Northstar Realty Finance (NRF) 10-K 2005 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

R	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2005 or
£	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________________________ to __________________________
Commission file number: 001-32330

NorthStar Realty Finance Corp.

(Exact name of registrant as specified in its charter)

Maryland	11-3707493
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
527 Madison Avenue, 16th Floor New York, New York	10022
(Address of principal executive offices)	(Zip Code)
(212) 319-8801 (Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class	Name of each exchange on which registered
Common Stock, $0.01 par value	New York Stock Exchange (NYSE)

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

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes £No R

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes £No R

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes RNo £

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. R

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definition of “accelerated filer and large accelerate filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer £ Accelerated filer R Non-accelerated filer £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes £No R

The aggregate market value of the registrant's voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2005, was $215,823,588. As of March 7, 2006, the registrant had issued and outstanding 30,569,738 shares of common stock, par value $0.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for the registrant's 2006 Annual Meeting of Stockholders (the "2006 Proxy Statement"), to be filed within 120 days after the end of the registrant's fiscal year ending December 31, 2005, are incorporated by reference into this Annual Report on Form 10-K in response to Part III, Items 10 ,11, 12, 13 and 14.

INDEX

Page

PART I
ITEM 1.	BUSINESS	5
ITEM 1A.	RISK FACTORS	22
ITEM 1B.	UNRESOLVED STAFF COMMENTS	39
ITEM 2.	PROPERTIES	40
ITEM 3.	LEGAL PROCEEDINGS	42
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	42
PART II
ITEM 5.	MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	43
ITEM 6.	SELECTED HISTORICAL CONSOLIDATED AND COMBINED FINANCIAL DATA	45
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	48
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	76
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	80
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	81
ITEM 9A.	CONTROLS AND PROCEDURES	82
PART III
ITEM 10.	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT	84
ITEM 11.	EXECUTIVE COMPENSATION	84
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT	84
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	84
ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	84
PART IV
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	85

FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments and financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.

Factors that could have a material adverse effect on our operations and future prospects are set forth in “Risk Factors” in this Annual Report on Form 10-K beginning on page 22. The factors set forth in the Risk Factors section could cause our actual results to differ significantly from those contained in any forward-looking statement contained in this report.

PART I

ITEM 1.BUSINESS

Overview

We are an internally-managed real estate finance company that makes investments in real estate debt, real estate securities and net lease properties. We conduct our operations so as to qualify as a real estate investment trust, or a REIT, for federal income tax purposes. We invest in those areas of commercial real estate finance that enable us to leverage our real estate investment expertise, utilize our broad capital markets knowledge, and capitalize on our ability to employ innovative financing structures.

We are focused on three core businesses:

· Real Estate Debt: We acquire, originate and structure senior and subordinate debt investments secured primarily by income-producing real estate properties.

· Real Estate Securities: We invest in commercial real estate debt securities, including commercial mortgage backed securities, or CMBS, REIT unsecured debt, and credit tenant loans.

· Net Lease Properties: We acquire properties that are primarily net leased to corporate tenants.

We believe that these businesses are complementary to each other due to their overlapping sources of investment opportunities, common reliance on real estate fundamentals and ability to utilize securitization to finance assets and enhance returns. We seek to match fund our real estate securities and real estate debt investments, primarily by issuing collateralized debt obligations, or CDOs. CDOs are a securitization structure whereby multiple classes of debt are issued to finance a portfolio of securities. We allocate capital to these businesses in such a way as to diversify our credit risk and optimize our returns. Our primary objectives are to produce attractive risk-adjusted returns and to generate predictable cash flow for distribution to our stockholders.

Our Business Strategy

Our primary objectives are to make real estate-related investments that produce attractive risk-adjusted returns and to generate predictable cash flow for distribution to our stockholders. Our strategy is to target sectors that combine characteristics of both real estate and fixed income investments. We believe we derive a competitive advantage from the combination of our real estate and capital markets expertise, which enables us to manage credit risk across all three business lines as well as to structure and finance our assets efficiently.

We believe our complementary core businesses provide us with the following synergies that enhance our competitive position:

Sourcing Investments - CMBS, real estate debt and net leased properties are often sourced from the same originators. We can offer a single source of financing by purchasing or originating a rated senior interest for our real estate securities portfolio and an unrated junior interest for our real estate debt portfolio.

Credit Analysis - Real estate debt interests are usually marketed to investors prior to the issuance of CMBS backed by rated senior interests secured by the same property. By participating in both sectors, we can utilize our underwriting resources more efficiently and enhance our ability to underwrite the securitized debt.

CDO Financing - Our experience and reputation as a CDO manager gives us access to low cost, match funded financing for all of our real estate securities and real estate debt investments.

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Capital Allocation - Through our participation in these three businesses, we benefit from market information that enables us to make more informed decisions with regard to the relative valuation of financial assets and capital allocation.

Our Corporate History

We were formed as a Maryland corporation in October 2003 in order to continue and expand the subordinate real estate debt, real estate securities and net lease businesses begun by our management at NorthStar Capital. We commenced operations upon the closing of our initial public offering in October 2004, or our IPO, and conduct substantially all of our operations and investing activities through our operating partnership, NorthStar Realty Finance Limited Partnership, and its subsidiaries.

Our Business Lines

Real Estate Debt Investments

Overview

We acquire, originate and structure senior and subordinate debt investments which we finance primarily by issuing CDO’s. These investments are generally secured by income-producing commercial and multifamily properties, including first lien mortgage loans, which are also referred to as senior mortgage loans, junior participations in first lien mortgage loans, which are often referred to as B-notes, second lien mortgage loans, mezzanine loans, and preferred equity interests in borrowers who own such properties.

Prior to a new real estate debt CDO issuance, there is a period during which we identify and acquire real estate debt investments for inclusion in the CDO. During the accumulation period, the investments are financed under a credit facility with a major lending institution. The advance rates under the credit facility vary depending on the criteria of the lending institution. During the accumulation period the investments and the financing are recorded on our consolidated balance sheet.

Our primary focus is directed at investing in and originating loans secured by income-producing assets, although we may on occasion make investments in real estate-related loans secured by properties that require stabilization, involve repositioning or may involve conversion to residential condominiums We seek to make real estate debt investments that offer the most attractive risk-adjusted returns and evaluate the risk based upon our underwriting criteria and the pricing of comparable investments.

Targeted Investments

Our real estate debt investments typically have the following characteristics:

• terms of 2 to 10 years and in some cases, such terms are inclusive of extension options;

• collateral in the form of a first mortgage or a subordinate interest in a first mortgage on real property, a pledge of ownership interests in a real estate owning entity or a preferred equity investment in a real estate owning entity;

• secured by income-producing commercial or multi-family properties;

• investment amounts of $5 million to $75 million;

• floating interest rates priced at a spread over LIBOR or fixed interest rates;

• the borrower purchases an interest rate cap or other hedge to protect against interest rate volatility in the case of floating rate investments; and

• an intercreditor agreement that outlines our rights relative to investors with more senior positions in the capital structure of the transaction and that typically provides us with a right to cure any defaults to the lender of those tranches senior to us and, under certain circumstances, to purchase senior tranches.

Underwriting Factors for Real Estate Debt

We employ a standardized underwriting process that focuses on a number of factors, including:

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• fundamental real estate analysis of the underlying real estate collateral, including tenant rosters, lease terms and the asset's overall competitive position in its market;

• market factors that may influence the economic performance of the collateral;

• the operating expertise and financial strength of the sponsor or borrower;

• the overall structure of the investment and the lenders' rights in the loan documentation;

• real estate and leasing market conditions affecting the asset;

• macroeconomic conditions that may influence operating performance;

• the ability to liquidate an investment through a sale or refinancing of the collateral;

• the cash flow coverage in place and projected to be in place over the term of the loan;

• a valuation of the property and our investment basis relative to its value;

• review of third-party reports including appraisals, engineering and environmental reports; and

• physical inspections of properties and markets.

We monitor property-level performance of the collateral underlying our debt investments. We regularly review updated information such as operating statements, rent rolls, major tenant lease signings, renewals, expirations and modifications; changes in property management and management fees; changes in operating expenses; borrower's and sponsor's financial condition; distributions from reserves and capital accounts; real estate market conditions; sales of comparable and competitive properties; occupancy and asking rents at competitive properties; and financial performance of major tenants.

Prior to June 30, 2005, we were primarily focused on the acquisition or origination of subordinate debt investments secured primarily by real estate properties. We have recently been placing more emphasis on the acquisition and origination of senior mortgage loans as such loans allow us a greater degree of control in loan structuring, provide us the opportunity to create subordinate interests in the loan, if desired, that meet our risk-return objectives, and allow us to maintain a more direct relationship with our borrowers.

We currently expect to continue to expand our acquisition and origination of senior mortgage loans as a complement to our core real estate debt investment business. To that end, on October 20, 2005, we entered into a definitive purchase agreement with Allied Capital Corporation to acquire Timarron Capital Corporation. Timarron, based in Dallas, Texas, was organized by former senior executives of Principal Financial and other leading financial institutions to develop a nationwide commercial mortgage loan origination platform. We closed on the acquisition on January 19, 2006. The purchase price was approximately $2.7 million. Timarron was renamed and reorganized as NRF Capital LP. NRF Capital LP will originate commercial mortgage loans for our commercial real estate debt portfolio.

Our Investments in Real Estate Debt

At December 31, 2005 we held the following real estate debt investments:

	Carrying Value (1) (in thousands)		% of Aggregate Carrying Value			Average Fixed Rate			Average Spread Over LIBOR			Number of Investments
Whole loans, floating rate	$	178,775		26.3	%		—			3.06	%		10
Whole loans, fixed rate		13,082		1.9	%		5.27	%		—			3
Subordinate mortgage interests, floating rate		237,276		34.8	%		—			4.97	%		17
Mezzanine loans, floating rate		223,621		32.8	%		—			4.86	%		11
Mezzanine loans, fixed rate		151		0.0	%		15.00	%		—			1
Preferred equity, fixed rate		28,201		4.2	%		9.36	%		—			2
Total / Average	$	681,106		100.0	%		8.09%(2	)		4.40%(3	)		44

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(1)At December 31, 2005, approximately $320 million of these investments serve as collateral for the CDO bonds of our fourth CDO issuance, CDO IV, and the balance are financed under either our Wachovia facility or under other repurchase agreements.

(2) Represents average fixed rate applicable to fixed rate loans.

(3) Represents average spread over LIBOR for floating rate loans.

We made the following additional real estate debt investments subsequent to December 31, 2005 and prior to March 7, 2006:

Subsequent to December 31, 2005	Carrying Value (in thousands)		Allocation by Investment Type			Average Fixed Rate			Average Spread Over LIBOR			Number of Investments
Whole loans, floating rate	$	92,335		54.0	%		—			3.33	%		5
Whole loans, fixed rate		—		—			—			—			—
Mezzanine loan, floating rate		66,580		39.0	%		—			9.34	%		2
Mezzanine loans, fixed rate		11,880		7.0	%		8.00	%		—			1
Total / Average	$	170,795		100.0	%		8.00%(1)			5.85%(2)			8

(1) Represents average fixed rate applicable to fixed rate loans.

(2) Represents average spread over LIBOR for floating rate loans.

As of March 7, 2006, all real estate debt investments were performing in accordance with the terms of the underlying loan agreements

Real Estate Debt CDO Issuances

CDO IV

 In June 2005, we closed CDO IV and retained all of the below investment grade securities and income notes, as listed below, of approximately $100 million. The CDO IV issuer issued $300 million face amount of the CDO bonds and sold them in a private placement to third parties. At closing, the proceeds of the issuance and sale of the CDO notes were used to repay the entire outstanding principal balance of $233.6 million under the DBAG facility.

The table below lists the classes of CDO bonds issued by CDO IV and their respective ratings, principal amounts and interest rates.

Class	Moody's/ S&P Ratings		Principal Amount (in thousands)		Interest Rate
A		Aaa/AAA	$	185,000		LIBOR + 0.35%
B		Aa2/AA		32,600		LIBOR + 0.45%
C		A2/A		31,800		LIBOR + 0.75%
D		Baa2/BBB		38,600		LIBOR + 1.60%
E		Baa3/BBB-		12,000		LIBOR + 1.75%
Total			$	300,000

The weighted average spread above LIBOR is 0.62%, excluding costs for the CDO bonds issued by CDO IV.

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The CDO IV issuer sold the Class A through Class E notes in a private placement. We retained the Class F and Class G notes from the CDO IV issuer and one of our subsidiaries purchased the income notes, all of which are eliminated in consolidation under U.S. GAAP. The CDO IV debt securities and income notes are expected to mature in 2013, but their contractual maturity date is July 2040.

The CDO IV issuer entered into a collateral management agreement with NS Advisors LLC, one of our subsidiaries, pursuant to which NS Advisors LLC has agreed to advise the CDO IV issuer on certain matters regarding the collateral interests and other eligible investments securing the Class A through Class F notes and supporting the Class G notes and income notes in exchange for a fee which is payable on a monthly basis in accordance with the priority of payments set forth in the indenture for the CDO IV debt securities. NS Advisors LLC’s aggregate fee is equal to 0.34875% per annum of the net outstanding portfolio balance, which is equal to the sum of (1) the aggregate principal balance of the collateral interests, excluding any impaired interests or written down interests and (2) cash and eligible investments held in certain accounts pledged as security for payment for the Class A through Class F notes. In addition, NS Advisors LLC receives a fee equal to 0.00125% of the outstanding principal balance of Class A and Class B notes as advancing agent.

Credit Facilities

Wachovia Facility

On July 13, 2005, our wholly owned subsidiary NRFC WA Holdings, LLC, or NRFC WA, entered into a master repurchase agreement, which we refer to as the Wachovia facility, with Wachovia Bank, National Association, or Wachovia. The Wachovia facility was amended in September 2005 and February 2006 and currently NRFC WA may borrow up to $400 million under this credit facility in order to finance the acquisition of primarily subordinate real estate debt and other real estate loans and securities. The additional capacity and flexiblility under the amendment will allow us to accumulate sufficient collateral for a contemplated real estate debt CDO, or CDO VI, and to continue to finance other investments.

Advance rates under the Wachovia facility range from 55% to 95% (subject to increase under certain circumstances) of the value of the assets for which the advance is to be made. Amounts borrowed under the Wachovia facility bear interest at one-month LIBOR plus a spread which ranges from 0.20% to 3.00%, depending on the type of asset for which the amount is borrowed. The Wachovia facility has an initial maturity date of July 12, 2008, except that certain advances under the Wachovia facility were required to be repaid by February 24, 2006. If a securitization transaction is not consummated by March 30, 2006, certain advances under the facility will be subject to commitment and unused facility fees. The Company has agreed to a limited guarantee for the amounts borrowed by NRFC WA under the Wachovia facility.

NRFC WA may extend the term of the Wachovia facility for one year if it is not in default and must pay an extension fee of 0.25% of the aggregate amount then outstanding under the facility. If NRFC WA extends the facility's term, it will be required to retire 25% of the aggregate amount then outstanding under the facility during each quarter of the remaining year of the term.

The debt outstanding under the Wachovia facility is subject to a number of terms, conditions and restrictions including, without limitation, scheduled interest payments and the maintenance of certain margin percentages on amounts outstanding under the facility. If the market value of an asset securing outstanding debt declines, NRFC WA may be required to satisfy a margin call by paying cash or providing additional collateral. Failure to meet any margin call could result in an event of default which would enable Wachovia to exercise various rights and remedies including acceleration of the maturity date of the debt outstanding under the facility and the sale of the collateral. An affiliate of NRFC WA was added as borrower under the Wachovia facility in the fourth quarter of 2005.

As of March 7, 2006, NRFC WA and its affiliates had $379.0 million of borrowings outstanding under this facility.

DBAG Facility

On December 21, 2004, NRFC DB Holdings, LLC, one of our subsidiaries, entered into a $150 million master repurchase agreement with Deutsche Bank AG, Cayman Islands Branch, which we refer to as the DBAG facility. On March 21, 2005, the DBAG facility was amended and restated to allow NRFC DB Holdings to borrow up to $300 million in order to finance the acquisition of primarily subordinate real estate debt and other real estate loans and securities. The additional capacity and flexibility under the amendment of the DBAG facility allowed us to accumulate sufficient collateral for CDO IV, and to continue to finance other investments.

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Under the terms of the DBAG facility, NRFC DB Holdings is able to finance the acquisition of mortgage loans secured by first liens on commercial or multifamily properties, junior participation interests in mortgage loans secured by first or second liens on commercial or multifamily properties, mezzanine loans secured by a pledge of the entire ownership interest in a commercial or multifamily property, B− or higher rated CMBS and BB or higher rated real estate CDOs, debt securities issued by a REIT and syndicated bank loans.

The DBAG facility has an initial three-year term, which may be extended for one additional year, subject to certain conditions and the payment of an extension fee. See "Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Debt Obligations — DBAG Facility and CDO Bonds Payable" for a description of such extension terms and fees and the advance amounts and rates for the financing of the acquisition of assets pursuant to the DBAG facility.

As of March 7, 2006, no amounts were outstanding under the DBAG facility.

NSF Venture

On February 1, 2006, we sold our interests in the NSF venture to the institutional pension fund which had an equity interest in the NSF venture and terminated the associated advisory agreements for total consideration of $2.9 million. We will recognize incentive income of approximately $1.2 million, which was deferred at December 31, 2005. Subsequent to January 31, 2006, we will no longer earn management or incentive fees from the NSF venture or from loans owned directly by the NSF venture investor. Prior to the sale, one of our subsidiaries, NorthStar Funding Managing Member LLC, was responsible for the origination, underwriting and structuring of all investments made by the NSF venture, but the institutional pension fund had the right to approve all investments that NorthStar Funding Management LLC proposed to make on behalf of the NSF venture. The NSF venture had focused exclusively on loans to office and multi-family properties. As of the time of the sale, the NSF venture held approximately $85.8 million of subordinate real estate debt.

Real Estate Securities Investments

Overview

We create and manage portfolios of primarily investment grade commercial real estate securities, which we finance by issuing CDOs. These securities include CMBS, fixed income securities issued by REITs, credit rated tenant loans and CDOs backed primarily by real estate securities. These securities are rated primarily investment grade and generally are not insured by the Federal Housing Administration or guaranteed by the Veterans Administration or otherwise guaranteed or insured. In addition to these securities, our investment grade CDOs may also include real estate whole loans or subordinate debt investments such as B-Notes and mezzanine loans. By financing these securities with long-term debt through the issuance of CDOs, we expect to generate attractive risk-adjusted equity returns and to match the term of our assets and liabilities.

CDOs are a securitization structure whereby multiple classes of debt are issued to finance a portfolio of securities. Cash flow from the portfolio of securities is used to repay the CDO liabilities sequentially, in order of seniority. The most senior classes of debt typically have credit ratings of "AAA" through "BBB−" and therefore can be issued at yields that are lower than the average yield of the securities backing the CDO. On each investment grade CDO we issue, we intend to retain the equity and the junior CDO debt securities and earn a spread between the yield on our assets and the yield on the CDO debt we issue. The equity and the junior CDO debt securities that we intend to retain are the most junior securities in the CDO's capital structure and are unrated or rated below investment grade. We also earn ongoing management fees for our management of the CDO collateral. A portion of these management fees is senior to the ‘‘AAA’’ rated debt securities of each CDO. We finance our real estate securities investments with the CDO debt we issue that initially represents approximately 93% of the value of these investments. In addition, we may also finance the junior CDO securities that we retain. The leverage level of our investment grade CDOs may vary depending on the composition of the portfolio and market conditions at the time of the issuance of each CDO. We may increase or decrease leverage on our investment grade CDOs, at securitization, upward or downward to improve returns or to manage credit risk. We may also use other capital markets techniques in addition to CDOs to finance our real estate securities portfolio.

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Prior to a new CDO issuance, there is a period during which real estate securities are identified and acquired for inclusion in a CDO. During this warehouse accumulation period, we direct the acquisition of securities by a financial institution, or the warehouse provider, that will be the lead manager of the CDO under a warehouse facility. In the warehouse arrangements we have utilized to date, the warehouse provider purchases the securities and holds them on its balance sheet. We contribute cash and other collateral which is held in escrow by the warehouse provider to back our commitment to purchase equity in the CDO and to cover our share of losses should the real estate securities need to be liquidated.

We expect to produce a stable income stream from our investments in real estate securities by carefully managing credit risk and interest rate risk. Securities are selected based on their long-term earnings potential and credit quality. Our primary objective is to derive earnings from interest income rather than trading gains. We use the real estate expertise of our management team to analyze the loans and properties backing these securities and to anticipate trends in the real estate markets.

NS Advisors LLC

One of our subsidiaries, NS Advisors LLC, manages our investment grade CDOs that have been issued and will manage our future investment grade CDOs. NS Advisors LLC earns 0.35% of the outstanding principal balance of the assets backing each of these CDO issuances as an annual management fee. NS Advisors also manages CDO IV, our subordinate real estate CDO, as discussed above. A summary of the collateral and the capital structure for each of our investment grade CDOs at December 31, 2005 is provided below.

	CDO Collateral - December 31, 2005											CDO Notes - December 31, 2005
Issuance	Date Closed		Par Value of CDO Collateral (in ’000s)		Weighted Average Interest Rate			Weighted Average Rating		Weighted Average Expected Life (years)		Outstanding CDO Notes(1) (in ’000s)		Weighted Average Interest Rate at 12/31/05(3)			Stated Maturity		Carrying Value 12/31/05(4) (in ’000s)		Carrying Value 12/31/04(4) (in ’000s)
CDO I(2)		8/21/03	$	352,041		6.62	%		BBB/BBB-		6.01	$	332,831		6.13	%		8/1/2038	$	9,792	$	10,411
CDO II		7/1/04		392,841		6.25	%		BBB/BBB-		6.65		356,170		5.58	%		6/1/2039		18,317		27,281
CDO III		3/10/05		401,790		6.06	%		BBB-		6.69		360,973		5.59	%		6/1/2040		20,085		--
CDO V		9/22/05		500,969		5.69	%		BBB		9.08		461,500		2.89	%		9/5/2045		41,860		--
Total			$	1,647,641								$	1,511,474						$	90,054	$	37,692

(1) Includes only notes held by third parties.

(2) We have an 83.33% interest in CDO I.

(3) Includes the effect of the interest rate swap held in each CDO. The weighted average interest rate for CDO V reflects the initial payment from the swap counterparty for CDO V. The effective interest rate on the CDO V Notes will increase in subsequent periods.

(4) Our potential loss in CDO I, CDO II, CDO III and CDO V is limited to the carrying value of our investment in CDO I, CDO II, CDO III and CDO V, respectively, at December 31, 2005 and 2004. Carrying value includes certain BB rated junior notes of CDO II, III and V.

CDO I, CDO II, CDO III and CDO V are variable interest entities. Unlike the other participants in these CDO issuances, who are either debt holders or swap counterparties, we, the Predecessor and the other preferred equity holders have residual interests in the net cash flow of the our CDO issuances, and therefore bear the first risk of loss. As of December 31, 2005, there had been no losses on these interests, and none of such real estate securities held by these CDOs were delinquent.

