly, the Company recognizes a charge equal to the fair value of these options at the date of grant multiplied by the number of options issued. This charge is amortized over the related remaining vesting terms to individuals as additional compensation.

Generally, for restricted stock awards, the Company measures compensation costs as of the date of grant and expenses such amounts against earnings, either at the grant date (if no vesting period exists) or ratably over the respective vesting/service period.

Impairment or disposal of long-lived assets—In accordance with the Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets” the Company presents current operations prior to the disposition of CTL assets and prior period results of such operations in discontinued operations in the Company’s Consolidated Statements of Operations.

Depletion—Assumptions and estimates are used in the recording of depletion. With the help of foresters and industry-standard computer software, merchantable standing timber inventory is estimated annually. An annual depletion rate for each timberland investment is established by dividing book cost of timber by standing merchantable inventory. Changes in the assumptions and/or estimations used in these calculations may affect the Company’s results, in particular depletion costs. Factors that can impact timber volume include weather changes, losses due to natural causes, differences in actual versus estimated growth rates and changes in the age when timber is considered merchantable.

Income taxes—The Company is subject to federal income taxation at corporate rates on its “REIT taxable income;” however, the Company is allowed a deduction for the amount of dividends paid to its shareholders, thereby subjecting the distributed net income of the Company to taxation at the shareholder level only. In addition, the Company is allowed several other deductions in computing its “REIT taxable income,” including non-cash items such as depreciation expense. These deductions allow the Company to shelter a portion of its operating cash flow from its dividend payout requirement under federal tax laws. The Company intends to operate in a manner consistent with and to elect to be treated as a REIT for tax purposes.

The Company can participate in certain activities from which it was previously precluded in order to maintain its qualification as a REIT as long as these activities are conducted in entities which elect to be treated as taxable subsidiaries under the Code, subject to certain limitations. As such, the Company, through its taxable REIT subsidiaries, is engaged in various real estate related opportunities, including: (i) servicing the Company’s loans and certain loan portfolios owned by third parties through a wholly-owned subsidiary of the taxable REIT subsidiary, iStar Operating, Inc. (“iStar Operating”); (ii) servicing securitized loans acquired in the acquisition of Falcon Financial through a wholly-owned taxable REIT subsidiary, Falcon Financial II, Inc, (“Falcon”); (iii) certain activities related to the purchase and sale of timber and timberlands through a taxable REIT subsidiary, TimberStar TRS, Inc.(“TimberStar TRS”); and (iv) managing corporate credit-oriented investment strategies through three taxable REIT subsidiaries, iStar Alpha TRS, Inc., iStar Alpha LLC Holding TRS, Inc. and iStar Alpha LLC Holdings TRS, Inc., (collectively, “iStar Alpha”). The Company will consider other investments through taxable REIT subsidiaries if suitable opportunities arise. iStar Operating, Falcon, TimberStar TRS and iStar Alpha are not consolidated for federal income tax purposes and are taxed as corporations. For financial reporting

13

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 3—Summary of Significant Accounting Policies (Continued)

purposes, current and deferred taxes are provided for in the portion of earnings recognized by the Company with respect to its interest in iStar Operating, Falcon, TimberStar TRS and iStar Alpha. Accordingly, except for the Company’s taxable REIT subsidiaries, no current or deferred taxes are provided for in the Consolidated Financial Statements.

Earnings per common share—In accordance with the Statement of Financial Accounting Standards No. 128 (“SFAS No. 128”), “Earning per Share,” the Company presents both basic and diluted earnings per share (“EPS”). Basic earnings per share (“Basic EPS”) is computed by dividing net income allocable to common shareholders by the weighted average number of shares outstanding for the period. Diluted earnings per share (“Diluted EPS”) reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, where such exercise or conversion would result in a lower earnings per share amount.

Reclassifications—Certain prior year amounts have been reclassified in the Consolidated Financial Statements and the related notes to conform to the 2005 presentation.