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Warehouse Agreement for CDO VII

On September 27, 2005, we entered into a warehouse arrangement with a major commercial bank whereby the bank has agreed to purchase up to $400 million of CMBS and other real estate debt securities under our direction, with the expectation of selling such securities to our fifth investment grade CDO issuances or CDO VII. As of December 31, 2005, we have deposited $10 million as security for the purpose of covering a portion of any losses or costs associated with the accumulation of these securities under the warehouse agreement and will be required to deposit additional equity based on accumulations of securities that will be made under the warehouse agreement. The bank had accumulated $156.4 million of real estate securities under the terms of the warehouse agreement as of December 31, 2005. As of March 7, 2006, the bank had accumulated $260.9 million of real estate securities under the terms of the warehouse agreement. The CDO VII warehouse agreement also provides for our notional participation in the income that the assets generate after deducting a notional debt cost.

Types of Real Estate Securities Collateralizing our Investment Grade CDOs

The various types of securities backed by real estate assets that we invest in, including CMBS, fixed income securities issued by REITs and real estate CDOs, are described in more detail below.

CMBS.    CMBS are backed by one or more loans secured by income-producing commercial and multifamily properties, or collateralized mortgage backed securities. These properties primarily consist of office buildings, retail properties, apartment buildings, industrial properties, health care properties and hotels. The properties are primarily located in the United States; although CMBS backed by properties located in Europe, Asia and other countries are a growing segment of the market. We have not yet invested in CMBS backed primarily by properties outside of the United States, but we may do so in the future. The loans are held in a trust that issues securities in the form of various classes of debt secured by the cash flows from the underlying loans. The securities issued by the trust have varying levels of priority in the allocation of cash flows from the pooled loans and are rated by one or more nationally recognized statistical rating agencies. These ratings reflect the risk characteristics of each class of CMBS and range from ‘‘AAA’’ to ‘‘CCC’’. Any losses realized on defaulted loans are absorbed first by the most junior, lowest-rated bond classes. Typically, all principal received on the loans is allocated first to the most senior outstanding class of bonds and then to the next class in order of seniority.

The portfolios of our four investment grade CDO issuances include different types of CMBS, including:

Conduit CMBS:    Conduit CMBS are backed by large pools of loans secured by first mortgages on properties owned by separate borrowers. Typically, the pool includes over 100 loans and the largest five loans together account for less than 20% of the total pool balance. The loans are also diversified by property type and location. Most loans have initial maturities of ten years, bear a fixed interest rate, and are subject to prepayment penalties or a prohibition against prepayment.

Fusion CMBS:    Fusion CMBS are similar to conduit CMBS, but have a higher percentage of the pool concentrated in one or more large loans. These large loans often have characteristics consistent with investment-grade rated securities.

Large Loan CMBS:    Large loan CMBS are typically backed by up to 20 large loans secured by first mortgages on properties owned by separate borrowers. It is typical for these individual loans to each have credit characteristics consistent with investment-grade rated securities.

Credit Tenant Lease CMBS:    These CMBS are backed by a series of loans secured by single-tenant properties. Retail property is the most prevalent asset class securing these types of loans. However, office properties and non-traditional asset classes are not uncommon in credit tenant lease CMBS.

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Single Borrower Portfolio CMBS:    These CMBS are backed by one or more cross-collateralized pools of assets owned by a single borrower. The borrowers for these types of transactions are typically of institutional quality and these securities are typically rated investment-grade.

Single Property CMBS:    This can be either an entire CMBS pool backed by a single property, or a tranche of a larger CMBS pool which is backed by a specific loan. The properties securing these loans are typically of very high quality.

Other Real Estate Securities.

REIT Fixed Income Securities:    REIT fixed income securities include both secured and unsecured debt issued by REITs. REITs own a variety of property types with a large number of companies focused on the office, retail, multifamily, industrial, healthcare and hotel sectors. In addition, several REITs focus on the ownership of self-storage properties and triple net lease properties. Certain REITs are more diversified in nature, owning properties across various asset classes. Both REIT secured and unsecured debt are typically rated by one or more nationally recognized statistical rating agencies. Currently, the majority of such notes issued by REITs are rated investment-grade. The majority of our long-term investments in REIT fixed income securities will be in REIT unsecured debt. We may also utilize credit derivatives, such as default swaps, to enhance returns or to manage our portfolio.

REIT unsecured debt is an unsecured general obligation of the issuing company and ranks equally with all existing and future unsecured and unsubordinated debt of the issuer. These notes typically pay a fixed interest rate semi-annually over their stated lives which typically range from 5 to 10 years.

Commercial Real Estate CDOs:    Commercial real estate CDOs, or CRE CDOs, are debt obligations typically collateralized by a combination of CMBS and REIT unsecured debt. CRE CDOs may also include real estate whole loans and other asset-backed securities as part of their underlying collateral, although this is not as common. A CRE CDO is a special-purpose vehicle that finances the purchase of CMBS, REIT debt and other assets by issuing rated liabilities rated by rating agencies and equity in private securities offerings.

CMBS Re-REMICS:    These securities are backed by a discrete pool of CMBS securities. These transactions are similar to CDOs, but have no interest coverage or principal coverage tests and are not managed. These pools are separated in tranches with any losses to the underlying CMBS securities first absorbed by the lowest-rated bond classes. Principal received is typically allocated to bond classes based on their level of seniority.

Financing Strategy for Real Estate Securities

As part of our financing strategy, we issue CDOs to finance discrete pools of real estate securities, and seek to match the terms of our assets and liabilities. In a CDO, the cash flow received from a portfolio of securities is applied to repaying several classes of bonds. Principal and interest payments are made sequentially starting with the most senior class of bonds. Principal payments received from the securities in the underlying pool are passed through to the CDO bonds when received, thereby creating a close match between the maturities of the assets and the CDO bonds. CDOs provide low cost financing because the most senior bond classes are rated ‘‘AAA’’ by the rating agencies. Approximately 74%, 73%, 74% and 77% of the bonds issued by CDO I, CDO II, CDO III and CDO V, respectively, were rated ‘‘AAA’’ by at least two rating agencies at the time of the initial issuance.

We may also utilize other securitization structures to provide long-term financing for our assets or we may issue CDOs that include subordinate debt or real estate debt secured by net lease properties.

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Hedging Strategy for Real Estate Securities

We use hedging techniques such as interest rate swaps, interest rate caps, short sales of securities and mortgage derivatives to manage our real estate securities portfolio's interest rate risk and to preserve a steady income stream regardless of movements in interest rates. We hedge fixed rate assets that are funded with floating rate liabilities to mitigate the potential impact of rising interest rates. The floating rate portions of the issuances of debt securities by our investment grade CDOs are each hedged with an interest rate swap for this purpose. Securities held by a bank pursuant to a warehouse agreement, which we participate in on a derivative basis, are hedged to mitigate the impact of interest rate fluctuations prior to the issuance of a CDO.

Underwriting Process for Real Estate Securities

Our underwriting process for real estate securities is focused on evaluating both the real estate risk of the underlying assets and the structural protections available to the particular class of securities in which we are investing. We believe that even when a security such as a CMBS or a REIT bond is backed by a diverse pool of properties, risk cannot be evaluated purely by statistical or quantitative means. Properties backing loans with identical debt service coverage ratios or loan-to-value ratios can have very different risk characteristics depending on their location, lease structure and physical condition. Our underwriting process seeks to identify those factors that may lead to an increase or decrease in credit quality over time.

Our underwriting process for the acquisition of real estate securities backed by a single loan or a small pool of large loans includes: (1) review of the rent roll and historical operating statements in order to evaluate the stability of the underlying property's cash flow; (2) utilization of our network of relationships with real estate investors and other professionals to identify market and sub-market trends in order to assess the property's competitive position within its market; and (3) evaluation of the loan's structural protections and intercreditor rights.

When evaluating a CMBS pool backed by large number of loans, we combine real estate analysis on individual loans with stress testing of the portfolio under various sets of default and loss assumptions. First, we identify a sample of loans in the pool which are subject to individual analysis. This sample typically includes the largest ten to fifteen loans in the pool, loans selected for risk characteristics such as low debt service coverage ratios, unusual property type or location in a weak market, and a random sample of small to medium sized loans in the pool. The loans in the sample are analyzed based on the available information, as well as any additional market or property level information that we are able to obtain. Each loan in the sample is assigned a risk rating, which affects the default assumptions for that loan in our stress test. A loan with the lowest risk rating is assumed to default and suffer a loss whereas loans with better risk ratings are assigned a lower probability of default. The stress tests we run allow us to determine whether the bond class in which we are investing would suffer a loss under the stressed assumptions. We invest only in securities in which we expect to recover our invested capital even if the underlying loans experience significant stress.

REIT securities are evaluated based on the quality, type and location of the property portfolio, the capital structure and financial ratios of the company, and management's track record, operating expertise and strategy. We also evaluate the REIT's debt covenants. Our investment decision is based on the REIT's ability to withstand financial stress, as well as more subjective criteria related to the quality of management and of the property portfolio

Net Lease Investments

Overview

Our strategy is to invest primarily in office, industrial and retail properties across the United States that are net leased to corporate tenants. Net lease properties are typically leased to a single tenant who agrees to pay basic rent, plus all taxes, insurance and operating expenses arising from the use of the leased property. We may also invest in properties that are leased to government tenants, for which we are responsible for some or all of the operating expenses. We target properties within two subsectors of the net lease market: (1) properties leased to unrated or below investment-grade corporate tenants; and (2) investments with lease terms of less than 15 years.

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We generally target properties that are located in primary or secondary markets with strong demand fundamentals, and that have a property design and location that make them suitable and attractive for alternative tenants.

We believe that most investors are primarily focused on assets leased to investment-grade tenants under leases with terms of 15 years or longer. In our experience, there is a more limited universe of acquirers with the real estate and capital markets expertise necessary to underwrite net lease assets with valuations that are more closely linked to real estate fundamentals than to tenant credit. We believe that well-located, general purpose real estate with flexible design characteristics can maintain or increase in value when re-leasing opportunities arise. By leveraging our relationships and employing our combination of skills to identify and execute asset acquisitions in sectors of the net lease market where less liquidity exists, we expect to generate risk-adjusted returns superior to those arising from more traditional net lease investment strategies. We originate net lease property investments through sellers or intermediaries structuring sale leaseback transactions and our proprietary network of property owners, corporate tenants and tenant representative brokers.

Underwriting Process for Net Lease Investments

Our ability to maximize the risk-adjusted returns available from investing capital in net lease properties will depend, in part, on our ability to underwrite and monitor tenant credit and real estate market and property fundamentals. We believe a thorough investment analysis is important to assessing the particular merits of a given investment.

We target investments in the net lease market that require particular focus on tenant credit and property-level fundamentals. We conduct detailed tenant credit analyses to assess, among other things, the potential for credit deterioration and lease default risk. This analysis is also employed to measure the adequacy of landlord protection mechanisms incorporated into the underlying lease.

Our underwriting process includes sub-market and property-level due diligence in order to understand downside investment risks, including quantifying the costs associated with tenant defaults and releasing scenarios. We model stress scenarios to understand the adequacy of important refinancing assumptions.

We incorporate the information obtained through the due diligence process into an investment memorandum, which includes base case and downside financial models to support the investment recommendations. Approval by our investment committee is required prior to funding any proposed investment.

Financing Strategy for our Net Lease Properties

We expect to finance the majority of our net lease investments at approximately 70% to 80% of the aggregate appraised value of our net lease investments on a stabilized basis. The financing typically will be non-recourse. We will seek to match the term of the financing with the term of the lease where possible.

Acquisitionsof Net Lease Properties

Chatsworth Portfolio

In January 2005, we acquired a portfolio of three net leased office properties, totaling 257,336 square feet of rentable space in Chatsworth, California for $63.5 million. The properties are 100% net leased to Washington Mutual Bank under two leases that expire in 2015.

Salt Lake City Property

In August 2005, we acquired a 117,553 square foot office building in Salt Lake City, Utah for approximately $22.0 million. This property is 100% leased to the General Services Administration under a lease that expires in 2012.

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EDS Portfolio

In September 2005, we acquired a portfolio of four office buildings with 387,842 square feet of rentable space for $61.4 million. The four buildings comprising the EDS portfolio, which are located in Rancho Cordova, California, Auburn Hills, Michigan and Camp Hill, Pennsylvania, were leased to EDS under leases expiring in 2015.

Executive Centre Portfolio

In December 2005, we acquired a portfolio of three class A office buildings, located in Cincinnati, Ohio, with 486,963 square feet of rentable space for $68.5 million. Two of the properties are 100% and 96% leased to General Electric Company under leases expiring in 2009 and 2010. The remaining building is leased 100% to Cincom Systems, Inc. under a lease that expires in 2011.

Quantum Joint Venture

In February 2006, through a 50% owned joint venture interest with Cushman & Wakefield Net Lease Trust, we acquired a portfolio of three adjacent class A office/flex buildings located Colorado Springs, CO, with 406,204 square feet of rentable space for $54.25 million. The properties are 100% leased to Quantum Corp. under leases expiring in 2021 (59%), 2013 (11%), 2011 (13%) and 2009 (17%).

Dispositions of Net Lease Properties

On June 30, 2005, we sold our fee interest in a 19,618 square foot retail condominium unit located at 729 Seventh Avenue in New York City for $29.0 million, or $1,478 per square foot, to an affiliate of The Riese Organization's Restaurant Division, National Restaurants Management Inc, or NRMI, and Himmel + Meringoff Properties. In connection with the sale, 729 7th Realty Corp., an affiliate of NRMI, agreed to discontinue the legal action that it had brought against us, settling our only material pending legal action.

On November 30, 2005, we sold our fee interest in a net lease property located at 1552 Broadway in New York City to NRMI, for a purchase price of $48 million, or $3,970 per square foot. The four-story, 12,091 square foot building is located at the corner of Broadway and West 46th Street in Times Square.

On January 31, 2006, the Company sold its leasehold interests in 25-27 West 34^th and 1372 Broadway, both of which are located in New York City, for $2.3 million.

Stock Offering

Stock Offering

In December 2005, we closed a public offering of 9.2 million common shares at $9.25 per share, which included 1.2 million shares to cover the underwriters’ over-allotment. Net proceeds from the offering were approximately $79 million. The proceeds from the offering were used to pay down short term debt and to fund new investments.

Financing

Mortgages

Chatsworth Mortgage

In connection with the acquisition of the Chatsworth Portfolio, we entered into a loan agreement (the "Chatsworth Mortgage") for a non-recourse mortgage in the principal amount of $44.0 million. The Chatsworth Mortgage matures on May 1, 2015 and bears interest at a fixed rate of 5.65%. The Chatsworth Mortgage requires monthly payments of $230,906 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $40.5 million at maturity, as well as monthly escrow deposits for ground lease payments required under the ground lease for the leasehold property. The Chatsworth Mortgage is secured by first mortgage liens and security interests on the Chatsworth Portfolio, including two fee owned properties and the leasehold interest in the other property, including assignments of leases and rents.

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Salt Lake City Mortgage

In connection with the acquisition of the Salt Lake City property, we entered into a loan agreement (the "Salt Lake City Mortgage") for a non-recourse mortgage in the principal amount of $17.0 million. The Salt Lake City Mortgage matures on September 1, 2012 and bears interest at a fixed rate of 5.16%. This loan requires monthly payments of $100,971 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $14.3 million at maturity, as well as monthly escrow deposits for real estate taxes.

EDS Mortgage

In connection with the acquisition of the EDS portfolio, we entered into a loan agreement (the “EDS mortgage”) for a non-recourse mortgage in the principal amount of $49.1 million. The EDS mortgage matures on October 8, 2015 and bears interest at a fixed rate of 5.37%. The loan requires monthly payments of $274,997 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $41.91 million at maturity, as well as monthly escrow deposits for real estate taxes.

Executive Centre Mortgage

In connection with the acquisition of the Executive Centre portfolio we entered into a $51.5 million mortgage that matures on January 1, 2016 and bears interest at a fixed rate of 5.851%. This non-recourse loan requires monthly payments of $303,732 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $48.1 million at maturity, as well as monthly escrow deposits for real estate taxes.

Mezzanine Loan

In connection with the acquisition of the Chatsworth Properties, we entered into a non-recourse mezzanine loan agreement (the "Chatsworth Mezzanine Loan") which was assigned to, then funded by, the warehouse provider for CDO III (the "Chatsworth Mezzanine Lender") for a mezzanine loan in the principal amount of $13.0 million. The Chatsworth Mezzanine Loan bears interest at a fixed rate of 6.64%, and requires monthly payments of interest only of $71,955 for the period February 1, 2005 through February 1, 2006. Principal and interest payments of $170,914 are due thereafter, which will fully amortize the Chatsworth Mezzanine Loan by maturity, May 1, 2014. The Chatsworth Mezzanine Loan is secured by a pledge of our equity interest in an affiliate of the borrower of the Chatsworth Mortgage. The Chatsworth Mezzanine Loan currently constitutes a portion of the portfolio of securities owned by CDO III.

Unsecured Credit Facility

On September 28, 2005, we entered into a master loan, guarantee and security agreement with Bank of America, N.A., through our Operating Partnership and NS Advisors LLC (the "BOA Master Loan Agreement"). The BOA Master Loan Agreement provides for an unsecured, $50 million revolving credit facility. The term of the unsecured facility is one year, with up to two one-year extensions at the discretion of Bank of America. If the unsecured facility is not extended by Bank of America, we have the option in lieu of immediate repayment to amortize the outstanding principal balance of the unsecured facility in equal quarterly installments over twelve months, upon payment of a quarterly 12.5 basis point fee on the outstanding balance under the unsecured facility at September 27, 2006 and each quarter thereafter. The interest rate on the unsecured facility is LIBOR, plus 325 basis points. In connection with the facility the Company paid an origination fee of 0.50% and, in addition, must pay an unused facility fee equal to 0.50% of the unused portion of the facility.

Trust Preferred Private Placements

On April 12, 2005 and May 25, 2005, NorthStar Realty Finance Trust and NorthStar Realty Finance Trust II, (the "Trusts") sold, in two private placements, trust preferred securities for an aggregate amount of $40 million and $25 million, respectively. We own all of the common stock of the Trusts. The Trusts used the proceeds to purchase our junior subordinated notes which mature on March 30, 2035 and June 30, 2035, respectively. These notes represent all of the Trusts' assets. The terms of the junior subordinated notes are substantially the same as the terms of the trust preferred securities. The trust preferred securities have a fixed interest rate of 8.15% and 7.74% per annum, respectively, during the first ten years, after which the interest rate will float and reset quarterly at the three-month LIBOR rate plus 3.25% per annum.

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On November 22, 2005 we completed our third private placement of $40 million of trust preferred securities through our subsidiary, NorthStar Realty Finance Trust III. The proceeds were used to repay $32 million of short term debt and to fund new investments. These trust preferred securities have a 30-year term, ending January 30, 2036. They bear interest at a fixed rate of 7.81% for the first ten years, ending January 2016, whereupon the rate floats at three-month LIBOR plus 2.83%. These securities are redeemable at par beginning on January 30, 2011.

On March 10, 2006, our subsidiary, NorthStar Realty Finance Trust IV, completed a private placement of $50 million of trust preferred securities. The sole assets of the trust consist of a like amount of junior subordinated notes due June 30, 2036 issued by our operating partnership and guaranteed by us.  The proceeds of the issuance of the notes were used to repay short term debt and to fund new investments. These trust preferred securities and the notes both have a 30-year term, ending June 30, 2036, and bear interest at a fixed rate of 7.95% for the first ten years, ending June 2016, whereupon the rate floats at three-month LIBOR plus 2.80%. These securities are redeemable at par beginning on June 30, 2011.

Regulatory Aspects of Our Investment Strategy

We conduct our operations so that we are not required to register as an investment company under the Investment Company Act of 1940, as amended. Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting, or trading in securities. Because we hold our securities and are not primarily in the business of investing, reinvesting and trading in securities, we do not believe we are subject to regulation as an investment company under Section 3(a)(1)(A). Section 3(a)(1)(C) of the Investment Company Act defines as an investment company any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer's total assets (exclusive of government securities and cash items) on an unconsolidated basis. Excluded from the term "investment securities," among other things, are U.S. government securities and securities issued by majority owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. This means that the securities issued by our majority owned subsidiaries that are excepted from the definition of "investment company" in Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis. This requirement limits the types of businesses in which we may engage through these subsidiaries.

A majority of our subsidiaries rely on exceptions and exemptions from the Investment Company Act. These exceptions and exemptions limit the types of assets these subsidiaries may purchase. For instance, CDO II, CDO III and CDO V rely on the exemption from the Investment Company Act provided by Rule 3a-7 thereunder, which is available for certain structured financing vehicles. This exemption limits the ability of these CDOs to sell their assets and reinvest the proceeds from asset sales. Our subsidiary that invests in net lease properties relies on the exception from the definition of "investment company" provided by Sections 3(c)(6) and 3(c)(5)(C) of the Investment Company Act, and CDO IV similarly relies on the 3(c)(5)(C) exception from the definition of "investment company". These exceptions except companies that primarily invest in real estate, mortgages and certain other qualifying real estate assets. Relying on the exception from the definition of "investment company" provided by Section 3(c)(5)(C) of the Investment Company Act, CDO IV is limited in the types of real estate related assets that it could invest in. We believe that neither our operating partnership nor the subsidiary REIT through which we hold the substantial majority of our investments are investment companies because each of them satisfy the 40% test of Section 3(a)(1)(C). We must monitor their holdings to ensure that the value of their investment securities does not exceed 40% of their respective total assets (exclusive of government securities and cash items) on an unconsolidated basis. Our subsidiaries that engage in operating businesses are not subject to the Investment Company Act.

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If the combined value of the investment securities issued by our subsidiaries that are excepted by Sections 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own, exceeds 40% of our total assets on an unconsolidated basis, we may be deemed to be an investment company. If our subsidiaries fail to maintain their exceptions or exemptions from the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration and other matters.

In addition to the foregoing, we believe that we should be able to rely on additional exemptions under the Investment Company Act.

Government Regulations

Many laws and governmental regulations are applicable to our investments and changes in these laws and regulations, or their interpretation by agencies and courts, occur frequently.

Americans with Disabilities Act

Under the American with Disabilities Act, or ADA, all public accommodations and commercial facilities are required to meet certain federal requirements related to access and use by disabled persons. These requirements became effective in 1992. Compliance with the ADA requirements could require removal of access barriers, and noncompliance could result in the imposition of fines by the federal government or an award of damages to private litigants. Although we believe that our properties are substantially in compliance with these requirements, we may incur additional costs to comply with the ADA. In addition, a number of additional federal, state and local laws may require us to modify any properties we purchase, or may restrict further renovations thereof, with respect to access by disabled persons. Additional legislation could impose financial obligations or restrictions with respect to access by disabled persons. Although we believe that such costs will not have a material adverse effect on us, if required changes involve a greater amount of expenditures than we currently anticipate, our ability to make expected distributions could be adversely affected.

Environmental Matters

Under various federal, state and local laws, ordinances and regulations relating to the protection of the environment, a current or previous owner or operator of real property may be held liable for the costs of removal or remediation of certain hazardous or toxic substances or petroleum product releases at such property. These laws often impose clean-up responsibility and liability without regard to whether the owner or operator was responsible for, or even knew of, the presence of such hazardous or toxic substances. The costs of investigation, removal or remediation of such substances may be substantial, and the presence of such substances may adversely affect our ability to rent or sell the property or to borrow using such property as collateral and may expose us to liability resulting from any release of or exposure to such substances. If we arrange for the disposal or treatment of hazardous or toxic substances at another location, we may be liable for the costs of removal or remediation of such substances at the disposal or treatment facility, whether or not such facility is owned or operated by us. We may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site that we own or operate. Certain environmental laws also impose liability in connection with the handling of or exposure to asbestos-containing materials, pursuant to which third parties may seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials and other hazardous or toxic substances. In connection with the ownership (direct or indirect), operation, management and development of real properties, we may be considered an owner or operator of such properties or as having arranged for the disposal or treatment of hazardous or toxic substances and therefore potentially liable for removal or remediation costs, as well as certain other related costs, including governmental penalties and injuries to persons and property.

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We believe that each of our properties are in compliance in all material respects with all federal, state and local laws, ordinances and regulations regarding hazardous or toxic substances. We have not been notified by any governmental authority, or are otherwise aware, of any material noncompliance, liability or claim relating to hazardous or toxic substances in connection with any of these properties. We are not aware of any environmental liabilities relating to our properties that would reasonably expect to have a material adverse effect on our financial condition or results of operations taken as a whole, nor are we aware of any such material environmental liability. However, it is possible that there are material environmental liabilities of which we are unaware. There can be no assurance that future laws, ordinances or regulations will not impose any material environmental liability or the current environmental condition of the properties will not be affected by tenants, by the condition of land or operations in the vicinity of the properties (such as the presence of underground storage tanks) or by third parties unrelated to us. If compliance with the various laws and regulations, now existing or hereafter adopted, exceeds our budgets for such items, our ability to make expected distributions to stockholders could be adversely affected.

Other Regulations

The net lease properties we own are also subject to various federal, state and local regulatory requirements, such as zoning and state and local fire and life safety requirements. Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. We believe that the properties are in material compliance with all such regulatory requirements. However, there can be no assurance that these requirements will not be changed or that new requirements will not be imposed which would require significant unanticipated expenditures by us and could have an adverse effect on our financial condition. Except as described in this report, we are not aware of any other laws or regulations that have a material effect on our operations, other than typical state and local laws affecting the development and operation of real property, such as zoning laws.

Competition

We are subject to significant competition in seeking real estate investments. We compete with many third parties engaged in real estate investment activities including other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, lenders, governmental bodies and other entities. In addition, there are other REITs with asset acquisition objectives similar to ours and others may be organized in the future. Some of these competitors, including larger REITs, have substantially greater financial resources than we do and generally may be able to accept more risk. They may also enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies.

Competition may limit the number of suitable investment opportunities offered to us. It may also result in higher prices, lower yields and a narrower spread of yields over our borrowing costs, making it more difficult for us to acquire new investments on attractive terms.

Employees

At December 31, 2005, we have 23 employees.

Corporate Governance and Internet Address

We emphasize the importance of professional business conduct and ethics through our corporate governance initiatives. Our board of directors consists of a majority of independent directors; the audit, nominating/corporate governance, and compensation committees of our board of directors are composed exclusively of independent directors. We have adopted corporate governance guidelines and a code of business conduct and ethics, which delineate our standards for our officers, directors and employees.

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Our internet address is www.nrfc.com. We make available, free of charge through a link on our site, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports, if any, as filed with the SEC as soon as reasonably practicable after such filing. Our site also contains our code of business conduct and ethics, code of ethics for senior financial officers, corporate governance guidelines, and the charters of our audit committee, nominating/corporate governance committee and compensation committee of our board of directors. Within the time period required by the rules of the SEC and the NYSE, we will post on our website any amendment to our code of business conduct and ethics and our code of ethics for senior financial officers as defined in the code.

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ITEM 1a.RISK FACTORS 

This section describes risk factors that could have a material adverse effect on our operations and future prospects. The risk factors set forth in this section could cause our actual results to differ significantly from those contained in this Annual Report on Form 10-K. In connection with the forward-looking statements that appear in this Annual Report on Form 10-K, you should carefully review the factors discussed below and the cautionary statements referred to under " Forward-Looking Statements."

Risks Related to Our Investments

The subordinate mortgage notes, mezzanine loans and participation interests in mortgage and mezzanine loans we invest in may be subject to risks relating to the structure and terms of the transactions, as well as subordination in bankruptcy, and there may not be sufficient funds or assets remaining to satisfy our subordinate notes, which may result in losses to us.

We invest in subordinate mortgage notes, mezzanine loans and participation interests in mortgage and mezzanine loans. These investments are subordinate to first mortgages on commercial property and are secured by subordinate rights to the commercial property or by equity interests in the commercial entity. If a borrower defaults or declares bankruptcy, after senior obligations are met, there may not be sufficient funds or assets remaining to satisfy our subordinate notes. Because each transaction is privately negotiated, subordinate mortgage notes can vary in their structural characteristics and lender rights. Our rights to control the default or bankruptcy process following a default will vary from transaction to transaction. The subordinate real estate debt that we intend to invest in may not give us the right to demand foreclosure as a subordinate real estate debtholder. Furthermore, the presence of intercreditor agreements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies and control decisions made in bankruptcy proceedings relating to borrowers. Bankruptcy and borrower litigation can significantly increase the time needed for us to acquire underlying collateral in the event of a default, during which time the collateral may decline in value. In addition, there are significant costs and delays associated with the foreclosure process.

We invest in subordinate mortgage-backed securities which are subject to a greater risk of loss than senior securities. We may hold the most junior class of mortgage-backed securities which are subject to the first risk of loss if any losses are realized on the underlying mortgage loans.

We invest in a variety of subordinate mortgage-backed securities and sometimes hold a "first loss" subordinate holder position. The ability of a borrower to make payments on the loan underlying these securities is dependent primarily upon the successful operation of the property rather than upon the existence of independent income or assets of the borrower. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit and any classes of securities junior to those in which we invest, we will not be able to recover all of our investment in the securities we purchase.

Expenses of enforcing the underlying mortgage loans (including litigation expenses), expenses of protecting the properties securing the mortgage loans and the lien on the mortgaged properties, and, if such expenses are advanced by the servicer of the mortgage loans, interest on such advances will also be allocated to such "first loss" securities prior to allocation to more senior classes of securities issued in the securitization. Prior to the reduction of distributions to more senior securities, distributions to the "first loss" securities may also be reduced by payments of compensation to any servicer engaged to enforce a defaulted mortgage loan. Such expenses and servicing compensation may be substantial and consequently, in the event of a default or loss on one or more mortgage loans contained in a securitization, we may not recover our investment.

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Our investments in REIT securities are subject to risks relating to the particular REIT issuer of the securities and to the general risks of investing in senior unsecured real estate securities, which may result in losses to us.

In addition to general economic and market risks, our investments in REIT securities involve special risks relating to the particular REIT issuer of the securities, including the financial condition and business outlook of the issuer. REITs generally are required to substantially invest in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments.

Our investments in REIT securities and other senior unsecured debt are also subject to the risks described above with respect to mortgage loans and mortgage-backed securities and similar risks, including:

• risks of delinquency and foreclosure;

• the dependence upon the successful operation of and net income from real property;

• risks generally related to interests in real property; and

• risks that may be presented by the type and use of a particular commercial property.

REIT securities are generally unsecured and may also be subordinate to other obligations of the issuer. We may also invest in REIT securities that are rated below investment-grade. As a result, investments in REIT securities are also subject to risks of:

· limited liquidity in the secondary trading market;

· substantial market price volatility resulting from changes in prevailing interest rates;

· subordination to the prior claims of banks and other senior lenders to the REIT;

· the operation of mandatory sinking fund or redemption provisions during periods of declining interest rates that could cause the issuer to reinvest premature redemption proceeds in lower yielding assets;

· the possibility that earnings of the REIT may be insufficient to meet its debt service and distribution obligations; and

· the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic downturns.

These risks may adversely affect the value of outstanding REIT securities and the ability of the issuers thereof to repay principal and interest or make distributions.

The mortgage loans we invest in and the mortgage loans underlying the mortgage-backed securities we invest in are subject to risks of delinquency, foreclosure, loss and bankruptcy of the borrower under the loan. If the borrower defaults, it may result in losses to us.

Commercial mortgage loans are secured by commercial property and are subject to risks of delinquency, foreclosure, loss and bankruptcy of the borrower. The ability of a borrower to repay a loan secured by an income-producing property is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things:

• tenant mix;

• success of tenant businesses;

• property management decisions;

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• property location and condition;

• competition from comparable types of properties;

• changes in laws that increase operating expense or limit rents that may be charged;

• any need to address environmental contamination at the property;

• the occurrence of any uninsured casualty at the property;

• changes in national, regional or local economic conditions and/or specific industry segments;

• declines in regional or local real estate values;

• declines in regional or local rental or occupancy rates;

• increases in interest rates;

• real estate tax rates and other operating expenses; and

• terrorism.

Any one or a combination of these factors may cause a borrower to default on a loan or to declare bankruptcy. If a default or bankruptcy occurs and the underlying asset value is less than the loan amount, we will suffer a loss.

We are subject to significant competition, and we may not be able to compete successfully for investments.

We are subject to significant competition for attractive investment opportunities from other real estate investors, some of which have greater financial resources than us, including publicly traded REITs, private REITs, investment banking firms, private institutional funds and private opportunity funds. We may not be able to compete successfully for investments.

Many of our investments are illiquid, and we may not be able to vary our portfolio in response to changes in economic and other conditions, which may result in losses to us.

Our investments are relatively illiquid and, therefore, our ability to sell and purchase properties, securities and debt promptly in response to a change in economic or other conditions will be limited. The Internal Revenue Code also places limits on our ability to sell properties held for fewer than four years. These considerations could make it difficult for us to dispose of properties, even if a disposition were in the best interests of our stockholders. In addition, a majority of the mortgage-backed securities, REIT securities and real estate debt that we purchase in connection with privately negotiated transactions will not be registered under the relevant securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in compliance with, those laws. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which may result in losses to us.

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We may not be able to acquire eligible securities for a CDO issuance, or may not be able to issue CDO securities on attractive terms, which may require us to seek more costly financing for our real estate securities investments or to liquidate assets.

We acquire investment grade real estate securities and finance them on a long-term basis through the issuance of CDOs. Prior to a new investment grade CDO issuance, there is a period during which real estate securities are identified and acquired for inclusion in a CDO, known as the warehouse accumulation period. During this period, we direct the acquisition of securities under a warehouse facility from a warehouse provider that will be the lead manager of the CDO. The warehouse provider then purchases the securities and holds them on its balance sheet. We contribute cash and other collateral which is held in escrow by the warehouse provider to back our commitment to purchase equity in the investment grade CDO and to cover our share of losses should securities need to be liquidated. As a result, we are subject to the risk that we will not be able to acquire, during the period that our warehouse facility is available, a sufficient amount of eligible securities to maximize the efficiency of a CDO issuance. In addition, conditions in the capital markets may make the issuance of a CDO less attractive to us when we do have a sufficient pool of collateral. If we are unable to issue a CDO to finance these assets or if doing so is not economical, we may be required to seek other forms of potentially less attractive financing or to liquidate the assets at a price that could result in a loss of all or a portion of the cash and other collateral backing our purchase commitment.

Our warehouse facilities and our CDO financing agreements may limit our ability to make investments.

In order for us to borrow money to make investments under our warehouse facilities, our warehouse providers have the right to review the potential investment for which we are seeking financing. We may be unable to obtain the consent of our warehouse providers to make investments that we believe are favorable to us. In the event that our warehouse providers do not consent to the inclusion of the potential asset in the warehouse facility, we may be unable to obtain alternate financing for that investment. Our warehouse provider's consent rights with respect to our warehouse facility may limit our ability to execute our business strategy.

In addition, each CDO financing that we engage in will contain certain eligibility criteria with respect to the collateral that we seek to acquire and sell to the CDO issuer. If the collateral does not meet the eligibility criteria for eligible collateral as set forth in the transaction documents of such CDO transaction, we may not be able to acquire and sell such collateral to the CDO issuer. The inability of the collateral to meet eligibility requirements with respect to our CDOs may limit our ability to execute our business strategy.

Our future investment grade CDOs will be collateralized with real estate securities that are similar to those collateralizing our four existing investment grade CDO issuances, and any adverse market trends that affect these types of real estate securities are likely to adversely affect our CDOs in general.

Our existing investment grade CDO issuances are collateralized by fixed and floating rate CMBS, REIT debt and real estate CDOs, and we expect that our future issuances will be backed by similar securities. Any adverse market trends that affect the value of these types of securities will adversely impact the value of our interests in our CDOs. Such trends could include declines in real estate values in certain geographic markets or sectors, underperformance of CMBS issued in a particular year, or changes in federal income tax laws that could affect the performance of debt issued by REITs.

We may make investments in non-U.S. dollar denominated securities, which will be subject to currency rate exposure and the uncertainty of foreign laws and markets, which may adversely impact our returns on non-dollar denominated investments.

We may purchase CMBS denominated in foreign currencies. We expect that our exposure, if any, would be principally to the British pound and the euro. A change in foreign currency exchange rates may adversely impact returns on our non-dollar denominated investments. We may hedge our foreign currency risk, subject to the REIT income qualification tests. However, we may not be able to do so successfully and may incur losses on these investments as a result of exchange rate fluctuations.

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We may make investments in assets with lower credit quality, which will increase our risk of losses.

We may invest in unrated securities, enter into net leases with unrated tenants or participate in unrated or distressed mortgage loans. A projection of an economic downturn, for example, could cause a decline in the price of lower credit quality investments and securities because the ability of obligors of net leases and mortgages, including mortgages underlying mortgage-backed securities, to make rent or principal and interest payments may be impaired. If this were to occur, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these investments and securities. We have not established and do not plan to establish any investment criteria to limit our exposure to these risks for future investments.

We have no established investment criteria limiting the geographic concentration of our investments in real estate debt, real estate securities or net lease properties. If our investments are concentrated in an area that experiences adverse economic conditions, our investments may lose value and we may experience losses.

Certain loans and securities in which we invest may be secured by a single property or properties in one geographic location. We hold leasehold interests in a portfolio of retail and commercial properties located in New York City. We also own a portfolio of three net leased commercial properties in Chatsworth, California. Net lease properties that we may acquire may also be located in New York City or may otherwise be located in a geographic cluster. These current and future investments carry the risks associated with significant geographical concentration. We have not established and do not plan to establish any investment criteria to limit our exposure to these risks for future investments. As a result, properties underlying our investments may be overly concentrated in certain geographic areas, and we may experience losses as a result. A worsening of economic conditions in the geographic area in which our investments may be concentrated could have an adverse effect on our business, including reducing the demand for new financings, limiting the ability of customers to pay financed amounts and impairing the value of our collateral.

Our rights to the collateral underlying securities in which we invest may be unenforceable.

Loans underlying the securities in which we invest are governed by written loan agreements and related documentation. It is possible that a court could determine that one or more provisions of a loan agreement are unenforceable, such as a loan prepayment provision or the provisions governing our security interest in the underlying collateral. If this were to happen with respect to material assets or groups of assets serving as collateral for the securities in which we invest, we could be adversely affected.

Interest rate fluctuations may reduce the spread we earn on our interest-earning investments and may reduce our net income.

Market risk is the exposure to loss resulting from changes in interest rates and equity prices. Although we seek to finance our assets on a match-funded basis and mitigate the risk associated with future interest rate volatility, we are subject to credit risk and interest rate risk with respect to our investments in real estate debt and real estate securities. The primary market risk that we are exposed to is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.

Our interest rate risk sensitive assets, liabilities and related derivative positions are generally held for non-trading purposes. As of December 31, 2005, a hypothetical 100 basis point increase in interest rates applied to our variable rate assets would increase our annual interest income by approximately $6,888,000, offset by an increase in our interest expense of approximately $5,430,000 on our variable rate liabilities. Similarly, a hypothetical 100 basis point decrease in interest rates would decrease our annual interest income by the same net amount.

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Our investments in real estate securities, mortgage notes, mezzanine loans and participation interests in mortgage and mezzanine loans are subject to changes in credit spreads and if spreads widen, the value of our loan and securities portfolios would decline.

Our investments in real estate securities are subject to changes in credit spreads. The value of these securities is dependent upon the yield demanded on these securities by the market based on the underlying credit. Excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these real estate securities, resulting in the use of a higher, or "wider," spread over the benchmark rate to value such securities. Under such conditions, the value of our securities portfolio would tend to decline. Such changes in the market value of our portfolio may adversely affect our net equity or cash flow directly through their impact on unrealized gains or losses on available-for-sale securities, and therefore our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.

The value of our investments in mortgage loans, mezzanine loans and participation interests in mortgage and mezzanine loans are also subject to changes in credit spreads. The majority of the loans we invest in are floating rate loans valued based on a market credit spread to LIBOR. The value of the loans is dependent upon the yield demanded by the market based on their credit. The value of our portfolio would tend to decline should the market require a higher yield on such loans, resulting in the use of a higher spread over the benchmark rate. Any credit or spread losses incurred with respect to our loan portfolio would affect us in the same way as similar losses on our real estate securities portfolio as described above.

Our hedging transactions may limit our gains or result in losses.

To limit the effects of changes in interest rates on our operations, we may employ hedging strategies, including engaging in interest rate swaps, caps, floors and other interest rate exchange contracts as well as engaging in short sales of securities or of future contracts. The use of these types of derivatives to hedge our assets and liabilities carries certain risks, including the risks that:

•  losses on a hedge position will reduce the cash available for distribution to stockholders;

•  losses may exceed the amount invested in such instruments;

•  a hedge may not perform its intended use of offsetting losses on an investment;

•  the counterparties with which we trade may cease making markets and quoting prices in such instruments, which may render us unable to enter into an offsetting transaction with respect to an open position; and

•  the counterparties with which we trade may experience business failures, which would most likely result in a default. Default by such counterparty may result in the loss of unrealized profits, which were expected to offset losses on our assets. Such defaults may also result in a loss of income on swaps or caps, which income was expected to be available to cover our debt service payments.

Our board of directors adopted a general policy with respect to the use of derivatives which generally allows us to use derivatives where appropriate, but does not set forth specific policies and procedures. Our results of operations may be adversely affected during any period as a result of the use of derivatives. If we anticipate that the income from any such hedging transaction will not be qualifying income for REIT income test purposes, we may conduct some or all of our hedging activities through a to-be-formed corporate subsidiary that is fully subject to federal corporate income taxation.

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Prepayment rates can increase, adversely affecting yields on our investments.

The value of our assets may be affected by prepayment rates on mortgage loans underlying the securities in which we intend to invest. Prepayment rates on mortgage loans are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of declining mortgage interest rates, prepayments on mortgage loans generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the yields on the assets that were prepaid. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain investments.

Investments in net lease properties may generate losses.

The value of our investments and the income from our investments in net lease properties may be significantly adversely affected by a number of factors, including:

•  national, state and local economic climates;

•  real estate conditions, such as an oversupply of or a reduction in demand for real estate space in the area;

•  the perceptions of tenants and prospective tenants of the convenience, attractiveness and safety of our properties;

•  competition from comparable properties;

•  the occupancy rate of our properties;

•  the ability to collect on a timely basis all rent from tenants;

•  the effects of any bankruptcies or insolvencies of major tenants;

•  the expense of re-leasing space;

•  changes in interest rates and in the availability, cost and terms of mortgage funding;

•  the impact of present or future environmental legislation and compliance with environmental laws;

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•  cost of compliance with the American with Disabilities Act of 1990, or ADA;

•  adverse changes in governmental rules and fiscal policies;

•  civil unrest;

•  acts of nature, including earthquakes, hurricanes and other natural disasters (which may result in uninsured losses);

•  acts of terrorism or war;

•  adverse changes in zoning laws; and

•  other factors which are beyond our control.

We may not be able to relet or renew leases at the properties held by us on terms favorable to us.

We are subject to the risks that upon expiration of leases for space located at our properties the space may not be relet or, if relet, the terms of the renewal or reletting (including the cost of required renovations or concessions to tenants) may be less favorable than current lease terms. Any of these situations may result in extended periods where there is a significant decline in revenues or no revenues generated by a property. If we are unable to relet or renew leases for all or substantially all of the space at these properties, if the rental rates upon such renewal or reletting are significantly lower than expected, or if our reserves for these purposes prove inadequate, we may be required to reduce or eliminate distributions to our stockholders.

Lease defaults or terminations or landlord-tenant disputes may adversely reduce our income from our net lease property portfolio.

Lease defaults or terminations by one or more of our significant tenants may reduce our revenues unless a default is cured or a suitable replacement tenant is found promptly. In addition, disputes may arise between the landlord and tenant that result in the tenant withholding rent payments, possibly for an extended period. These disputes may lead to litigation or other legal procedures to secure payment of the rent withheld or to evict the tenant. Any of these situations may result in extended periods during which there is a significant decline in revenues or no revenues generated by a property. If this were to occur, it could adversely affect our results of operations.

Environmental compliance costs and liabilities associated with our properties or our real estate related investments may materially impair the value of our investments.

Under various federal, state and local laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up certain hazardous substances released at the property, and may be held liable to a governmental entity or to third parties for property damage and for investigation and cleanup costs incurred by such parties in connection with the contamination. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs it incurs in connection with the contamination. The presence of contamination or the failure to remediate contamination may adversely affect the owner's ability to sell or lease real estate or to borrow using the real estate as collateral. The owner or operator of a site may be liable under common law to third parties for damages and injuries resulting from environmental contamination emanating from the site. We may experience environmental liability arising from conditions not known to us.

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We may invest in real estate, or mortgage loans secured by real estate, with environmental problems that materially impair the value of the real estate. There are substantial risks associated with such an investment. We have only limited experience in investing in real estate with environmental liabilities.

Our insurance on our real estate may not cover all losses.

There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. Any uninsured loss could result in both loss of cash flow from and the asset value of the affected property.

As a result of the events of September 11, 2001, insurance companies are limiting and charging significant premiums to cover acts of terrorism in insurance policies. As a result, although we, our tenants or our borrowers generally carry terrorism insurance, we may suffer losses from acts of terrorism that are not covered by insurance. In addition, the mortgage loans which are secured by certain of our properties contain customary covenants, including covenants that require us to maintain property insurance in an amount equal to the replacement cost of the properties, which may increase the cost of obtaining the required insurance.

We may change our investment strategy without stockholder consent and make riskier investments.

We may change our investment strategy at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this Form 10-K. A change in our investment strategy may increase our exposure to interest rate and real estate market fluctuations.

Our portfolio is leveraged, which may adversely affect our return on our investments and may reduce cash available for distribution.

We leverage our portfolio through borrowings, generally through the use of bank credit facilities, repurchase agreements, mortgage loans on real estate, securitizations, including the issuance of CDOs, and other borrowings. The type and percentage of leverage varies depending on our ability to obtain credit facilities and the lender's estimate of the stability of the portfolio's cash flow. However, we do not restrict the amount of indebtedness that we may incur. Our return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that can be derived from the assets acquired. Moreover, we may have to incur more recourse indebtedness.

The repurchase agreements and bank credit facilities that we use to finance our investments may require us to provide additional collateral.

We use bank credit facilities, including repurchase agreements, to finance some of our investments, primarily on an interim basis. If the market value of the loans pledged or sold by us to a funding source decline in value, we may be required by the lending institution to provide additional collateral or pay down a portion of the funds advanced. We may not have the funds available to pay down our debt, which could result in defaults. Posting additional collateral to support our credit facilities will reduce our liquidity and limit our ability to leverage our assets. In the event we do not have sufficient liquidity to meet such requirements, lending institutions can accelerate our indebtedness, increase interest rates and terminate our ability to borrow. Such a situation would likely result in a rapid deterioration of our financial condition and solvency.