Use of estimates—The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

New accounting standards—In December 2004, the FASB released Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”), “Share-Based Payment.” This standard requires issuers to measure the cost of equity-based service awards based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the requisite service period (typically the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The Company will initially measure the cost of liability-based service awards based on their current fair value. The fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. Companies can comply with FASB No. 123R using one of three transition methods: (1) the modified prospective method; (2) the modified retrospective method; or (3) a variation of the modified retrospective method. The provisions of this statement are effective for annual periods beginning after June 15, 2005. The Company adopted the fair-value method in the third quarter 2002 (retroactive to the beginning of the year) and applied the prospective method of SFAS No. 148 which allowed the Company to expense the options granted in that year.

In September 2004, the Emerging Issues Task Force issued FASB Topic No. D-108 (“EITF D-108”), “Use of the Residual Method to Value Acquired Assets Other than Goodwill” which requires that a direct value method be used to value intangible assets acquired in business combinations completed after

14

---

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 3—Summary of Significant Accounting Policies (Continued)

September 29, 2004. EITF D-108 also requires that an impairment test using a direct value method on all intangible assets that were previously evaluated using the residual method be performed no later than the beginning of the first fiscal year beginning after December 15, 2004. Any impairments arising from the initial application of a direct value method would be reported as a cumulative effect of accounting change. The Company adopted the provisions of this statement, as required, on October 1, 2004, and it did not have a significant financial impact on the Company’s Consolidated Financial Statements.

In December 2003, the SEC issued Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition” which supercedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104’s primary purpose is to rescind the accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21. The Company adopted the provisions of this statement immediately, as required, and it did not have a significant impact on the Company’s Consolidated Financial Statements.

In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Accountants issued Statement of Position 03-3 (“SOP 03-3”), “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” SOP 03-3 addresses the accounting for acquired loans that show evidence of having deteriorated in terms of credit quality since their origination (i.e., impaired loans). Because of their deteriorated credit quality, the loans are generally acquired at a discount (i.e., below their par value). Loans that are subject to SOP 03-3 acquired in a business combination that are accounted for as purchase business combinations should be recorded, as a result of the allocation of the acquisition price pursuant to Statement of Financial Accounting Standards No. 141 (“SFAS No. 141”), “Business Combinations”, at their fair value. The Company adopted the provisions of this statement, as required, on January 1, 2005, and it did not have a significant financial impact on the Company’s Consolidated Financial Statements.

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (“SFAS No. 150”), “Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity.” This standard requires issuers to classify as liabilities the following three types of freestanding financial instruments: (1) mandatorily redeemable financial instruments; (2) obligations to repurchase the issuer’s equity shares by transferring assets; and (3) certain obligations to issue a variable number of shares. The FASB issued FASB Staff Position (“FSP”) 150-3, which defers the provisions of paragraphs 9 and 10 of SFAS No. 150 indefinitely as they apply to mandatorily redeemable noncontrolling interests associated with finite-lived entities. The Company adopted the provisions of this statement, as required, on July 1, 2003, and it did not have a significant financial impact on the Company’s Consolidated Financial Statements.

15

iStar Financial Inc.
Notes to Consolidated Financial Statements (Continued)

Note 4—Loans and Other Lending Investments

The following is a summary description of the Company’s loans and other lending investments (in thousands)(1):

 

Explanatory Notes:

(1)                Details (other than carrying values) are for loans outstanding as of June 30, 2005.

(2)                Substantially all variable-rate loans are based on 30-day LIBOR and reprice monthly. The 30-day LIBOR on June 30, 2005 was 3.34%. As of June 30, 2005, four loans with a combined carrying value of $65.3 million have a stated accrual rate that exceeds the stated pay rate. Two loans, with an aggregate carrying value of $99.7 million, have been placed on non-accrual status and therefore are considered non-performing loans (see Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Management) and the Company is only recognizing income based on cash received for interest on the default rate.

(3)                Includes a participation interest in a first mortgage.

(4)                The loans require fixed payments of principal and interest resulting in partial principal amortization over the term of the loan with the remaining principal due at maturity.

(5)                Under some of the loans, the Company may receive additional payments representing additional interest from participation in available cash flow from operations of the underlying real estate collateral.

(6)                Generally consists of term preferred stock or debt interests that are specifically originated or structured to meet customer financing requirements and the Company’s investment criteria. These investments do not typically consist of securities purchased in the open market or as part of broadly-distributed offerings.