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Further, our credit facility providers require us to maintain a certain amount of cash uninvested or set aside unlevered assets sufficient to maintain a specified liquidity position in order to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.

Lenders may require us to enter into restrictive covenants relating to our operations.

When we obtain financing, lenders impose restrictions on us that affect our ability to incur additional debt, our capability to make distributions to stockholders and our flexibility to determine our operating policies. Loan documents we execute may contain negative covenants that limit, among other things, our ability to repurchase stock, distribute more than a certain amount of our funds from operations, and employ leverage beyond certain amounts, any of which may limit our operating flexibility.

The use of CDO financings with coverage tests may have a negative impact on our operating results and cash flows.

We have purchased, and expect to purchase in the future, subordinate classes of bonds in our CDO financings. The terms of the CDO securities issued by us include and will include coverage tests, including over-collateralization tests, which are used primarily to determine whether and to what extent principal and interest proceeds on the underlying collateral debt securities and other assets may be used to pay principal of and interest on the subordinate classes of bonds in the CDO. In the event the coverage tests are not satisfied, interest and principal that would otherwise be payable on the subordinate classes may be re-directed to pay principal on the senior bond classes. Therefore, our failure to satisfy the coverage tests could adversely affect our operating results and cash flows.

Certain coverage tests (based on delinquency levels or other criteria) may also restrict our ability to receive net income from assets pledged to secure the CDOs. We cannot assure you, in advance of completing negotiations with the rating agencies or other key transaction parties on any future CDOs, the actual terms of the delinquency tests, over-collateralization terms, cash flow release mechanisms or other significant factors regarding the calculation of net income to us. Failure to obtain favorable terms with regard to these matters may materially and adversely affect the availability of net income to us. If our assets fail to perform as anticipated, our over-collateralization or other credit enhancement expense associated with our CDOs will increase.

Our due diligence may not reveal all of a borrower's liabilities and may not reveal other weaknesses in its business.

Before making a loan to a borrower, we assess the strength and skills of such entity's management and other factors that we believe are material to the performance of the investment. This process is particularly important and subjective with respect to newly organized entities because there may be little or no information publicly available about the entities. In making the assessment and otherwise conducting customary due diligence, we rely on the resources available to us and, in some cases, an investigation by third parties. There can be no assurance that our due diligence processes will uncover all relevant facts or that any investment will be successful.

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Credit ratings assigned to our investments are subject to ongoing evaluations and we cannot assure you that the ratings currently assigned to our investments will not be downgraded.

Some of our investments are rated by Moody's Investors Service, Fitch Ratings or Standard & Poor's, Inc. The credit ratings on these investments are subject to ongoing evaluation by credit rating agencies, and we cannot assure you that any such rating will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. If rating agencies assign a lower-than-expected rating or reduce, or indicate that they may reduce, their ratings of our investments in the future, the value of these investments could significantly decline, which may have an adverse affect on our financial condition.

Risks Related to Our Company

In the past, our internal controls over financial reporting were found to have material weaknesses.

Our management identified certain deficiencies in our predecessor's internal controls over financial reporting during the course of its review in December 2004 of the financial statements of our predecessor that were to be included in our Form 10-Q for the quarter ended September 30, 2004. Based upon further investigation, we discovered certain errors in the accounting for transactions entered into during June 2004 and the third quarter of 2004 in connection with CDO II and in the reporting of allocated general and administrative expenses. These errors required us to adjust our predecessor's financial statements for the six months ended June 30, 2004, as described in Note 2 to the financial statements included in our Form 10-Q for the quarter ended September 30, 2004, and to make certain adjustments to our predecessor's financial statements for the three and nine months ended September 30, 2004. The deficiencies identified by our management in December 2004 included (1) the communication between business unit personnel and financial reporting personnel with respect to the accounting for certain transactions associated with our predecessor's CDO investments and other company activity, (2) the level of training of accounting and financial reporting personnel, and (3) the level of detailed, quality control review of our predecessor's financial statements. Taken together, management concluded that these deficiencies rose to the level of a material weakness in our predecessor's internal controls over financial reporting for the three months ended September 30, 2004.

In December 2004, our prior independent registered public accounting firm, Ernst & Young LLP, advised our management and audit committee that it considered our internal controls over financial reporting to have the significant deficiencies identified by management in December 2004 which, considered in combination, constituted a material weakness in our internal controls. The term "material weakness" refers to an organization's internal control deficiency in which the design or operation of a component of internal control does not reduce to a relatively low level the risk that a material misstatement may be contained in the organization's financial statements. In March 2005, Ernst & Young LLP advised our management and audit committee that such significant deficiencies in our internal controls over financial reporting continued to exist.

Since December 2004, we have had to expend significant financial resources, and our management has had to spend significant time, in order to take a series of measures designed to remedy these significant deficiencies. We may continue to expend significant financial resources and time in order to improve our internal controls over financial reporting. Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2005 based on the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005. Additionally, Grant Thornton LLP, our current independent registered public accounting firm, has audited management’s assessment and has issued an attestation report concurring with management’s assessment.

We cannot assure you that there will not be any other significant deficiencies that in combination constitute material weaknesses in our internal control over financial reporting in the future.

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Our ability to operate our business successfully would be harmed if key personnel with long-standing business relationships terminate their employment with us.

Our future success depends, to a significant extent, upon the continued services of our key personnel, including certain of our executive officers and Mr. Hamamoto in particular. For instance, the extent and nature of the experience of our executive officers and nature of the relationships they have developed with real estate developers and financial institutions are critical to the success of our business. Our executive officers have significant real estate investment experience. We cannot assure you of their continued employment with us. The loss of services of certain of our executive officers could harm our business and our prospects.

In connection with the IPO, our board of directors has adopted the NorthStar Realty Finance Corp. Long-Term Incentive Bonus Plan, which we refer to as the incentive bonus plan, in order to retain and incentivize officers and certain key employees. At December 31, 2005, based on the facts and information then available and assumptions regarding the returns on our investments at December 31, 2005, our management estimates that we will meet the hurdle of 12.5% return on invested capital during two one-year performance periods beginning October 1, 2005 and 2006 under the incentive bonus plan, and therefore, at December 31, 2005, we expect to issue awards under the incentive bonus plan. However, if we do not meet the return hurdles that our compensation committee established under the incentive bonus plan for the two-year period beginning October 1, 2005, we will ultimately not grant any awards under this plan to members of our management or other of our employees who provide services to us. As a result, we may be unable to motivate and retain our management and these other employees. Our inability to motivate and retain these individuals could also harm our business and our prospects. Additionally, competition for experienced real estate professionals could require us to pay higher wages and provide additional benefits to attract qualified employees, which could result in higher compensation expenses to us.

We may not be able to renew our office sublease expiring in September 2007 or renew our sublease on comparable terms, which could have an adverse impact on our financial condition, results of operations and business.

Our primary office space, which we have subleased from NorthStar Capital, is set to expire in September 2007. Given the highly competitive leasing market and price appreciation in New York City since the commencement of the original lease, following September 2007 we will not likely be able to lease this office space on terms comparable to our existing terms, if at all. Paying more for this existing office space or relocating our business to a new office space could have an adverse impact on our financial condition and results of operations and could have the effect of diverting our resources away from the focus of our core businesses.

Our financial condition and results of operations depend on our ability to manage future growth effectively.

Our ability to achieve our investment objectives depends on our ability to grow, which depends, in turn, on our ability to identify and invest in subordinated and senior real estate debt, real estate securities and net lease properties that meet our investment criteria. Accomplishing this result on a cost-effective basis is largely a function of our structuring of the investment process and our access to financing on acceptable terms. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations.

Our management has limited experience operating a publicly-owned REIT.

We commenced operations upon consummation of our IPO in October 2004. Our management has limited experience operating a publicly-owned REIT. Given our recent IPO, you will be limited in fully evaluating our management's public company and REIT operational abilities.

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We are subject to potential conflicts of interest in our relationship with our management relating to the time such individuals may devote to other matters for NorthStar Capital, and with NorthStar Capital, and our conflict of interest policies may not successfully eliminate the influence of such conflicts.

Our President and Chief Executive Officer, David Hamamoto, is the Co-Chief Executive Officer of NorthStar Capital. We expect that Mr. Hamamoto will devote a majority of his time and efforts to managing our affairs. However, he also devotes such time as is necessary to the management of NorthStar Capital's business operations, and he may engage in other business ventures. As a result, Mr. Hamamoto may be subject to conflicts in prioritizing his time and efforts. Mr. McCready, our general counsel and secretary, also serves as a director and the President and Chief Operating Officer of NorthStar Capital. While Mr. McCready continues to devote a significant amount of his time to the business of NorthStar Capital, he devotes the majority of his time and efforts to our business affairs.

In the future, we may enter into additional transactions with NorthStar Capital with the approval of the independent members of our board. Although Maryland law addresses certain conflicts of interest situations and our board has adopted certain policies relating to conflicts of interest requiring, among other things, that all transactions in which directors or executive officers have a material interest be approved by a majority of our disinterested directors, our policies or Maryland law requirements may not be successful in eliminating the influence of such conflicts.

Assuming redemption of all operating partnership units beneficially owned by NorthStar Capital for shares of our common stock, NorthStar Capital would beneficially own approximately 11% of our common stock and may be able to significantly influence matters submitted to a vote of our stockholders.

Assuming redemption of all operating partnership units beneficially owned by NorthStar Capital for shares of our common stock, NorthStar Capital would beneficially own approximately 11% of our outstanding common stock. If NorthStar Capital causes the redemption of these operating partnership units and we elect to issue shares of our common stock in exchange for such units, NorthStar Capital may be able to significantly influence the election of all of the members of our board of directors and the outcome of all matters submitted to a vote of our stockholders, including matters involving mergers or other business combinations, the acquisition or disposition of assets, the incurrence of indebtedness and the issuance of any additional shares of common stock or other equity securities. NorthStar Capital's influence over us may not always be exerted in a manner consistent with the interests of our other stockholders.

Maintenance of our Investment Company Act exemption imposes limits on our operations.

We conduct our operations so that we are not required to register as an investment company under the Investment Company Act of 1940, as amended, or the Investment Company Act. Section 3(a)(1)(C) of the Investment Company Act defines as an investment company any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer's total assets (exclusive of government securities and cash items) on an unconsolidated basis. Excluded from the term "investment securities," among other things, are U.S. government securities and securities issued by majority owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. Because we are a holding company that conducts its businesses through subsidiaries, this means that the securities issued by our subsidiaries that rely on the exception from the definition of "investment company" in Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis. This requirement limits the types of businesses in which we may engage through these subsidiaries.

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A majority of our subsidiaries rely on exceptions and exemptions from the Investment Company Act. These exceptions and exemptions limit the types of assets these subsidiaries may purchase. For instance, CDO II, CDO III and CDO V rely on the exemption from the Investment Company Act provided by Rule 3a-7 thereunder, which is available for certain structured financing vehicles. This exemption limits the ability of these CDOs to sell their assets and reinvest the proceeds from asset sales. Our subsidiary that invests in net lease properties relies on the exception from the definition of "investment company" provided by Sections 3(c)(6) and 3(c)(5)(C) of the Investment Company Act, and CDO IV similarly relies on the 3(c)(5)(C) exception from the definition of "investment company". These exceptions except companies that primarily invest in real estate, mortgages and certain other qualifying real estate assets. Relying on the exception from the definition of "investment company" provided by 3(c)(5)(C) of the Investment Company Act, CDO IV is limited in the types of real estate related assets that it could invest in. We believe that neither our operating partnership nor the subsidiary REIT through which we hold the substantial majority of our investments are investment companies because each of them satisfy the 40% test of Section 3(a)(1)(C). We must monitor their holdings to ensure that the value of their investment securities does not exceed 40% of their respective total assets (exclusive of government securities and cash items) on an unconsolidated basis. Our subsidiaries that engage in operating businesses are not subject to the Investment Company Act.

If the combined value of the investment securities issued by our subsidiaries that rely on the exception provided by Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own, exceeds 40% of our total assets on an unconsolidated basis, we may be deemed to be an investment company. If we fail to maintain an exemption, exception or other exclusion from registration as an investment company, we could, among other things, be required either (a) to substantially change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company, either of which could have an adverse effect on us and the market price of our common stock. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration and other matters.

Maryland takeover statutes may prevent a change of our control. This could depress our stock price.

Under Maryland law, "business combinations" between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as any person who beneficially owns 10% or more of the voting power of the corporation's shares or an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding voting stock of the corporation. A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by which he otherwise would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board.

After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least 80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder.

These super-majority vote requirements do not apply if the corporation's common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form previously paid by the interested stockholder for its shares.

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The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer, including potential acquisitions that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders. The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our board of directors has exempted any business combinations (a) between us and NorthStar Capital or any of its affiliates and (b) between us and any person, provided that any such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person). Consequently, the five-year prohibition and the super-majority vote requirements do not apply to business combinations between us and any of them. As a result, such parties may be able to enter into business combinations with us that may not be in the best interest of our stockholders, without compliance with the supermajority vote requirements and the other provisions in the statute.

Our authorized but unissued common and preferred stock and other provisions of our charter and bylaws may prevent a change in our control.

Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock and authorizes our board, without stockholder approval, to amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have the authority to issue. In addition, our board of directors may classify or reclassify any unissued shares of common stock or preferred stock and may set the preferences, rights and other terms of the classified or reclassified shares. Our board could establish a series of common stock or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for the common stock or otherwise be in the best interest of our stockholders.

Our charter and bylaws also contain other provisions that may delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

Maryland law also allows a corporation with a class of equity securities registered under the Securities Exchange Act of 1934, as amended, or the Securities Exchange Act, and at least three independent directors to elect to be subject, by provision in its charter or bylaws or a resolution of its board of directors and notwithstanding any contrary provision in the charter or bylaws, to a classified board, unless its charter prohibits such an election. Our charter contains a provision prohibiting such an election to classify our board under this provision of Maryland law. This makes the company more vulnerable to a change in control. If our stockholders voted to amend this charter provision and to classify our board of directors, the staggered terms of our directors could reduce the possibility of a tender offer or an attempt at a change in control even though a tender offer or change in control might be in the best interests of our stockholders.

Risks Related to REIT Tax Status

Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.

We intend to operate in a manner so as to qualify as a REIT for federal income tax purposes. However, qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only a limited number of judicial and administrative interpretations exist. Even an inadvertent or technical mistake could jeopardize our REIT status. Our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. Moreover, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of, and trading prices for, our common stock. We hold a substantial majority of our assets in a majority owned subsidiary, which we refer to as our private REIT. Our private REIT is organized to qualify as a REIT for federal income tax purposes. Our private REIT must also meet all of the REIT qualification tests under the Internal Revenue Code. If the private REIT did not qualify as a REIT, it is likely that NorthStar Realty would also not qualify as a REIT. If, for any reason, we failed to qualify as a REIT and unless we were entitled to relief under certain Internal Revenue Code provisions, we would be unable to elect REIT status for the four taxable years following the year during which we ceased to so qualify.

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Complying with REIT requirements may force us to borrow funds to make distributions to stockholders or otherwise depend on external sources of capital to fund such distributions.

To qualify as a REIT, we are required to distribute at least 90% of our annual taxable income, subject to certain adjustments, to our stockholders. To the extent that we satisfy the distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we distribute to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws. While we intend to make distributions sufficient to avoid imposition of the 4% tax, there can be no assurance that we will be able to do so. We anticipate that distributions generally will be taxable as ordinary income, although a portion of such distributions may be designated by us as long-term capital gain to the extent attributable to capital gain income recognized by us, or may constitute a return of capital to the extent that such distribution exceeds our earnings and profits as determined for tax purposes.

From time to time, we may generate taxable income greater than our net income for financial reporting purposes due to, among other things, amortization of capitalized purchase premiums, or our taxable income may be greater than our cash flow available for distribution to stockholders (for example, if a borrower defers the payment of interest in cash pursuant to a contractual right or otherwise). If we do not have other funds available in these situations we could be required to borrow funds, sell investments at disadvantageous prices or find another alternative source of funds to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity.

Because of the distribution requirement, it is unlikely that we will be able to fund all future capital needs, including capital needs in connection with investments, from cash retained from operations. As a result, to fund future capital needs, we likely will have to rely on third-party sources of capital, including both debt and equity financing, which may or may not be available on favorable terms or at all. Our access to third-party sources of capital will depend upon a number of factors, including the market's perception of our growth potential and our current and potential future earnings and cash distributions and the market price of our common stock.

Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.

Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes, such as mortgage recording taxes. Any of these taxes would decrease cash available for distribution to our stockholders. In addition, in order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we may hold some of our assets through taxable subsidiary corporations.

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Complying with REIT requirements may cause us to forego otherwise attractive opportunities or liquidate otherwise attractive investments.

To qualify as a REIT for federal income tax purposes we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. As discussed above, we may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution.

We must also ensure that at the end of each calendar quarter at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities of any one issuer (other than government securities and qualified real estate assets), and no more than 20% of the value of our total securities can be represented by securities of one or more taxable REIT subsidiaries. If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences, unless certain relief provisions apply. As a result, compliance with the REIT requirements may hinder our ability to operate solely on the basis of profit maximization and may require us to liquidate or forego otherwise attractive investments.

Complying with REIT requirements may limit our ability to hedge effectively.

The REIT provisions of the Internal Revenue Code may limit our ability to hedge our operations. In general, income from hedging transactions does not constitute qualifying income for purposes of the REIT 75% and 95% gross income requirements. To the extent, however, that we enter into a hedging contract to reduce interest rate risk or foreign currency risk on indebtedness incurred to acquire or carry real estate assets, any income that we derive from the contract would be excluded from gross income for purposes of calculating the REIT 95% gross income test if specified requirements are met, but would not be excluded and would not be qualifying income for purposes of calculating the REIT 75% gross income test. As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous, which could result in greater risks associated with interest rate or other changes than we would otherwise incur.

Liquidation of collateral may jeopardize our REIT status.

To continue to qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our mortgage and preferred equity investments to satisfy our obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our status as a REIT.

We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our common stock.

At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations may take effect retroactively and could adversely affect us or you as a stockholder. Legislation enacted in 2003 generally reduced the federal income tax rate on most dividends paid by corporations to individual investors to a maximum of 15%. REIT dividends, with limited exceptions, do not benefit from the rate reduction, because a REIT's income is generally not subject to corporate level tax. As such, this legislation could cause shares in non-REIT corporations to be a more attractive investment to individual investors than shares in REITs and could have an adverse effect on the value of our common stock.

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The stock ownership restrictions of the Internal Revenue Code for REITs and the 9.8% stock ownership limit in our charter may inhibit market activity in our stock and restrict our business combination opportunities.

To qualify as a REIT, five or fewer individuals, as defined in the Internal Revenue Code to include certain entities, may not own, actually or constructively, more than 50% in value of our issued and outstanding stock at any time during the last half of a taxable year. Attribution rules in the Internal Revenue Code determine if any individual or entity actually or constructively owns our stock under this requirement. Additionally, at least 100 persons must beneficially own our stock during at least 335 days of a taxable year. To help insure that we meet these tests, our charter restricts the acquisition and ownership of shares of our stock.

Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person, including entities, may own more than 9.8% of the value of our outstanding shares of stock or more than 9.8% in value or number (whichever is more restrictive) of our outstanding shares of common stock. The board may not grant an exemption from these restrictions to any proposed transferee whose ownership in excess of 9.8% of the value of our outstanding shares would result in the termination of our status as a REIT. Despite these restrictions, it is possible that there will be five or fewer individuals who own more than 50% in value of our outstanding shares, which could cause us to fail to qualify as a REIT. These restrictions on transferability and ownership will not apply, however, if our board of directors determines that it is no longer in our best interest to continue to qualify as a REIT.

These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of the stockholders.

The "taxable mortgage pool" rules may increase the taxes that we or our stockholders may incur, and may limit the manner in which we effect future securitizations.

Certain of our current and future securitizations could be considered to result in the creation of taxable mortgage pools for federal income tax purposes. As a REIT, so long as we own 100% of the equity interests in a taxable mortgage pool, we would generally not be adversely affected by the characterization of the securitization as a taxable mortgage pool. Certain categories of stockholders, however, such as foreign stockholders eligible for treaty benefits, stockholders with net operating losses, and certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to the taxable mortgage pool. In addition, to the extent that our stock is owned by tax-exempt "disqualified organizations," such as certain government-related entities that are not subject to tax on unrelated business income, although Treasury regulations have not yet been drafted to clarify the law, we may incur a corporate level tax on a portion of our income from the taxable mortgage pool. In that case, all of our investors and not just our investors who are "disqualified organizations" will bear a portion of the cost associated with the imposition of such tax on us. See "Federal Income Tax Considerations—Taxation of NorthStar Realty—Taxable Mortgage Pools" and "Federal Income Tax Considerations—Taxation of Stockholders—Taxation of Tax-Exempt Stockholders." Moreover, we would be precluded from selling equity interests in these securitizations to outside investors, or selling any debt securities issued in connection with these securitizations that might be considered to be equity interests for tax purposes. These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions.

ITEM 1B. Unresolved Staff Comments

Not applicable.

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ITEM 2.PROPERTIES

Our investments in net lease properties, which comprise our net lease business segment, are described under "Net Lease Properties." The following table sets forth certain information with respect to each of the net lease properties in the portfolio as of December 31, 2005:

Net Lease Portfolio: Property Information
Property Address	Square Feet		Ownership Interest		Leasehold Expiration Date		Major Tenants		Percent of Total Square Feet Leased			Annualized Rent		Lease/ Sublease Expiration Date
9401 Oakdale, Los Angeles, CA		97,336		Leasehold		May 2039		Washington Mutual Bank		100	%	$	2,296,000		June 2015
19850/60 Plummer , Los Angeles CA		160,000		Fee		N/A		Washington Mutual Bank		100	%	$	3,407,000		June 2015
2222 West 2300 South, Salt Lake City, UT		117,553		Fee		N/A		General Services Administration		100	%	$	2,316,000		April 2012
10888 White Rock Rd Rancho Cordova, CA		68,000		Fee		N/A		Electronic Data Systems Corp		100	%	$	1,380,000		September 2015
985 West Entrance Dr, Auburn Hills, MI		55,692		Fee		N/A		Electronic Data Systems Corp.		100	%	$	682,000		September 2015
1080 West Entrance Dr, Auburn Hills MI		50,000		Fee		N/A		Electronic Data Systems Corp.		100	%	$	528,000		September 2015
225 Grandview Ave, Camp Hill, PA		214,150		Fee		N/A		Electronic Data Systems Corp.		100	%	$	2,395,000		September 2015
111 Merchant St, Springdale, OH		173,145		Fee		N/A		General Electric Company		100	%	$	1,657,000		December 2009
55 Merchant St., Springdale, OH		174,554		Fee		N/A		Cincom Systems, Inc.		100	%	$	2,313,000		December 2011
25 Merchant St., Springdale, OH		139,264		Fee		N/A		General Electric Company		98	%	$	1,191,000		March 2010
25-27 West 34th Street (5)		21,140		Leasehold		12/30/2009		Payless Shoes (d/b/a Parade of Shoes)		13.2	%	$	475,000		Dec. 2009
								Sleepy's		14.2	%	$	116,000		Dec. 2009
								Solstice		4.0	%	$	262,000		Dec. 2009
								Su & Su		23.6	%	$	89,000		Dec. 2009
								Orion Technology		21.3	%	$	95,000		Dec. 2009
								AT&T Wireless		0.0%(2)		$	44,000		Nov. 2009
										76.3	%

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Net Lease Portfolio: Property Information
Property Address	Square Feet	Ownership Interest	Leasehold Expiration Date	Major Tenants	Percent of Total Square Feet Leased	Annualized Rent	Lease/ Sublease Expiration Date

36 West 34th Street	17,665	Leasehold	7/31/2015(3)	Aerosoles	12.5	%	$	396,000	June 2012
				Active Temporaries	18.1	%	$	65,000	May 2014
				233-70 Restaurant Corp.	18.1	%	$	19,000	Aug. 2014
				Montes Food	9.1	%	$	89,000	Sep. 2013
				Mother's Work	11.1	%	$	118,000	July 2016
				TLP LLC (d/b/a Curves)	11.1	%	$	62,000	July 2006
				Wolfe Doyle Advertising	9.1	%	$	60,000	June 2011
				Life is Beautiful Spa	10.9	%	$	51,000	March, 2015
					100.0	%
701 Seventh Avenue	7,500	Leasehold	12/30/2012	Sbarro, Inc.	100.0	%	$	559,000(1)	Dec. 2012
987 Eighth Avenue	10,800	Leasehold	4/30/2008(4)	Duane Reade	100.0	%	$	600,000	June 2017
1372 Broadway(5)	4,200	Leasehold	6/30/2006	Merel Foods	19.0	%	$	89,000	June 2006
				Leather Villa	14.3	%	$	85,000	June 2006
				1372 Photo Corp.	19.0	%	$	146,000	June 2006
				O-Dett Enterprises	47.7	%	$	60,000	June 2006
					100.0	%
Total Net Rentable Space	1,310,999
Unleasable Space	4,100
Total square feet	1,306,899

(1) Tenant pays percentage rent and no taxes.

(2) Tenant leases space on the roof of the building for a cellular antenna.

(3) The leasehold on 36 West 34th Street includes two 21-year extension options and one 15-year extension option. Upon extension, the leasehold would expire in 2072.

(4) The leasehold on 987 Eighth Avenue includes a 21-year extension option. Upon extension, the leasehold would expire in 2029.

(5) Under contract to sell these properties at December 31, 2005 for total purchase price of $2.3 million. The sale closed January 31, 2006.

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ITEM 3.LEGAL PROCEEDINGS

We are not subject to any legal proceedings required to be disclosed hereunder

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

No matters were submitted to a vote of our security holders during the fourth quarter of 2005.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock has been listed on the New York Stock Exchange under the symbol "NRF" since the completion of our IPO in October 2004. The following table sets forth the high, low and last sales prices for our common stock, as reported on the New York Stock Exchange, and dividends for the periods indicated.

Period	High		Low		Close		Dividends
2004
October 26, 2004 to December 31, 2004	$	11.50	$	8.65	$	11.45		N/A
2005
First Quarter	$	11.45	$	9.34	$	9.68	$	0.15(1)
Second Quarter	$	10.90	$	9.58	$	10.34	$	0.15(2)
Third Quarter	$	10.79	$	9.31	$	9.39	$	0.23(3)
Fourth Quarter	$	10.41	$	8.89	$	9.94	$	0.27(4)

(1) On April 21, 2005, we declared a dividend of $0.15 per share of common stock, payable with respect to the quarter ended March 31, 2005, to stockholders of record as of May 2, 2005. We made this payment on May 16, 2005.

(2) On July 28, 2005, we declared a dividend of $0.15 per share of common stock, payable with respect to the quarter ended June 30, 2005, to stockholders of record as of August 8, 2005. We made this payment on August 15, 2005.

(3) On October 6, 2005, we declared a dividend of $0.23 per share of common stock, payable with respect to the quarter ended September 30, 2005, to stockholders of record as of October 14, 2005. We made this payment on October 21, 2005.

(4) On January 26, 2006, we declared a dividend of $0.27 per share of common stock, payable with respect to the quarter ended December 31, 2005, to stockholders of record as of February 3, 2006. We made this payment on February 10, 2006.

On March 7, 2006, the closing sales price for our common stock, as reported on the NYSE, was $10.00 As of March 7, 2006, there were 20 record holders of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name.

Equity Compensation Plan Information

The following table summarizes information, as of December 31, 2005, relating to our equity compensation plan pursuant to which grants of securities may be made from time to time.

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Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights		Number of securities available for issuance under equity compensation plans (excluding securities reflected in first column)
Approved by Security Holders:
2004 Omnibus Stock Incentive Plan		852,919 1		n/a		526,039
2004 Long-Term Incentive Bonus Plan		-		n/a		698,142 2
Total		852,919		n/a		1,224,181

(1) Represents units of partnership interest which are structured as profits interest, or LTIP Units, in our operating partnership. Conditioned on minimum allocation to the capital accounts of the LTIP Unit for federal income tax purposes, each LTIP Unit may be converted, at the election of the holder, into one common unit of limited partnership interest in our operating partnership, or OP Units. Each of the OP Units underlying these LTIP Units are redeemable at the election of the OP Unit holder for (i) cash equal to the then fair market value of one share of our common stock, or (ii) at the option of the Company in its capacity as general partnership of our operating partnership, one share of our common stock.

(2)  As of December 31, 2005, the compensation committee of our board of directors had allocated an aggregate of 636,783 shares of our common stock to certain of the eligible participants as potential awards pursuant to the incentive bonus plan if we achieve the return hurdles established by the compensation committee for the two one-year performance periods beginning October 1, 2005 and October 1, 2006. Each of the eligible participants will be entitled to receive half of his or her allocated award if we meet the return hurdle for the one-year period beginning October 1, 2005 and such eligible participant is employed through the end of this first performance period. Each of the eligible participants will be entitled to the other half of his or her total allocated award amount if we meet the return hurdle for the one-year period beginning on October 1, 2006 and such eligible participant is employed through the end of this second performance period. If we do not meet the return hurdle for the one-year period beginning October 1, 2005, but we meet the return hurdle for the two-year period beginning October 1, 2005 (determined by averaging our performance over the two-year period) and an eligible participant is employed through the end of this two-year period, such eligible participant will be entitled to receive his or her total allocated award amount.

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ITEM 6.SELECTED HISTORICAL CONSOLIDATED AND COMBINED FINANCIAL DATA

The information below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the combined financial statements of our predecessor and the respective related notes, each included elsewhere in this Form 10-K.

Our predecessor is an aggregation, on a combined and uncombined basis, of the entities through which NorthStar Capital owned and operated its subordinate real estate debt, real estate securities and net lease properties businesses and was not a separate legal operating entity. The ultimate owners of these entities were NorthStar Capital and certain others who had minority ownership interests in these entities. NorthStar Partnership, the operating partnership of NorthStar Capital, was the managing member with day-to-day operational responsibility of the entities controlled by NorthStar Capital that are combined in our predecessor's historical financial statements. Where our predecessor had a non-controlling interest in any of the entities that comprised our predecessor, such entities are presented as part of our predecessor on an uncombined basis. The selected combined historical financial information presented for the period January 1, 2004 to October 28, 2004 and for the years ended December 31, 2003, 2002, and 2001 relates to the operations of our predecessor. The selected combined historical financial information presented for the years ended December 31, 2003, 2002 and 2001 has been derived from the audited combined statements of operations of our predecessor. The selected historical consolidated information presented for the period October 29, 2004 to December 31, 2004 relates to our operations and has been derived from our audited consolidated statement of operations included in this Annual Report on Form 10-K. The selected historical consolidated information presented for the year ended December 31, 2005 has been derived from our audited consolidated statement of operations included in this Annual Report on Form 10-K.

Our consolidated financial statements include our majority-owned subsidiaries which we control. Where we have a non-controlling interest, such entity is reflected on an unconsolidated basis.

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	The Company			The Company (consolidated)			The Predecessor (combined)
	(consolidated)			Period						Year Ended December 31,
	Year Ended December 31, 2005			October 29, 2004 to December 31, 2004			Period January 1, 2004 to October 28, 2004			2003			2002			2001
Statements of Operations Data:
Revenues:
Rental and escalation income	$	11,403,000		$	510,000		$	—		$	—		$	—		$	—
Advisory and management fee income		112,000			38,000			185,000			64,000			—			—
Advisory and management fee income — related parties		4,813,000			665,000			2,437,000			1,026,000			8,000			—
Interest income		40,043,000			3,990,000			31,000			502,000			—			—
Interest income — related parties		8,374,000			727,000			1,828,000			—			—			—
Other		352,000			—			—			—			—			—
Total revenues		65,097,000			5,930,000			4,481,000			1,592,000			8,000			—
Expenses:
Real estate properties — operating expenses		1,911,000			100,000			—			—			—			—
Interest expense		32,568,000			3,352,000			285,000			—			—			—
Management fees — related party		62,000			85,000			—			—			—			—
General and administrative
Direct:
Salaries and other compensation		5,490,000			797,000			953,000			1,289,000			206,000			—
Shared services — related party		1,145,000			231,000			—			—			—			—
Equity based compensation		5,847,000			2,991,000			—			—			—			—
Insurance		916,000			148,000			—			—			—			—
Auditing and professional fees		3,634,000			790,000			—			—			—			—
Formation and organization costs		—			517,000			—			—			—			—
Other general and administrative		2,036,000			378,000			181,000			203,000			27,000			—
Allocated:
Salaries and other compensation		—			—			3,060,000			2,146,000			806,000			187,000
Insurance		—			—			318,000			252,000			10,000			5,000
Other general and administrative		—			—			925,000			1,098,000			135,000			45,000
Total general and administrative		19,068,000			5,852,000			5,437,000			4,988,000			1,184,000			237,000
Depreciation and amortization		4,352,000			190,000			—			—			—			—
Total expenses		57,961,000			9,579,000			5,722,000			4,988,000			1,184,000			237,000
Income (loss) from operations		7,136,000			(3,649,000	)		(1,241,000	)		(3,396,000	)		(1,176,000	)		(237,000	)
Equity in earnings of unconsolidated/uncombined ventures		226,000			83,000			1,520,000			2,048,000			1,369,000			1,146,000
Other gains and losses:
Unrealized gain (loss) on investments and other		867,000			200,000			279,000			1,219,000			—			—
Realized gain on investments and other		2,160,000			293,000			636,000			1,866,000			—			—
Net income before minority interest		10,389,000			(3,073,000	)		1,194,000			1,737,000			193,000			909,000
Minority interest		(2,116,000	)		(632,000	)		—			—			—			—
Net income (loss) from continuing operations	$	8,273,000		$	(2,441,000	)	$	1,194,000		$	1,737,000		$	193,000		$	909,000
Income from discontinued operations, net of minority interest		547,000			2,000			—			—			—			—
Gain on sale of discontinued operations, net of minority interest		28,852,000			—			—			—			—			—
Net income (loss)	$	37,672,000		$	(2,439,000	)	$	1,194,000		$	1,737,000		$	193,000		$	909,000
Net income (loss) per share from continuing operations	$	0.38		$	(0.12	)
Income per share from discontinued operations		0.03			—
Gain per share on sale of discontinued operations		1.33			—
Net income (loss) per share available to common shareholders	$	1.74		$	(0.12	)
Weighted average number of shares of common stock outstanding:
Basic		21,660,993			20,868,865
Diluted		27,185,013			(1)

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	December 31,
Balance Sheet Data (at period end)	2005		2004		2003		2002		2001
Operating real estate- net	$	198,708,000	$	43,544,000	$	—	$	—	$	—
Investments in and advances to unconsolidated/ uncombined ventures		5,458,000		5,363,000		15,537,000		12,650,000		16,883,000
Debt securities held for trading		—		826,611,000		—		—		—
Debt securities available for sale		149,872,000		37,692,000		9,187,000		—		—
Real estate debt investments		681,106,000		70,569,000		—		—		—
Total assets		1,153,439,000		1,078,078,000		32,815,000		25,545,000		16,883,000
Mortgage notes and loans payable		174,296,000		40,557,000		—		—		—
Liability to subsidiary trusts issuing preferred securities		108,258,000		—		—		—		—
CDO bonds payable		300,000,000		—		—		—		—
Credit facilities		243,002,000		27,821,000		—		—		—
Repurchase obligations		7,054,000		800,418,000		—		—		—
Total liabilities		860,736,000		902,322,000		322,000		241,000		—
Minority interest		44,278,000		32,447,000		—		—		—
Stockholders' and Owners' equity		248,425,000		143,309,000		32,493,000		25,304,000		16,883,000
Total liabilities and stockholders'/ owners' equity	$	1,153,439,000	$	1,078,078,000	$	32,815,000	$	25,545,000	$	16,883,000

	The Company (consolidated)						The Predecessor (combined)
										Year Ended December 31,
	2005			Period October 29, 2004 to December 31, 2004			Period January 1, 2004 to October 28, 2004			2003			2002			2001
Other Data:
Cash Flow from:
Operating activities from continuing operations	$	848,733,000		$	(828,783,000	)	$	2,440,000		$	1,289,000		$	—		$	—
Investing activities		(880,198,000	)		(108,032,000	)		(19,197,000	)		(9,830,000	)		595,000			(35,000	)
Financing activities		11,630,000			981,923,000			18,369,000			9,554,000			(595,000	)		35,000

^{(1) For the period of October 29, 2004 through December 31, 2004, we did not present the weighted average number of shares of common stock outstanding on a diluted basis because there was a net loss available to common stockholders for the period and the effect would have been anti-dilutive.}

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

The following discussion should be read in conjunction with our and our predecessor's financial statements and notes thereto included in Part II, Item 8 of this report.

Organization and Overview

We are an internally-managed REIT that was formed in October 2003 to continue and expand the real estate debt, real estate securities and net lease businesses of NorthStar Capital. Upon the consummation of our IPO, three subsidiaries of NorthStar Capital contributed 100% of their respective interests in entities through which NorthStar Capital engaged in these businesses in exchange for units of limited partnership interest in our operating partnership and approximately $36.1 million. Our management team consists primarily of the same individuals who managed these businesses for NorthStar Capital.

We commenced operations upon the consummation of our IPO. We conduct substantially all of our operations and make our investments through our operating partnership, of which we are the sole general partner. Through our operating partnership, Northstar Realty Finance Limited Partnership, including its subsidiaries, we:

• acquire, originate and structure senior and subordinate debt investments secured primarily by income-producing commercial and multifamily properties;

• invest in commercial real estate debt securities, including CMBS, REIT unsecured debt and credit tenant loans; and

• acquire properties that are primarily net leased to corporate tenants.

We believe that these businesses are complementary to each other due to their overlapping sources of investment opportunities, common reliance on real estate fundamentals and ability to utilize securitization to finance assets and enhance returns. We seek to match fund our real estate securities and real estate debt investments, primarily by issuing CDOs. We allocate capital to these businesses in such a way as to diversify our credit risk and to optimize our returns.

Basis of Presentation

Set forth below is a discussion of the financial condition and results of operations of our predecessor for 2003 and the period January 1, 2004 through October 28, 2004 and of NorthStar Realty Finance Corp. for the period from the commencement of our operations on October 29, 2004 to December 31, 2004 and for the year ended December 31, 2005.

Our predecessor is an aggregation, on a combined and uncombined basis, of the entities through which NorthStar Capital owned and operated its subordinate real estate debt, real estate securities and net lease properties businesses and was not a separate legal operating entity. The ultimate owners of these entities were NorthStar Capital and its minority owners. NorthStar Partnership, the operating partnership of NorthStar Capital, was the managing member with day-to-day operational responsibility of the entities controlled by NorthStar Capital that are combined in our predecessor's historical financial statements. Where our predecessor had a non-controlling interest in any of the entities that comprised our predecessor, such entities are presented as part of our predecessor on an uncombined basis. Because the discussion of the financial condition and results of operations for 2003 and the period January 1, 2004 through October 28, 2004, which set forth below, relates to the entities comprising our predecessor, it reflects the historical financing and operational strategies of these entities.

Although the entities comprising our predecessor operated as separate businesses of NorthStar Capital, these businesses utilized certain of NorthStar Capital's employees, insurance and administrative services. General and administrative expenses incurred by NorthStar Capital on behalf of all of its business units which include salaries and benefits, rent, furniture, equipment, travel and entertainment, accounting, legal services and other expenses were allocated to our predecessor by NorthStar Capital's identification of specific expense items, where practical, and otherwise by an estimation of the level of effort devoted by certain of NorthStar Capital's employees. In the opinion of management, the methods used to allocate general and administrative expenses and other costs were reasonable.

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Upon the closing of our IPO in October 2004, certain subsidiaries of NorthStar Capital contributed their interests in NorthStar Capital's subordinate real estate debt, real estate securities and net lease businesses, which we refer to as the initial investments, to our operating partnership, pursuant to several contribution agreements. Upon the contribution of the initial investments to our operating partnership, these businesses became fully integrated and therefore we present our financial statements on a consolidated basis for all periods thereafter. Simultaneously with this contribution, we entered into a shared facilities and services agreement with NorthStar Capital, pursuant to which certain general and administrative services required to run these businesses were provided by NorthStar Capital for a period of one year in exchange for an annual fee of $1.57 million.

Since our IPO, we have hired additional accounting, legal and administrative personnel and have obtained separate office space sufficient to temporarily accommodate most of our business operations. Accordingly, following the initial one-year term of the shared facilities and services agreement, which expired on October 29, 2005, we terminated the agreement and entered into a more limited sublease agreement with NorthStar Capital. Under the new sublease, we rent on a month-to-month basis the NorthStar Capital office space currently used by our accounting, legal and administrative personnel (currently 7 people). The sublease rent is calculated as a per person monthly charge, based on a "turn key" office arrangement (computer, network, telephone and furniture supplied) for each person utilizing the NorthStar Capital facilities. We may increase or decrease the number of people needing such accommodations, and we expect that the sublease rental payment would increase or decrease accordingly. The sublease agreement was approved by a majority of the independent board members of both our board of directors and the board of directors of NorthStar Capital.

Sources of Operating Revenues

Historically, our predecessor primarily derived operating revenues from earnings of uncombined ventures which consisted of our predecessor's proportionate share of the net income from the rental operations of the New York property portfolio and from real estate debt investments. In more recent periods, our predecessor also derived operating revenues from advisory fees related to our real estate securities and real estate debt businesses, the residual interests in the cash flows of its investment grade CDOs based on our equity interests in such CDOs and the interest income on our junior debt investments in its investment grade CDOs.

Subsequent to our IPO and the integration of the real estate debt, real estate securities and net lease properties businesses, we primarily derive operating revenues from rental income, from the rental operations of our net lease property portfolio, interest income on our consolidated investments in real estate debt, the residual interests in the cash flows of our investment grade CDOs based on our equity interests in such CDOs and the interest income on our junior debt investments in our investment grade CDOs, earnings of an unconsolidated venture which consists of our proportionate share of the net income of the NSF venture's subordinate debt investments and advisory fees related to our real estate securities and real estate debt businesses.

    Real Estate Debt

Direct Investments.    The additional liquidity provided by the net proceeds of our IPO allowed us to increase the number and range of real estate debt transactions in which we invest. We used a portion of the net proceeds of our IPO to make investments in real estate debt, which are consolidated on our balance sheet, including the assets of CDO IV.

Prior to June 30, 2005, we were primarily focused on the acquisition or origination of subordinate debt investments secured primarily by real estate properties. We have recently been placing more emphasis on the acquisition and origination of senior mortgage loans as such loans allow us a greater degree of control in loan structuring and allow us to maintain a more direct relationship with our borrowers. We expect to continue to expand our acquisition and origination of senior mortgage loans as a complement to our core real estate debt investment business.

We earn interest income and origination fees on these consolidated investments, but we do not earn advisory fees on these investments.

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NSF Venture.    NorthStar Capital commenced its business of investing in subordinate real estate debt in 2001 through the NSF venture. NorthStar Funding Managing Member LLC, a majority-owned subsidiary of NorthStar Capital prior to the contribution of the initial investments to our operating partnership, is the managing member and holder of 50% of the outstanding membership interests in NorthStar Funding Management LLC, the managing member of the NSF venture. NorthStar Funding Management LLC is responsible for the origination, underwriting and structuring of all investments made by the NSF venture, but an institutional pension fund which has an equity interest in the NSF venture, or the NSF venture investor, had the right to approve all investments that NorthStar Funding Management LLC proposes to make on behalf of the NSF venture.

NorthStar Funding Investor Member LLC, a majority-owned subsidiary of NorthStar Capital prior to the contribution of the initial investments to our operating partnership, owned a 5% interest in the NSF venture and the NSF venture investor owns the remaining 95%. Prior to July 10, 2003, NorthStar Funding Investor Member LLC held a 10% interest in the NSF venture. On July 10, 2003, the terms of the NSF venture were amended to increase the NSF venture investor’s capital commitment to $190 million, or 95% of $200 million, and reduce NorthStar Funding Investor Member LLC's interest to 5%. NorthStar Capital contributed its interests in the NSF venture to our operating partnership upon consummation of our IPO. On February 1, 2006 we sold our interests in the NSF venture to the NSF venture investor for $2.9 million. We will recognize approximately $1.2 million of incentive income which had been deferred at December 31, 2005.

Prior to the sale of our interests in the NSF venture on February 1, 2006, we received an advisory fee of 1% of contributed capital per annum as compensation for NorthStar Funding Management LLC's management of the NSF venture's investments. We were also entitled to a profit participation equal to 10% of the profit after a minimum return on the NSF venture's capital and a return of capital based upon the performance of the NSF venture's investments. NorthStar Funding Managing Member LLC received 75% of this 10% profit participation prior to our IPO, and receives 100% of this 10% profit participation thereafter. We also earned an additional advisory fee from the NSF venture investor for underwriting and placing the senior participation and sub-participation interests that are acquired by the NSF venture investor directly from the NSF venture.

Our equity in earnings of the NSF venture includes interest income and origination fees on investments.

    Real Estate Securities

We invest in CMBS and other commercial real estate debt securities which are primarily investment-grade and are financed with long-term debt through the issuance of investment grade CDOs, thereby matching the terms of the assets and the liabilities.

We earn a spread between the yield on the assets and the interest expense incurred on the CDO debt issued through our investments in the equity interests and the junior CDO debt of each CDO issuer.

We also earn ongoing management fees for our management and monitoring of the CDO collateral of our investments in our investment grade CDOs. These fees equal 0.35% of the related CDO collateral.

Prior to a new investment grade CDO issuance, there is a period during which real estate securities are identified and acquired for inclusion in a CDO. During this warehouse accumulation period, we direct the acquisition of securities under a warehouse facility by a financial institution, or warehouse provider, that will be the lead manager of the CDO. The warehouse provider then purchases the securities and holds them on its balance sheet. We direct the acquisition of securities by the warehouse provider during this period, but we do not earn any fees for providing this service to either the warehouse provider or the issuer of the CDO, which will receive such securities upon the closing of the CDO. We contribute cash and other collateral, which is held in escrow by the warehouse provider, to back our commitment to purchase equity in the CDO and to cover our share of losses should securities need to be liquidated. Pursuant to the warehouse agreement, we share gains, including the net interest earned during the warehouse accumulation period, and losses, if any, with the warehouse provider.

During the warehouse accumulation period, our participation under the warehouse agreement is reflected in our financial statements as a non-hedge derivative, which is reflected at fair value and any unrealized gain or loss is charged to operations. Based on an analysis of our predecessor's interest in CDO I as a variable interest entity under FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities," the financial statements of CDO I were not consolidated into our or our predecessor's financial statements as of December 31, 2003, 2004 or 2005, since neither our predecessor nor we were the primary beneficiary of CDO I. Similarly, the financial statements of CDO II, III and V were not consolidated into our financial statements since we were not the primary beneficiary of CDO II, III and V. Accordingly, we have designated these beneficial interests in preferred equity of CDO I and the unrated income notes of CDO II, III and V as available for sale securities as they meet the definition of a debt instrument due to their underlying redemption provisions.

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    Net Lease Properties

We earn rental income from office, industrial and retail properties that are net leased to corporate tenants.

At December 31, 2005, one of our wholly owned subsidiaries, ALGM, owns the New York property portfolio, which consisted of five leasehold interests in five properties which vary in size from 4,200 square feet to 21,140 square feet and had a total of 61,305 net rentable square feet. Three of the properties are primarily leased or subleased to single users and two are leased or subleased to multiple tenants.

On June 30, 2005, we sold our ownership interest in a 19,618 square foot retail condominium unit at 729 Seventh Avenue in New York City for $29.0 million, or $1,478 per square foot, to 729 7th Realty Corp., an affiliate of NRMI and Himmel + Meringoff Properties. In connection with the sale, 729 7th Realty Corp. agreed to discontinue the legal action that it had brought against us, settling the only material legal action pending against us.

On November 30, 2005, we sold our fee interest in the property at 1552 Broadway in New York City to NRMI, for a purchase price of $48 million, or $3,970 per square foot and repaid the balance of the ALGM loan with a portion of the proceeds. The four-story, 12,091 square foot building is located at the corner of Broadway and West 46^th Street in Times Square.

The results of operations for the New York property portfolio are reflected in our predecessor's equity in earnings of uncombined ventures because our predecessor owned a 97.5% non-managing equity interest in ALGM. Concurrently with the contribution of the ALGM’s assets to our operating partnership in connection with our IPO and formation transactions, we purchased the remaining 2.5% managing equity interest of ALGM that we did not own from ALGM I Equity LLC with $1.6 million of the proceeds of our IPO. The results of operations of ALGM have been consolidated in our financial statements subsequent to our IPO.

On January 14, 2005, we acquired the Chatsworth Portfolio for $63.5 million. The Chatsworth Portfolio is net leased to Washington Mutual Bank, FA, under leases that expire in June 2015. We financed the acquisition with a $44 million first mortgage and a $13 million mezzanine loan which was funded by the warehouse provider under the warehouse agreement for CDO III. This mezzanine loan currently constitutes a portion of the portfolio of securities owned by CDO III.

On August 2, 2005, we acquired a 117,553 square foot office building in Salt Lake City, Utah for approximately $22.0 million. This property is 100% leased to the General Services Administration under a lease that expires in April 2012 and was financed with a 5.16% fixed rate, seven year non-recourse first mortgage loan of $17 million. We paid the balance of the purchase price in cash.

On September 30, 2005, we acquired from EDS for $61.4 million the EDS Portfolio, a portfolio of four office buildings with 387,842 square feet of rentable space that are located in Rancho Cordova, California, Auburn Hills, Michigan and Camp Hill, Pennsylvania, and leased these buildings back to EDS under leases expiring in 2015. The first year rent is approximately $5.0 million, with rent increases of 10.0% at the beginning of the third lease year, 10.0% at the beginning of the sixth lease year and 2.5% at the beginning of the ninth lease year. We financed the acquisition with a $49.1 million non-recourse mortgage with a fixed rate of 5.373% which matures in 2015. In connection with the acquisition, Koll Development Company, an affiliate of NorthStar Capital, received a brokerage commission of $921,000. The acquisition and the associated brokerage fees payable to Koll Development Company were approved in advance by all of the independent members of our board of directors.

In December 2005, we acquired a portfolio of three class A office buildings, located in Cincinnati, Ohio, with 486,963 square feet of rentable space for $68.5 million. Two of the properties are 100% and 96% leased to General Electric Company under leases expiring in 2009 and 2010. The remaining building is leased 100% to Cincom Systems, Inc. under a lease that expires in 2011. We financed the acquisition with a $51.5 million non-recourse first mortgage.

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Critical Accounting Policies

The preparation of financial statements in conformity with U.S. generally accepted accounting principles, or U.S. GAAP, requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Management has identified certain critical accounting policies that affect the more significant judgments and estimates used by management in the preparation of our predecessor's combined financial statements and our consolidated financial statements. Management evaluates on an ongoing basis estimates related to critical accounting policies, including those related to revenue recognition, allowances for doubtful accounts receivable and impairment of investments in uncombined ventures and debt securities available for sale. The estimates are based on information that is currently available to management, as well as on various other assumptions that management believes are reasonable under the circumstances.

Principles of Consolidation

The consolidated financial statements include our accounts and our majority-owned subsidiaries and variable interest entities (“VIE”) where we are deemed the primary beneficiary in accordance with the provisions and guidance of Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), “Consolidation of Variable Interest Entities”(“Fin 46(R)”). All significant intercompany balances have been eliminated in consolidation.

Fin 46 (R) requires a VIE to be consolidated by its primary beneficiary. The primary beneficiary is the party that aborbs a majority of the VIE’s anticipated losses and or a majority of the expected returns. We have evaluated our real estate debt investments and our investments in each of our five CDO issuers to determine whether we are VIE’s. For each of these investments, we have evaluated (1) the sufficiency of the fair value of the entity’s equity investment at risk to absorb losses, (2) whether as a group, the holders of the equity investment at risk have (a) the direct or indirect ability through voting rights to make decisions about the entity’s significant activities, (b) the obligation to absorb the expected losses of the entity and their obligations are not protected directly or indirectly, (c) the right to receive the expected residual return of the entity and their rights are not capped, (3) whether the voting rights of these investors are proportional to their obligations to absorb the expected losses of the entity, their rights to recieve the expected returns of their equity, or both and (4) whether substantially all of the entities activities involve or are conducted on behalf of an investor that has disproportionately fewer voting rights.

As of December 31, 2005, we identified eight interests in entities which were determined to be VIE’s under FIN 46 (R) they are as follows; CDO I, CDO II, CDO III, CDO V, NorthStar Realty Finance Trust I, II, and III and a preferred equity investment in a net lease property.

Based on management's analysis, we are not the primary beneficiary since we don’t absorb a majority of the expected losses or are entitled to a majority of the expected residual returns. Accordingly, these VIE’s were not consolidated into our financial statements as of December 31, 2005 or 2004.

Operating Real Estate

Operating real estate properties are carried at historical cost less accumulated depreciation. Cost directly related to the acquisition are capitalized. Ordinary repairs and maintenance which are not reimbursed by our tenants are expensed as incurred. Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their useful life.

In accordance with Statement of Financial Standards (“SFAS”) 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” a property to be disposed of is reported at the lower of its carrying value or its estimated fair value less the cost to sell. Once an asset is determined to be held for sale, depreciation and straight-line rental income are no longer recorded. In addition, the asset is reclassified to assets held for sale on the consolidated balance sheet and the results of operations are reclassified to income (loss) from discontinued operations in our consolidated statements of operations.

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In accordance with SFAS No. 141 “Business Combinations”(“SFAS 141”) we allocate the purchase price of operating properties to land, building, tenant improvements, deferred lease cost for the origination costs of the in-place leases and to intangibles for the value of the above or below market leases. We amortize the value allocated to the in-place leases over the remaining lease term. The value allocated to the above or below market leases are amortized over the remaining lease term as an adjustment to rental income.

Debt Securities Available for Sale

We determine the appropriate classification of our investments in debt securities at the time of purchase and reevaluate such determination at each balance sheet date. Debt securities for which we do not have the intent or the ability to hold to maturity are classified as available for sale securities. We have designated our investments in CDO I, II, III and V as available for sale securities as they meet the definition of a debt instrument due to their redemption provisions. Debt securities available for sale are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in the consolidated statements of stockholders' equity. Our investments in CDO I, II, III and V are relatively illiquid, and their value must be estimated by management. Fair value is based primarily upon broker quotes or management's estimates. These estimated values are subject to significant variability based on market conditions, such as interest rates and current spreads. Changes in the valuations do not affect either our reported income or cash flows, but impact stockholders' equity and owners' equity, respectively.

Real Estate Debt Investments

We must periodically evaluate each of our direct investments in real estate debt for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan. Upon a determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. Significant judgment is required both in determining impairment and in estimating the resulting loss allowance. Allowances for loan investment losses are established based upon a periodic review of the loan investments. Income recognition is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. In performing this review, management considers the estimated net recoverable value of the loan as well as other factors, including the fair market value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic conditions in the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized from the loan investments may differ materially from the carrying value at the balance sheet date. As of the date of this Annual Report on Form 10-K, all of our direct investments in real estate debt are fully performing and we have determined that no loss allowances have been necessary with respect to the loans.

Revenue Recognition

Rental income from leases is recognized on a straight-line basis over the noncancelable term of the respective leases. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in unbilled rent receivable in our consolidated balance sheets.

Tenant reimbursement income is recognized in the period in which the related expense is incurred. Rental revenue, which is based upon a percentage of the sales recorded by our tenants is recognized in the period such sales were earned by the respective tenants.

Interest income from our unsecuritized loan investments is recognized on an accrual basis over the life of the investment using the effective interest method. Additional interest to be collected at payoff is recognized over the term of the loan as an adjustment to yield.

Interest income from debt securities available for sale and held for trading is recognized on the accrual basis of accounting over the life of the investment on a yield-to-maturity basis.

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In connection with our investments in CDO I, II, III and V, we recognize interest income on these investments pursuant to Emerging Issues Task Force (‘‘EITF") 99-20, ‘‘Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," Interest income is recognized on an estimated effective yield to maturity basis. Accordingly, on a quarterly basis, we calculate a revised yield on the current amortized cost of the investment and a current estimate of cash flows based upon actual and estimated prepayment and credit loss experience. The revised yield is then applied prospectively to recognize interest income.

Advisory fee income from both third parties and affiliates are recognized on the accrual basis as services are rendered and the fee income is contractually earned in accordance with the respective agreements. Fees from affiliated ventures accounted for under the equity method, such as the NSF venture, are partially eliminated against the related equity in earnings in such affiliated ventures to the extent of our ownership.

We earn incentive income related to the performance of the NSF venture through NFMM, who, as the managing member of the NSF venture, is entitled to a promoted interest (i.e., the distribution of a disproportionate allocation of cash flow) after other members have obtained a specified return threshold and return of capital. We follow Method 1 of EITF Topic D-96 for recording such incentive income. Under Method 1 of EITF Topic D-96, no incentive income is recorded until all contingencies have been eliminated. Incentive income distributions received by NFMM, which are subject to refund to the NSF venture if certain return thresholds are not met, are recorded as unearned income (a liability) on our consolidated balance sheets.

Credit Losses, Impairment and Allowance for Doubtful Accounts

We assess whether unrealized losses on the change in fair value on our debt securities reflect a decline in value which is other than temporary. If it is determined the decline in value is other than temporary the impaired securities are written down through earnings to their fair values. Significant judgment of management is required in this analysis, which includes, but is not limited to, making assumptions regarding the collectibility of the principal and interest, net of related expenses, on the underlying loans.

Allowances for real estate debt investment losses are established based upon a periodic review of the loan investments. Income recognition is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the suspended loan becomes contractually current and performance is demonstrated to be resumed. In performing this review, management considers the estimated net recoverable value of the loan as well as other factors, including the fair market value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic situation of the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized from the loan investments may differ materially from the carrying value at the balance sheet date.

We review long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Upon determination that an impairment exists, the related asset is written down through earnings to its estimated fair value.

Allowance for doubtful accounts for tenant receivables are established based on periodic review of aged receivables resulting from estimated losses due to the inability of its tenants to make required rent and other payments contractually due. Additionally, we established, on a current basis, an allowance for future tenant credit losses on billed and unbilled rents receivable based upon an evaluation of the collectibility of such amounts.

Risks and Uncertainties

In the normal course of business, we encounter primarily two significant types of economic risk: credit and market. Credit risk is the risk of default on our securities, loans, leases, and derivatives that result from a borrower's, lessee's or derivative counterparty's inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of investments in securities, loans and real estate, or in derivatives, such as our CDO Deposit and Warehouse Agreement and our investment in the CDO Issuers, due to changes in interest rates, spreads or other market factors, including the value of the collateral underlying loans and securities and the valuation of real estate held us. Management believes that the carrying values of its investments are fairly stated, taking into consideration these risks along with estimated collateral values, payment histories and other market information.

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Stock Based Compensation

We have adopted the fair value method of accounting prescribed in SFAS No. 123 "Accounting for Stock Based Compensation" ("SFAS 123") (as amended by SFAS No. 148) for equity based compensation awards. SFAS 123 requires an estimate of the fair value of the equity award at the time of grant rather than the intrinsic value method. All fixed equity based awards to employees and directors, which have no vesting conditions other than time of service, will be amortized to compensation expense over the award's vesting period based on the fair value of the award at the date of grant.

Performance-Based Compensation

Our board of directors has adopted the long term incentive bonus plan, in order to retain and incentivize officers and certain key employees of us, co-employees of us and NorthStar Capital and employees of NorthStar Capital who provide services to us pursuant to the shared facilities and services agreement, which we collectively refer to as the eligible participants. As of December 31, 2005, the compensation committee of our board of directors had allocated an aggregate of 698,142 shares of our common stock to certain of the eligible participants as potential awards pursuant to the long term incentive bonus plan if we achieve the return hurdles established by the compensation committee for the two one-year performance periods beginning October 1, 2005 and October 1, 2006. The compensation committee has established a return hurdle for these performance periods of a 12.5% annual return on paid in capital, as defined in the incentive bonus plan. If we achieve these return hurdles, these awards may be paid in cash, shares of common stock, long term incentive plan units or LTIP units or other shared-based form.

Each of the eligible participants will be entitled to receive half of his or her allocated award if we meet the return hurdle for the one-year period beginning October 1, 2005 and such eligible participant is employed through the end of this first performance period. Each of the eligible participants will be entitled to the other half of his or her total allocated award amount if we meet the return hurdle for the one-year period beginning on October 1, 2006 and such eligible participant is employed through the end of this second performance period. If we do not meet the return hurdle for the one-year period beginning October 1, 2005, but we meet the return hurdle for the two-year period beginning October 1, 2005 (determined by averaging our performance over the two-year period) and an eligible participant is employed through the end of this two-year period, such eligible participant will be entitled to receive his or her total allocated award amount.

At December 31, 2005, management has made its best estimate of our performance during these two performance periods, based on the facts and information then available and assumptions regarding the returns on our investments at December 31, 2005. On the basis of the foregoing, management has estimated that we will meet the return hurdle in these performance periods. If we do not ultimately meet the return hurdle during the performance periods, we will not grant any awards under the incentive bonus plan to any of the eligible participants.

Unconsolidated Ventures

Management is required to make subjective assessments as to whether there are impairments in the values of its investment in unconsolidated ventures accounted for using the equity method. As no public market exists for these investments, management estimates the recoverability of these investments based on projections and cash flow analysis. These assessments have a direct impact on our and our predecessor's net income because recording an impairment loss results in an immediate negative adjustment to net income. The following is a summary of the accounting policies relating to the unconsolidated ventures of us and our predecessor that are most affected by judgments, estimates and assumptions.

Real Estate Debt Investments.    We record the transfer of a participation or sub-participation in a loan investment as a sale when the attributes of the transaction meet the criteria for sale of SFAS 140, "Accounting for Transfers of Financial Assets and Extinguishments of Liabilities," including transferring the financial interest beyond the reach of its creditors and placing no substantive restrictions on the resale of the participation or sub-participation by the purchaser.

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Revenue Recognition.    ALGM was accounted for as an uncombined venture until our purchase of the 2.5% managing membership interest in ALGM on October 29, 2004. Prior to such date, management applied the same revenue recognition policy with respect to properties in the New York property portfolio as described under "— Critical Accounting Policies — Revenue Recognition" above.

Derivatives and Hedging Activities

We account for our derivatives and hedging activities in accordance with SFAS No. 133, ‘‘Accounting for Derivative Instruments and Hedging Activities," which requires us to recognize all derivatives as either assets or liabilities in the consolidated balance sheet and to measure those instruments at fair value. Additionally, the fair value adjustments of each period will affect our consolidated financial statements differently depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity.

For those derivative instruments that are designated and qualify as hedging instruments, we must designate the hedging instrument, based upon the exposure being hedged, as either a cash flow hedge or a fair value hedge.

Generally, all derivatives we enter into are intended to qualify as hedges under accounting principles generally accepted in the United States, unless specifically stated otherwise. Toward this end, the terms of hedges are matched closely to the terms of hedged items.

With respect to derivative instruments that have not been designated as hedges, any net payments under, or fluctuations in the fair value of, such derivatives are recognized currently in income. Our CDO Deposit and Warehouse Agreements have been designated as non-hedge derivatives.

Our derivative financial instruments contain credit risk to the extent that its bank counterparties may be unable to meet the terms of the agreements. We minimize such risk by limiting our counterparties to major financial institutions with good credit ratings. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123, (revised 2004) Share-Based Payment, or SFAS No. 123 (R), which supersedes APB opinion No. 25, Accounting for Stock Issued to Employees and its related implementation guidance. SFAS No. 123 (R) established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123 (R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123 (R) is effective for fiscal years beginning after June 15, 2005. The impact of adopting SFAS No. 123 (R) is not expected to have a material adverse impact on our financial condition or results of operations.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and SFAS No. 3. SFAS No. 154 changes the requirements for the accounting and reporting of a change in accounting principle by requiring that a voluntary change in accounting principle be applied retrospectively with all prior periods’ financial statements presented on the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also requires that a change in depreciation or amortization for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle and corrections of errors in previously issued financial statements should be termed a “restatement”. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We believe that the adoption of SFAS No. 154 will not have a material effect our consolidated financial statements.

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  In June 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on Issue No. 04-05, “Determining Whether a General Partner, or General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-05”). EITF 04-05 provides a framework for determining whether a general partner controls, and should consolidate, a limited partnership or a similar entity. EITF 04-05 became effective on June 29, 2005, for all newly formed or modified limited partnership arrangements and January 1, 2006 for all existing limited partnership arrangements. We believe that the adoption of this standard will not have a material effect on our consolidated financial statements.

Accounting for the Purchase of Certain Securities and Related Repurchase Agreements

     In certain instances, we have purchased securities from a counterparty and subsequently financed the acquisition of these securities through repurchase agreements, which are also collateralized by these securities, with the same counterparty (a “Same Party Transaction”). We currently record the acquisition of these securities as assets and the related financings under repurchase agreements as liabilities gross on our consolidated balance sheet. The securities are generally short term highly liquid securities classified as debt securities held for trading, with changes in the fair value of these securities being recorded in the income statement. The corresponding interest income earned on these securities and interest expense incurred on the related repurchase agreements are reported gross on our consolidated statements of income.

As of December 31, 2004, we had $351.0 million in securities and $333.4 million in financings under the related repurchase agreements. As of December 31, 2005 and March 13, 2006, we had no remaining Same Party Transactions.

However, based upon our understanding of a technical interpretation of the provisions of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), Same Party Transactions may not qualify as a purchase by us because the securities purchased by us in Same Party Transactions may not be determined to be legally isolated from the counterparty to such transactions. The result of this technical interpretation would be to preclude us from presenting (i) these securities and the related financings under repurchase agreements on a gross basis on our consolidated balance sheet and (ii) the related interest income earned and interest expense incurred on a gross basis on our consolidated statements of income. Instead, we would be required to present Same Party Transactions on a net basis as derivatives. This alternate view would not have a material impact on stockholders’ equity as of, or net income for the years ending December 31, 2004 or December 31, 2005.

     If we were to determine it was required to apply this technical interpretation of SFAS 140, the potential change in its accounting treatment would not affect the economics of the Same Party Transactions, but would affect how these transactions were reported on our consolidated financial statements. We believe that our cash flows, liquidity and ability to pay dividend distributions would be unchanged and that our taxable income would not be affected. Although we believe that our accounting for Same Party Transactions is appropriate, we will continue to evaluate such position as the interpretation of this issue among industry participants and standard setters evolves.

Results of Operations

Our predecessor's results of operations for the period from January 1, 2004 to October 28, 2004 and for the year ended 2003 are not necessarily indicative of our future results of operations due to the impact of our IPO, the acquisition of additional interests in ALGM and its resulting consolidation, the expansion of our real estate securities and real estate debt businesses, and our new investments and their related debt financing. To facilitate a comparison of the results of operations for the year ended December 31, 2005 to 2004 and 2003, we have combined our predecessor’s results for the period from January 1, 2004 to October 28, 2004 with the results of our operations for the period from October 29, 2004 to December 31, 2004. We refer to this combined period as the 2004 pro forma period. We will compare the year ended December 31, 2005 to the 2004 pro forma period and compare the 2004 pro forma period to the year ended December 31, 2003.

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We sold our interests in 729 Seventh Avenue on June 30, 2005 and sold our fee interest in the property located at 1552 Broadway on November 30, 2005. On December 30, 2005, we entered into a contract to sell our leasehold interest in 27 West 34th Street and terminate the leasehold interest in 1372 Broadway. Accordingly, the properties' previously reported revenues and expenses were reclassified to income from discontinued operations for the year ended December 31, 2005 and the portion of the 2004 pro forma period for which such operations were consolidated. For the year ended December 31, 2003 there was no reclassification for these properties since they were held within an equity method investment by our Predecessor.

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	The Company			The Company/The Predecessor			The Predecessor
	Year Ended December 31,			2004 Pro Forma			Year Ended December 31,
	2005			Period			2003
Revenues:
Rental and escalation income	$	11,403,000		$	510,000		$	—
Advisory and management fee income		112,000			223,000			64,000
Advisory and management fee income - related parties		4,813,000			3,102,000			1,026,000
Interest income		40,043,000			4,021,000			—
Interest income- related parties		8,374,000			2,555,000			502,000
Other revenue		352,000			—			—
Total revenues		65,097,000			10,411,000			1,592,000
Expenses:
Real estate properties - operating expenses		1,911,000			100,000			—
Interest expense		32,568,000			3,637,000			—
Management fees - related parties		62,000			85,000			—
General and administrative:
Salaries and other compensation		5,490,000			4,810,000			3,435,000
Equity based compensation		5,847,000			2,991,000			—
Shared services - related party		1,145,000			231,000			—
Insurance		916,000			466,000			252,000
Auditing and professional fees		3,634,000			790,000			—
Formation and organization costs		—			517,000			—
Other general and administrative		2,036,000			1,484,000			1,301,000
Total general and administrative		19,068,000			11,289,000			4,988,000
Depreciation and amortization		4,352,000			190,000			—
Total expenses		57,961,000			15,301,000			4,988,000
Income (loss) from operations		7,136,000			(4,890,000	)		(3,396,000	)
Equity in earnings of unconsolidated/uncombined ventures		226,000			1,603,000			2,048,000
Unrealized gain (loss) on investments and other		867,000			479,000			1,219,000
Realized gain (loss) on investments and other		2,160,000			929,000			1,866,000
Income (loss) before minority interest		10,389,000			(1,879,000	)		1,737,000
Minority Interest		(2,116,000	)		(632,000	)		—
Net income (loss) from continuing operations		8,273,000			(1,247,000	)		1,737,000
Income from discontinued operations, net of minority interest		547,000			2,000			—
Gain from discontinued operations, net of minority interest		28,852,000			—			—
Net income (loss)	$	37,672,000		$	(1,245,000	)	$	1,737,000

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Comparison of the Year Ended December 31, 2005 to the 2004 Pro Forma period

Revenues

Rental and escalation income

Rental and escalation income for the year ended December 31, 2005 totaled $11.4 million, representing a $10.9 million increase compared to $0.5 million in the 2004 pro forma period. The increase was attributable to the following acquisitions; the Chatsworth Portfolio on January 14, 2005, the Salt Lake City property on August 2, 2005, the EDS Portfolio on September 30, 2005 and the Cincinnati properties on December 8, 2005, which collectively contributed an additional $8.7 million of rental income in addition to $2.7 million from the New York property portfolio. For the 2004 pro forma period, the New York property portfolio had $0.5 million of rental and escalation income, which was accounted for under the equity method of accounting for the period from January 1, 2004 to October 28, 2004. We acquired the 2.5% managing interest in the New York property portfolio on October 29, 2004 and accordingly the operations of these properties have been consolidated into the condensed consolidated financial statements for the period October 29, 2004 to December 31, 2004 and for the year ended December 31, 2005.

Advisory and management fee income

Advisory and management fee income decreased by $111,000, or 50%, to $112,000 for the year ended December 31, 2005 compared to $223,000 for the 2004 pro forma period due to a lower average portfolio balance in 2005 in the NSF venture.

Advisory and management fee income - related parties

Advisory fees from related parties for the year ended December 31, 2005 totaled $4.8 million, representing an increase of approximately $1.7 million, or 55%, compared to $3.1 million for the 2004 pro forma period. The increase was comprised primarily of higher fees earned for CDO II, CDO III (which closed March 10, 2005) and CDO V (which closed September 22, 2005) of $0.7 million, $1.1 million and $0.5 million, respectively, offset by lower fees on CDO I of $0.1 million due to principal paydowns of the real estate securities in that CDO. This increase was offset by a decrease in fees earned from the NSF venture of approximately $0.5 million, which was due to a lower average portfolio loan balance for the year ended December 31, 2005.

Interest income

Interest income for the year ended December 31, 2005 totaled $40.0 million, representing an increase of $36.0 million, compared to $4.0 million for the 2004 pro forma period. The increase was primarily attributable to $30.5 million of interest on real estate debt investments made in 2005. In addition, interest income on our short term AAA-rated, short term, floating rate securities increased $4.9 million from $3.4 million in 2004 to $8.3 million in 2005, or 244%. We liquidated that balance of our portfolio in the fourth quarter of 2005. The balance of the increase is interest income of $0.6 million on cash collateralizing our short security sales and other investments.

Interest income - related parties

Interest income from related parties for the year ended December 31, 2005 totaled $8.4 million, representing an increase of $5.8 million, or 223%, compared to $2.6 million for the 2004 pro forma period. The increase was attributable to higher average investments in our four investment grade CDOs in 2005, which earned interest income of $4.2 million in the year ended December 31, 2005, including $1.1 million from CDO I and II, approximately $2.2 million from CDO III, which closed on March 10, 2005, and $0.9 million from CDO V, which closed on September 22, 2005, and higher interest income of approximately $0.4 million from our "BB" rated junior classes of debt securities of CDO II, in which we were invested for the full year in 2005, versus approximately five months in 2004. We also earned $1.2 million on real estate securities and other investments.

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Other revenue

Other revenue for the year ended December 31, 2005 totaled $0.4 million, representing an increase of $0.4 million compared to the 2004 profoma period. The increase is primarily attributable to an exit fee earned on one of our real estate debt investments.

Expenses

Real estate properties - operating expenses

Property operating expenses for the year ended December 31, 2005 totaled $1.9 million, representing an increase of $1.8 million, compared to $0.1 million for the 2004 pro forma period. The increase was attributable to $0.5 million of higher property operating expenses from the New York property portfolio which was accounted for under the equity method of accounting for the period January 1, 2004 to October 28, 2004. We acquired the 2.5% managing interest in the New York property portfolio on October 29, 2004 and accordingly the operations of these properties have been consolidated into the condensed consolidated financial statements for a full year in 2005 versus a partial year in 2004. We acquired the Chatsworth Portfolio on January 14, 2005, the Salt Lake City property on August 2, 2005, the EDS Portfolio on September 30, 2005, and the Cincinnati properties on December 8, 2005 which collectively contributed an additional $1.3 million of property operating expenses.

Interest expense

Interest expense for the year ended December 31, 2005 totaled approximately $32.6 million, representing an increase of $29.0 million, compared to $3.6 million for the 2004 pro forma period. This increase was primarily attributable to the following: approximately $4.3 million of increased interest in 2005 on financing for our investments in AAA-rated, short term, floating rate securities (we had acquired these investments subsequent to our IPO in October 2004); approximately $0.4 million of increased interest in 2005 on our investment in the "BB" rated junior classes of debt securities and unrated income securities of CDO II and on securities underlying short sales we entered into during 2004; approximately $5.0 million of interest expenses on mortgage and mezzanine debt on our net lease properties; $7.4 million on our real estate debt facilities; approximately $7.6 million on our non-recourse CDO IV bonds; approximately $0.2 million on our Bank of America facility; $4.4 million of interest expense on liabilities to the three subsidiary trusts that issued preferred securities in the second and fourth quarters of 2005.

Management fees - related party

Management fees - related party for the year ended December 31, 2005 totaled $62,000, representing an decrease of $23,000, or 27%, compared to $85,000 for the 2004 pro forma period. The decrease was attributable to the New York property portfolio, which was accounted for under the equity method of accounting in the 2004 profoma period. ALGM incurred a one time termination fee related to its management agreement during the 2004 profoma period. We acquired the 2.5% managing interest in the New York property portfolio on October 29, 2004 and accordingly the operations of these properties have been consolidated into our consolidated financial statements for a full year in 2005 and for a partial year in 2004.

General and administrative

General and administrative expenses for the year ended December 31, 2005 totaled $19.1 million, representing an increase of $7.8 million, or 69%, compared to $11.3 million for the 2004 pro forma period. General and administrative expenses, excluding equity based compensation expense, for the year ended December 31, 2005 totaled $13.2 million, representing an increase of $5.0 million, or 61%, compared to $8.2 million for the 2004 pro forma period. The increase was comprised of the following:

Salaries and other compensation (direct and allocated) for the year ended December 31, 2005 totaled $5.5 million, representing an increase of approximately $0.7 million, or 15%, compared to $4.8 million for the 2004 pro forma period. The increase was primarily attributable to an increase in salaries due to higher staffing levels to accommodate the expansion of our three businesses subsequent to our IPO throughout 2005.

Shared services - related party for the year ended December 31, 2005 totaled $1.1 million, representing an increase of approximately $0.9 million, compared to $0.2 million for the 2004 pro forma period. The increase was attributable to the shared facilities and services agreement we entered into with NorthStar Capital on October 29, 2004. On October 29, 2005, we terminated that agreement and entered into a more limited sublease agreement with NorthStar Capital. Under the new sublease effective November 1, 2005, we rent from NorthStar Capital office space currently used by our accounting, legal and administrative personnel on a month to month basis. The sublease rent is calculated as a per person monthly charge, based on a "turn key" office arrangement (computer, network, telephone and furniture supplied) for each person utilizing NorthStar Capital facilities. These direct costs are reflected in other general and administrative expenses.

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Equity based compensation expense for the year ended December 31, 2005 totaled $5.8 million, representing an increase of $2.8 million, or 93%, compared to $3.0 million for the 2004 pro forma period. The increase was attributable to approximately $0.2 million in connection with an employee outperformance bonus plan for one of our executive officers, approximately $2.4 million in connection with the three-year vesting of equity based awards issued under our 2004 Omnibus Stock Incentive Plan (which includes approximately $0.4 million of additional amortization in the fourth quarter for employees of Northstar Capital who became fully vested in connection with our termination of the shared facilities and service agreement on October 29, 2005), $2.2 million in connection with our Long-Term Incentive Bonus Plan or our incentive bonus (of which $1.7 million was a catch up adjustment due to a revision in management’s estimate that we will now likely meet the required earnings hurdle during the first and second measurement periods and all shares under the incentive bonus plan will likely be earned), and compensation expense of $0.3 million in connection with the grants to the members of our Board of Directors. These increases were offset by a reduction of $2.3 million of amortization in 2005 relating to buyouts of a profits interest in NS Advisors LLC from one of our employees and membership interests in Northstar Funding Managing Member, LLC from two former employees in the 2004 pro forma period in connection with our IPO.

Insurance (direct and allocated) for the year ended December 31, 2005 totaled $0.9 million, representing an increase of $0.4 million, or 80%, compared to $0.5 million for the 2004 pro forma period. The increase was attributable to direct costs incurred for directors and officers liability policies we acquired subsequent to the IPO in 2004 and renewed in October 2005.

Auditing and professional fees for the year ended December 31, 2005 totaled $3.6 million, representing an increase of $2.8 million, or 350%, compared to $0.8 million for the 2004 pro forma period. The increase was primarily attributable to auditing fees of $1.7 million, comprised of 2004 audit fees expensed in 2005, quarterly reviews performed by our auditors, Sarbanes-Oxley compliance work and audit work completed during 2005 related to our 2005 year-end audit, in addition, there were higher legal costs of $0.4 million associated with general corporate matters, and increased consulting fees of approximately $0.7 million associated with year end and periodic reporting obligations and recruiting during the year ended December 31, 2005. There were no formation expenses for the year ended December 31, 2005. We incurred approximately $0.5 million of expenses in connection with our formation and organization in the 2004 profoma period.

Other general and administrative expenses (direct and allocated) for the year ended December 31, 2005 totaled $2.0 million, representing an increase of approximately $0.5 million, or 33%, compared to $1.5 million for the 2004 pro forma period. This increase was primarily attributable to public company expenses of $0.5 million, which includes public relations costs of approximately $0.1 million.

Depreciation and amortization

Depreciation and amortization expense for the year ended December 31, 2005 totaled $4.4 million, representing an increase of $4.2 million, compared to $0.2 million for the 2004 pro forma period. This increase was primarily attributable to $3.1 million of depreciation and amortization expense and $0.3 million related to the amortization of the intangible assets under SFAS 141 for the Chatsworth Portfolio acquired on January 14, 2005, the Salt Lake City property acquired on August 2, 2005, the EDS Portfolio acquired on September 30 2005 and the Cincinati properties acquired on December 8, 2005. In addition, $0.8 million of depreciation expense is attributable the New York property portfolio which was accounted for under the equity method of accounting for the period January 1, 2004 to October 28, 2004. We acquired the 2.5% managing interest in the New York property portfolio on October 29, 2004 and accordingly the operations of these properties have been consolidated into our consolidated financial statements in 2005.

Equity in earnings of unconsolidated/uncombined ventures

Equity in earnings for the year ended December 31, 2005 totaled $0.2 million, representing a decrease of $1.4 million, or 88%, compared to $1.6 million for the 2004 pro forma period. The decrease was attributable to the decrease in the equity in earnings of the NSF venture of approximately $0.3 million due to lower average portfolio loan balances in 2005 and a decrease of $1.1 million from the New York property portfolio which was accounted for under the equity method of accounting for the period January 1, 2004 to October 28, 2004. We acquired the 2.5% managing interest in the New York property portfolio on October 29, 2004 and accordingly the operations of these properties have been consolidated into our consolidated financial statements in 2005.

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Unrealized gain on investments and other

Unrealized gain on investments and other increased by approximately $0.4 million for the year ended December 31, 2005 to $0.9 million from $0.5 million for the 2004 pro forma period. This increase is primarily related to unrealized gains on investments of $0.7 million on the CDO III warehouse agreement and approximately $0.7 million on the CDO V warehouse agreement, offset by $0.5 million of unrealized losses on the CDO VII warehouse. Unrealized gains on investments of $0.5 million for the 2004 profoma period consisted of $0.5 million on the CDO II warehouse agreement and $0.5 million on the CDO III warehouse agreement, offset by $0.4 million of unrealized losses on short sales of securities and $0.1 million on our investments in AAA-rated, short term, floating rate securities.

Unrealized gains on investments relating to each of these CDO warehouse agreements represent the changes in fair value of each warehouse agreement during the portion of the warehouse term included in the financial reporting period.

Realized gain on investments and other

Realized gain (loss) on investments and other for the year ended December 31, 2005 totaled $2.2 million, representing an increase of $1.3 million compared to $0.9 million in the 2004 pro forma period. The increase was attributable to 2005 realized gains of $0.7 million and $0.6 million, representing the increase in fair value related to the net interest income on the accumulated securities during the warehouse period of the CDO III warehouse and CDO V warehouse, respectively. We sold $10 million of our BB junior rated debt securities to the warehouse provider for CDO V, realizing a gain on sale of $0.8 million in the year ended December 31, 2005. In addition, we realized a $0.1 million gain in the year ended December 31, 2005 related to the sale of our investments in AAA-rated, short term, floating rate securities.

Realized gains on investments of $0.9 million for the 2004 pro forma period, of which $0.6 million was related to the CDO II warehouse agreement and $0.3 million related to sales of portions of our AAA-rated, short term, floating rate securities .

Income from discontinued operations, net of minority interest

We sold our interests in 729 Seventh Avenue on June 30, 2005 and sold our fee interest in the property located at 1552 Broadway on November 30, 2005. On December 30, 2005, we entered into a contract to sell our leasehold interest in 27 West 34^th Street and terminate the leasehold interest in 1372 Broadway. Accordingly, these properties' and leashold interests operations were reclassified to income from discontinued operations. The properties and leashold interests were accounted for under the equity method of accounting as part of the New York property portfolio prior to our IPO.

Gain on sale from discontinued operations, net of minority interest

We sold our interests in 729 Seventh Avenue and 1552 Broadway for $29 million and $48 million, respectively, recognizing gains on sale, net of minority interest of $8.6 million and $20.2 million, respectively, for the year ended December 31, 2005. We had no such gain in 2004.

Comparison of 2004 Pro Forma period to the Year Ended December 31, 2003

Revenues

Rental and escalation income

Rental income of approximately $0.5 million represents rental income from ALGM’s tenants during the period October 29, 2004 to December 31, 2004. In 2003 and through our IPO, ALGM was uncombined and our share of ALGM’s operations was reflected in equity in earnings of uncombined ventures. As part of the formation transactions, we acquired the remaining 2.5% interest in ALGM, which is consolidated in our financial statements for the period October 29, 2004 to December 31, 2004.

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Advisory and management fee income

Advisory and management fee income in 2004 increased by $0.1 million, or 50%, to approximately $0.2 million as a result of higher fees earned from third parties due to a larger porfolio in the NSF venture.

Advisory and management fee income -related parties

Advisory and management fee income from related parties in the 2004 pro forma period increased by $2.1 million, or 210%, to approximately $3.1 million as a result of asset advisory fees earned in 2004 for CDO I and CDO II (which had closed in July 2004) of approximately $2.1 million, and approximately $1.0 million in fees earned from the NSF venture due to a larger portfolio balance. Advisory and management fee income from related parties totaling $1.0 million in 2003 includes advisory fees earned for CDO I of $0.5 million for the period August 21, 2003 (date of closing) through December 31, 2003 and approximately $0.5 million from the NSF venture.

Interest income

Interest income increased by $4.0 million, representing an increase of $4.0 million compared to the year ended December 31, 2003. The interest income earned in the pro forma period 2004 includes approximately $3.4 million earned from our investments in AAA-rated, short-term, floating rate securities which are backed by commercial or residential mortgage loans with proceeds from our initial public offering, interest income of approximately $0.4 million on the three subordinate real estate debt investments made on our balance sheet subsequent to our IPO and $0.2 million on cash collateralizing our short security sales and other investments. In 2003, all interest income related to our investment in our first CDO transaction, CDO I, which closed in August 2003.

Interest income -related parties

Interest income - related parties increased by $2.1 million, to approximately $2.6 million, from $0.5 million in 2003. The interest income earned in 2004 includes interest income on debt securities available for sale of approximately $2.6 million, which is comprised of approximately $1.2 million of interest earned on CDO I and $1.4 million of interest income earned on our investment in the "BB" rated junior classes of debt securities and unrated income securities of CDO II, which closed in July 2004. In 2003, all interest income related to our investment in our first CDO transaction, CDO I, which closed in August 2003.

Expenses

Real estate property operating expenses, management fees and depreciation and amortization expense

Real estate property expenses of $0.1 million, management fees (related party) of $0.1 million, and depreciation and amortization expense of $0.2 million relate to the ALGM properties for the period October 29, 2004 to December 31, 2004. Included in the related party management fee is a non-recurring termination payment of $0.4 million related to the termination of our previous management agreement. In 2003 and through our IPO, ALGM was uncombined and our share of ALGM’s operations was reflected in equity in earnings of uncombined ventures. As part of the formation transactions, we acquired the remaining 2.5% managing equity interest in ALGM, which is consolidated in our financial statements for the period October 29, 2004 to December 31, 2004.

Interest expense

Interest expense for the year ended December 31, 2004 totaled approximately $3.6 million, while we did not incur any interest expense in 2003. Interest expense in 2004 is comprised of interest on reverse repurchase obligations with major banking institutions totaling approximately $3.1 million, which were used to finance our investments in AAA-rated, short-term, floating rate securities and our investment in the "BB" rated junior classes of debt securities and unrated income securities of CDO II. In addition, we incurred interest expense of approximately $0.1 million related to ALGM’s mortgage as well as interest on capital leases for the period October 29, 2004 to December 31, 2004 and approximately $0.4 million of interest expense on the securities underlying the short sales we entered into during 2004.

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General and administrative expenses

General and administrative expenses for the 2004 pro forma period totaled $11.3 million, representing an increase of $6.3 million, or 126%, compared to $5.0 million for the year ending December 31, 2003. The increase was comprised of the following:

Salary expense increased by approximately $1.4 million, or 41%, to approximately $4.8 million for the pro forma period ended December 31, 2004. The increase is primarily related to an increase in allocated salaries in 2004 as compared to 2003, due to higher staffing levels to accommodate the expansion of our three businesses.

Shared services - related party for the 2004 profoma period totaled $0.2 million, representing an increase of approximately $0.2 million compared to the year ending December 31, 2003. The increase was attributable to the shared facilities and services agreement we entered into with NorthStar Capital on October 29, 2004.

Equity based compensation expense of $3.0 million for the 2004 pro forma period relates to the following formation transactions in connection with our IPO as follows: approximately $1.6 million of compensation expense was recognized in connection with the buyout of a 15% profits interest (which was a compensation arrangement) in NS Advisors from one of its employees, approximately $1.0 million of compensation expense was recognized in connection with the buyout of a 25% profits interest in Northstar Funding Managing Member, LLC, which was held by two former employees of NorthStar Capital, and approximately $0.4 million has been charged to compensation expense in connection with the three-year vesting of equity based awards issued in connection with our IPO under our Omnibus Stock Incentive Plan.

Insurance (direct and allocated) for the 2004 pro forma period totaled $0.5 million, representing an increase of $0.2 million, or 67%, compared to $0.3 million of allocated costs for the year ending December 31, 2003. The increase was attributable to direct costs incurred for directors and officers policies we acquired subsequent to the IPO in 2004.

Auditing and professional fees for the 2004 pro forma period totaled $0.8 million, representing an increase of $0.8 million compared to the year ended December 31, 2003. The increase was attributable to direct professional fees of $0.5 million incurred in connection with quarterly review services performed by our auditors and $0.3 million of legal and other professional fees.

We incurred approximately $0.5 million of expenses in connection with our formation and organization in the 2004 pro foma period.

Other general and administrative expenses for the 2004 pro forma period increased by approximately $0.2 million, or 15%, to approximately $1.5 million compared to the year ending December 31, 2003. This increase is primarily related to various public company expenses, including director fees, organizational costs, as well as general and administrative costs associated with ALGM, which is consolidated in our financial statements from October 29, 2004.

Equity in earnings of unconsolidated/uncombined ventures

Equity in earnings for the 2004 pro forma period totaled $1.6 million, representing a decrease of $0.4 million or 20%, compared to $2.0 million for the year ended December 31, 2003. The decrease was attributable to the equity in earnings in ALGM which decreased by $0.6 million. The results for 2004 represent our 97.5% share of the earnings prior to October 29, 2004. Subsequent to October 29, 2004, when we acquired the remaining 2.5% managing membership interest, ALGM was consolidated in our financial statements.

This decrease was offset by our increase in equity in earnings from the NSF venture of approximately $0.2 million for the 2004 pro forma period. The net income of the NSF venture increased due to higher interest income earned for all of 2004 on loan participations that closed late in 2003, in addition to the closing of a new loan in September 2004.

Unrealized gain on investments and other

Unrealized gain on investments and other for the 2004 pro forma period decreased by approximately $0.7 million compared to $1.2 million for the year ended December 31, 2003. Unrealized gains on investments in the 2004 pro forma period consisted of unrealized gains of $0.5 million on the CDO III warehouse agreement and approximately $0.5 million on the CDO II warehouse agreement, offset by $0.4 million of unrealized losses on short sales of securities and $0.1 million on our investments in AAA-rated, short term, floating rate securities .

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There were $1.2 million of unrealized gains, of which $1.0 million related to CDO I and $0.2 million related to CDO II in 2003. The CDO I gains represented the increase in fair value of the warehouse agreement from January 1, 2003 through August 21, 2003, the day the warehouse agreement was terminated and the underlying securities were transferred into CDO I. Similarly, the CDO II unrealized gain represents the change in the fair value of the warehouse agreement.

Realized gain on investments and other

Realized gains on investments and other decreased by approximately $1.0 million from $1.9 million in 2003 to $0.9 million in the 2004 pro forma period. Realized gains for the 2004 pro forma period consisted of a $0.3 million gain related to the sale of a portion of our temporary investments in AAA-rated, short-term, floating rate securities and a $0.6 million gain representing the increase in fair value of the CDO II warehouse agreement from January 1, 2004 through July 2004 when the warehouse agreement terminated. In 2003, the realized gain of $1.9 million related to the increase in fair value of the CDO I warehouse agreement from January 1, 2003 through August 2003 when the warehouse agreement terminated.

Minority Interest

Minority interests were approximately $0.6 million for the 2004 pro forma period as a result of allocating approximately 21% of the consolidated loss before minority interests to the limited partner unit holders in our operating partnership for the period October 29, 2004 to December 31, 2004, (“Unit holders”). There was no minority interest in our Predecessor for the year ended December 31, 2003 through the date of our IPO.

Liquidity and Capital Resources

As of December 31, 2005, we had a unrestricted cash and cash equivalents balance of $27.9 million. As a REIT, we are required to distribute at least 90% of our annual REIT taxable income to our stockholders, and we intend to distribute all or substantially all of our REIT taxable income in order to comply with the REIT distribution requirements of the Internal Revenue Code and to avoid federal income tax and the nondeductible excise tax. We believe that our unrestricted cash balances together with the available borrowing capacity under our existing credit facilities, proceeds from the sale of assets, proceeds from private placement of trust preferred securities and cash flow provided from our operations, will be sufficient to allow us to fund the equity portion of our new investments, make distributions necessary to enable us to continue to qualify as a REIT and fund our operations for at least the next 12 months. In order to fund investments that we may make in the next 12 months, we may borrow additional funds under our current credit facilities, issue debt securities or raise additional equity capital.

We expect to meet our long term liquidity requirements, including the repayment of debt and our investment funding needs, through existing cash resources and additional borrowings, the issuance of debt and/or equity securities and the liquidation or refinancing of assets.

Debt Obligations

As of December 31, 2005, we had the following debt outstanding:

	Carrying Amount at 12/31/05 (in thousands)	Stated Maturity	Interest Rate	Weighted Average Expected Life (in years)
Mortgage notes payable (non-recourse):
Chatsworth	$43,777	5/1/2015	5.65%	9.34
Salt Lake City	16,919	9/1/2012	5.16%	6.67
EDS	49,120	10/8/2015	5.37%	9.78
Executive Centre	51,480	01/1/2016	5.85%	10.01
Mezzanine loan payable (Chatsworth) (non-recourse)	13,000	5/1/2014	6.64%	8.34
Repurchase obligations	7,054	See Repurchase Obligations below	LIBOR + 0.6% to 1.25%	Various, generally 30 days
CDO Bonds Payable (CDO IV) (non-recourse)	300,000	7/1/2040	LIBOR + 0.62% (Average Spread)	8.0
Wachovia credit facility	243,002	7/12/2008	LIBOR + 0.2% to 2.5%	2.53
Bank of America credit facility	-	09/27/2006	LIBOR + 3.25%	0.74
Liability to subsidiary trusts issuing preferred securities
Trust I	41,240	3/30/2035	8.15%	—
Trust II	25,780	6/30/2035	7.74%	—
Trust III	41,238	1/30/2036	7.81%	—
DBAG facility	—	12/21/2007	LIBOR + 0.75% to 2.25%	1.97
	$832,610

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Chatsworth Mortgage Loan.    The Chatsworth mortgage matures on May 1, 2015 and bears interest at a fixed rate of 5.65%. This non-recourse loan requires monthly payments of $230,906, representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $40.5 million at maturity, as well as monthly escrow deposits for ground lease payments required under the ground lease for the leasehold property.

Salt Lake City Mortgage Loan.    The Salt Lake City Mortgage matures on September 1, 2012 and bears interest at a fixed rate of 5.16%. This non-recourse loan requires monthly payments of $100,971, representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $14.32 million at maturity, as well as monthly escrow deposits for real estate taxes.

EDS Mortgage Loan.    The EDS Mortgage matures on October 8, 2015 and bears interest at a fixed rate of 5.373%. This non-recourse loan requires monthly payments of $274,997, representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $41.91 million at maturity, as well as monthly escrow deposits for real estate taxes.

Executive Centre Mortgage Loan.    The Executive Centre Mortgage matures on January 1, 2016 and bears interest at a fixed rate of 5.851%. This non-recourse loan requires monthly payments of $303,732, representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $48.1 million at maturity, as well as monthly escrow deposits for real estate taxes.

Chatsworth Mezzanine Loan.    This non-recourse loan bears interest at a fixed rate of 6.64%, and requires monthly payments of interest only of $71,955 for the period February 1, 2005, through February 1, 2006, and principal and interest payments of $170,914, thereafter, which will fully amortize the loan by the maturity date of May 1, 2014.

Repurchase Obligations.    We have $7.1 million of repurchase agreements with two counterparties. These repurchase agreements are used to finance certain investments on a short term basis, prior to their sale or transfer to one of our CDOs to finance these assets on a permanent basis. These repurchase obligations mature in less than thirty days, with interest rates of LIBOR plus 0.05% to 0.07%.

Wachovia Facility.    On July 13, 2005, our wholly owned subsidiary NRFC WA Holdings, LLC, or NRFC WA, entered into a master repurchase agreement, which we refer to as the Wachovia facility, with Wachovia Bank, National Association, or Wachovia. The Wachovia facility was amended in September 2005 and currently NRFC WA may borrow up to $400 million under this credit facility in order to finance the acquisition of primarily subordinate real estate debt and other real estate loans and securities. The additional capacity and flexiblility under the amendment will allow us to accumulate sufficient collateral for a contemplated real estate debt CDO, or CDO VI, and to continue to finance other investments.

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Advance rates under the Wachovia facility range from 55% to 95% (subject to increase under certain circumstances) of the value of the assets for which the advance is to be made. Amounts borrowed under the Wachovia facility bear interest at one-month LIBOR plus a spread which ranges from 0.20% to 3.00%, depending on the type of asset for which the amount is borrowed. The Wachovia facility has an initial maturity date of July 12, 2008, except that certain advances under the Wachovia facility were required to be repaid by February 24, 2006. If a securitization transaction is not consummated by March 30, 2006, certain advances under the facility will be subject to commitment and unused facility fees. The Company has agreed to a limited guarantee for the amounts borrowed by NRFC WA under the Wachovia facility.

NRFC WA may extend the term of the Wachovia facility for one year if it is not in default and must pay an extension fee of 0.25% of the aggregate amount then outstanding under the facility. If NRFC WA extends the facility's term, it will be required to retire 25% of the aggregate amount then outstanding under the facility during each quarter of the remaining year of the term.

The debt outstanding under the Wachovia facility is subject to a number of terms, conditions and restrictions including, without limitation, scheduled interest payments and the maintenance of certain margin percentages on amounts outstanding under the facility. If the market value of an asset securing outstanding debt under the Wachovia facility declines, NRFC WA may be required to satisfy a margin call by paying cash or providing additional collateral. Failure to meet any margin call could result in an event of default which would enable Wachovia to exercise various rights and remedies including acceleration of the maturity date of the debt outstanding under the facility and the sale of the collateral. Following September 30, 2005, an affiliate of NRFC WA was added as a borrower under the Wachovia facility.

As of December 31, 2005, NRFC WA and its affiliates had $243.0 million of borrowings outstanding under this facility.

Bank of America Facility.    On September 28, 2005, we entered into a master loan, guarantee and security agreement with Bank of America, N.A., our operating partnership and NS Advisors LLC, which we refer to as the Bank of America facility. The Bank of America facility provides for an unsecured, $50 million revolving credit facility. The term of the unsecured facility is one year, with up to two one-year extensions at the discretion of Bank of America. If the unsecured facilty is not extended by Bank of America, we have the option in lieu of immediate repayment to amortize the outstanding principal balance of the unsecured facility in equal quarterly installments over twelve months upon payment of a quarterly 12.5 basis point fee on the outstanding balance under the unsecured facility at September 27, 2006 and each quarter thereafter. The interest rate on the unsecured facility is LIBOR, plus 325 basis points.

The Bank of America facility contains certain covenants, including, among other things, financial covenants requiring the Company to have minimum cash liquidity, minimum tangible net worth, maximum debt to tangible net worth and minimum debt service coverage. The Bank of America facility also contains certain customary representations and warranties and events of default. The obligations of our operating partnership, which is the borrower under the unsecured facility, are guaranteed by us, NS Advisors LLC and each of our respective subsidiaries and any subsidiary of our operating partnership whose assets are included in the borrowing base for the unsecured facility.

At December 31, 2005, we had no borrowings outstanding under the Bank of America facility.

Liability to Subsidiary Trusts Issuing Preferred Securities.    On April 12, 2005, May 25, 2005, and November 22, 2005 NorthStar Realty Finance Trust, NorthStar Realty Finance Trust II and NorthStar Realty Finance Trust III, which we refer to as the Trusts, sold, in three private placements, trust preferred securities for an aggregate amount of $40 million, $25 million, and $40 million, respectively. We own all of the common stock of the Trusts. The Trusts used the proceeds to purchase our operating partnership’s junior subordinated notes due March 30, 2035, June 30, 2035 and January 30, 2036, respectively, which represent all of the Trusts' assets. The terms of the junior subordinated notes are substantially the same as the terms of the trust preferred securities. The trust preferred securities have fixed interest rates of 8.15%, 7.74% and 7.81% per annum, respectively, during the first ten years, after which the interest rate will float and reset quarterly at the three-month LIBOR rate plus 3.25% per annum, for Trust I and II, and 2.83% for Trust III.

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We may redeem the notes, in whole or in part, for cash, at par, after March 30, 2010, June 30, 2010, and January 30, 2011, respectively. To the extent we redeem the notes, the Trusts are required to redeem a corresponding amount of trust preferred securities. On September 16, 2005, we amended the trust agreements and indentures for Trust I and II to modify some of the payment dates for a portion of the junior subordinated notes and trust preferred securities.

The ability of the Trusts to pay dividends depends on the receipt of interest payments on the notes. We have the right, pursuant to certain qualifications and covenants, to defer payments of interest on the notes for up to nine consecutive quarters. If payment of interest on the notes is deferred, the Trusts will defer the quarterly distributions on the trust preferred securities for a corresponding period. Additional interest accrues on deferred payments at the annual rate payable on the notes, compounded quarterly.

DBAG Facility and CDO Bonds Payable.    On December 21, 2004, NRFC DB Holdings, LLC, one of our subsidiaries, entered into a $150 million master repurchase agreement with Deutsche Bank AG, Cayman Islands Branch, which we refer to as the DBAG facility. On March 21, 2005, the DBAG facility was amended and restated to allow NRFC DB Holdings to borrow up to $300 million in order to finance the acquisition of primarily subordinate real estate debt and other real estate loans and securities. The additional capacity and flexibility under the amendment of the DBAG facility allowed us to accumulate sufficient collateral for CDO IV, and to continue to finance other investments.

On June 14, 2005, we closed CDO IV and issued $300 million face amount of the CDO bonds which were sold in a private placement to third parties. The proceeds of the CDO IV issuance were used to repay the entire outstanding principal balance of the DBAG facility of $233.6 million at closing. The availability under the DBAG facility was reduced to $150 million subsequent to the closing of CDO IV.

The DBAG facility has an initial three-year term, which may be extended for one additional year if NRFC DB Holdings is not in default and pays an extension fee of 0.25% of the aggregate outstanding amount under the facility. If NRFC DB Holdings extends the term of the facility, it will be required to retire 25% of the aggregate outstanding amount each quarter during the remaining year of the term.

Under the terms of the DBAG facility, NRFC DB Holdings is able to finance the acquisition of mortgage loans secured by first liens on commercial or multifamily properties, junior participation interests in mortgage loans secured by first or second liens on commercial or multifamily properties, mezzanine loans secured by a pledge of the entire ownership interest in a commercial or multifamily property, B− or higher rated CMBS and BB or higher rated real estate CDOs, debt securities issued by a REIT and syndicated bank loans.

During the period from March 21, 2005 through June 14, 2005, amounts advanced under the DBAG facility in order to finance the acquisition of assets that were included in CDO IV bore interest at one-month LIBOR plus a spread of 1.00% and amounts advanced for all other assets bore interest at one-month LIBOR plus a spread which ranges from 0.75% to 2.25%. After June 14, 2005, all amounts advanced under the amended DBAG facility bear interest at a rate of one-month LIBOR plus the spread which ranges from 0.75% to 2.25%. Assets will be financed at advance rates ranging from 40% to 92.5% of the value of the assets as applicable to the asset category.

Effective April 1, 2005, the covenants under the DBAG facility require us to maintain a certain minimum tangible net worth, a certain minimum debt service coverage ratio, a certain range of ratios of recourse indebtedness to net worth and certain minimum amounts of cash or marketable securities based on our ratio of recourse indebtedness to net worth.

The debt that may be outstanding under the DBAG facility is subject to a number of terms, conditions and restrictions including, without limitation, the maintenance of certain margin percentages on amounts outstanding under the facility. If the market value of an asset securing the outstanding debt declines, cash flow due NRFC DB Holdings may be suspended and if market value continues to decline, NRFC DB Holdings may be required to satisfy a margin call by paying cash or providing additional collateral. Failure to meet any margin call could result in an event of default which would enable Deutsche Bank AG to exercise various rights and remedies including acceleration of the maturity date of the debt outstanding under the DBAG facility or the sale of the assets financed thereunder.

At December 31, 2005, we were in compliance with all covenants under our debt obligations.

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Capital Expenditures

During 2006, we do not expect to incur any material capital expenditures with respect to our net lease portfolio, since most of these expenses are the obligations of our tenants.

Cash Flows

Year Ended December 31, 2005 Compared to 2004 Pro Forma Period

To facilitate a comparison of cash flows for the year ending December 31, 2005 to the prior year, we have combined our predecessor's cash flows for the period from January 1, 2004 to October 28, 2004 with our cash flows for the period from October 29, 2004 to December 31, 2004.

The net cash flow provided by operating activities of $848.7 million increased $1,675.1 million for the year ended December 31, 2005 from a use of $826.4 million of cash for the 2004 pro forma period. This increase was primarily due to sales of all short-term highly liquid investments of $826.4 million in 2005, which we had acquired in the 2004 pro forma period. The corresponding repayment of short term repurchase financing was included in financing activities.

The net cash flow used in investing activities of $880.2 million increased by $753 million for the year ended December 31, 2005 from a use of $127.2 million for the 2004 pro forma period. Net cash used in investing activities in 2005 consisted primarily of the purchase of operating real estate, funds used to purchase debt securities available for sale, real estate debt investments, as well as funding of new warehouse deposits for our CDOs.

The net cash flow provided by financing activities of $11.6 million decreased by $988.7 million for the year ended December 31, 2005 from $1,000.3 million of cash flow provided by financing activities for the pr forma period ended December 31, 2004. The primary use of cash flow in financing activities in 2005 was for the repayment of our repurchase agreements which financed our short term, highly liquid investments, the repayment of the DBAG facility in connection with the closing of CDO IV, the repayment of a portion of the existing mortgage on the ALGM portfolio in connection with the sales of 729 Seventh Avenue and 1552 Broadway and payments of dividends and distributions to our unit holders of $14.2 million. This was offset by proceeds from our secondary offering, the issuance of CDO IV bonds, issuance of trust preferred securities and our mortgage and credit faciility borrowings.

2004 Pro Forma Period Compared to Year Ended December 31, 2003

The net cash flow used in operating activities of $826.3 million for the pro forma period ended December 31, 2004 decreased by $827.6 million, from $1.3 million of cash provided by operations for the year ended December 31, 2003, primarily due to the required inclusion of purchases of short-term highly liquid investments in operating activities, where the corresponding short-term repurchase financing is included in financing activities. Adjusting for the effect of these purchases, cash provided from operating activities would have only decreased $0.8 million from the 2004 prp forma period to 2003.

The net cash flow used in investing activities increased by $117.4 million for the pro forma period ended December 31, 2004 to a use of $127.2 million from a use of $9.8 million for the year ended December 31, 2003. Net cash used in investing activities in 2004 consisted primarily of purchases of real estate and interests in entities in connection with our IPO, funds used to purchase our interest in the unrated income and the "BB" rated notes of CDO II, as well as purchases of subordinate debt investments.

The net cash flow provided by financing activities increased by $990.7 million for the pro forma period ended December 31, 2004 to $1.0 billion from $9.6 million from financing activities for the year ended December 31, 2003. The primary sources of cash flow from financing activities in 2004 were our net proceeds from our repurchase agreements and credit facility, net IPO proceeds, loan proceeds to finance CDO II and contributions by owners, prior to our IPO.

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Recent Developments

Real Estate Debt Investments

The following summarizes real estate debt investments acquired from January 1, 2006 through March 7, 2006, (dollars in thousands):

January 1, 2006 through March 7, 2006	Carrying Value (in thousands)		Allocation by Investment Type			Average Spread Over LIBOR			Average Fixed Rate			Number of Investments
Whole loans, floating rate	$	92,335		54.0	%		3.33	%		—			5
Whole loans, fixed rate		—		—			—			—			—
Mezzanine loans, floating rate		66,580		39.0	%		9.34	%		—			2
Mezzanine loan, fixed rate		11,880		7.0	%		—			8.00	%		1
Total / Average	$	170,795		100.0	%		5.86	%		8.00	%		8

Timarron Acquisition

On October 20, 2005, we entered into a definitive purchase agreement with Allied Capital Corporation to acquire Timarron Capital Corporation. Timarron, based in Dallas, Texas, was organized by former senior executives of Principal Financial and other leading financial institutions to develop a nationwide commercial mortgage loan origination platform. We closed on the acquisition on January 19, 2006. The purchase price was approximately $2.7 million. Timarron was renamed and reorganized as NRF Capital LP. NRF Capital LP will originate commercial mortgage loans for our commercial real estate debt portfolio.

NSF Venture Sale

On February 1, 2006, we sold our interests in the the NSF venture to the NSF venture investor and terminated the associated advisory agreements for total consideration of $2.9 million.  We will recognize approximately $1.2 million of incentive income which had been deferred at December 31, 2005. Subsequent to January 31, 2006, we will no longer earn management or incentive fees from the NSF venture or from loans owned directly by the NSF venture investor.

Net Lease Properties

On January 31, 2006, we sold our leasehold interests in 27 West 34^th Street and 1372 Broadway, both in New York City, for $2.3 million. We anticipate recognizing a gain on sale of approximately $200,000 in the first quarter of 2006.

Quantum Joint Venture

In February 2006, through a 50% owned joint venture interest with Cushman & Wakefield Net Lease Trust, we acquired a portfolio of three adjacent class A office/flex buildings located Colorado Springs, CO, with 406,204 square feet of rentable space for $54.25 million. The properties are 100% leased to Quantum Corp. under leases expiring in 2021 (59%), 2013 (11%), 2011 (13%) and 2009 (17%).

Private Placement

On March 10, 2006, our subsidiary, NorthStar Realty Finance Trust IV, completed a private placement of $50 million of trust preferred securities. The sole assets of the trust consist of a like amount of junior subordinated notes due June 30, 2036 issued by our operating partnership and guaranteed by us.  The proceeds of the issuance of the notes were used to repay short term debt and to fund new investments. These trust preferred securities and the notes both have a 30-year term, ending June 30, 2036, and bear interest at a fixed rate of 7.95% for the first ten years, ending June 2016, whereupon the rate floats at three-month LIBOR plus 2.80%. These securities are redeemable at par beginning on June 30, 2011.

Dividends

On January 26, 2006, we declared a cash dividend of $0.27 per share of common stock. The dividend was paid on February 10, 2006 to the shareholders of record as of the close of business on February 3, 2006.

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Contractual Commitments

As of December 31, 2005, we had the following contractual commitments and commercial obligations (in thousands):

	Payments Due by Period
Contractual Obligations	Total		Less than 1 year		1-3 years		3-5 years		After 5 years
Mortgage loan - Chatsworth	$	43,777	$	271	$	584	$	663	$	42,259
Mortgage loan - Salt Lake City		16,919		335		722		803		15,059
Mortgage loan - EDS		49,120		103		1,320		1,479		46,218
Mortgage loan - Executive Centre		51,480		—		—		—		51,480
Mezzanine loan payable - Chatsworth		13,000		1,015		2,676		3,055		6,254
Repurchase agreements		7,054		7,054		—		—		—
Securities sold, not yet purchased
CDO bonds payable		300,000		—		—		—		300,000
Liability to subsidiary trusts issuing preferred securities		108,258		—		—		—		108,258
Wachovia facility		243,002		—		243,002		—		—
Bank of America facility		—		—		—		—		—
Capital leases(1)		17,778		353		807		974		15,644
Operating leases		17,088		967		994		994		14,133
Total contractual obligations	$	867,476	$	10,098	$	250,105	$	7,968	$	599,305

⁽¹⁾ Includes interest on the capital leases.

Off Balance Sheet Arrangements

As of December 31, 2005, we had the material off balance sheet arrangements described below.

Our potential losses in CDO I, CDO II, CDO III and CDO V are limited to our aggregate carrying value which was approximately $90.1 million at December 31, 2005.

The terms of the portfolio of real estate securities held by CDO I, CDO II, CDO III and CDO V are structured to be matched with the terms of the non-recourse CDO liabilities. These CDO liabilities are repaid with the proceeds of the principal payments on the real estate securities collateralizing the CDO liabilities when these payments are actually received. There is no refinancing risk associated with the CDO liabilities, as principal is only due to the extent that it has been collected on the underlying real securities and the stated maturities are noted above. CDOs produce a relatively predictable income stream based on the spread between the interest earned on the underlying securities and the interest paid on the CDO liabilities. This spread may be reduced by credit losses on the underlying securities or by hedging mismatches. CDO I, CDO II, CDO III and CDO V have not incurred any losses on any of their securities investments from the date of purchase through December 31, 2005. We receive quarterly cash distributions from CDO I and monthly cash distributions from CDO II, CDO III and CDO V, each representing our proportionate share of the residual cash flow from the CDOs, as well as collateral advisory fees and interest income on the unrated income notes of CDO II, CDO III and CDO V. Our residual interests in the cash flows of these CDOs are accounted for as debt securities pursuant to EITF Topic 99-20.

The following table describes certain terms of the collateral for and the notes issued by CDO I, CDO II, CDO III and CDO V as of December 31, 2005:

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	CDO Collateral							CDO Notes
	Par Value of CDO Collateral (in ’000s)		Weighted Average Interest Rate			Weighted Average Expected Life (years)		Outstanding CDO Notes(1) (in ’000s)		Weighted Average Interest Rate			Stated Maturity
CDO I	$	352,041		6.62	%		6.01	$	332,831		6.13	%		8/1/2038
CDO II	$	392,841		6.25	%		6.65	$	356,170		5.58	%		6/1/2039
CDO III	$	401,790		6.06	%		6.69	$	360,973		5.59	%		6/1/2040
CDO V	$	500,969		5.69	%		9.08	$	461,500		2.89	%		9/5/2045

⁽¹⁾ Includes only notes held by third parties.

CDO I, CDO II, CDO III and CDO V are variable interest entities. However, management has determined that we are not, and our predecessor was not, the primary beneficiary of CDO I, CDO II, CDO III or CDO V and as such, in accordance with FIN 46R, we did not consolidate CDO I, CDO II, CDO III or CDO V. The FASB has continued to discuss potential refinements to FIN 46R associated with, among other things, the types of interests which create variability and which type of interests absorb income and loss variability, and how such income and loss variability should be measured. In the event that the FASB modifies its interpretation of FIN 46R as it applies to the consolidation of variable interest entities, we would reevaluate our determination of the primary beneficiary. Depending on the modifications which are made, it is possible that we may be required to consolidate our interests in our CDOs in the future.

At this time, we do not anticipate a substantial risk of incurring a loss with respect to any of the arrangements described above.

Warehouse Agreement for CDO VII

On September 27, 2005, we entered into a warehouse arrangement with a major commercial bank whereby the bank has agreed to purchase up to $400 million of CMBS and other real estate debt securities under our direction, with the expectation of selling such securities to our fifth investment grade CDO issuance, or CDO VII. As of December 31, 2005, we have deposited $10.0 million as security for the purpose of covering a portion of any losses or costs associated with the accumulation of these securities under the warehouse agreement and will be required to deposit additional equity based on accumulations of securities that will be made under the warehouse agreement. The bank had accumulated $156.4 million of real estate securities under the terms of the warehouse agreement as of December 31, 2005. The CDO VII warehouse agreement also provides for our notional participation in the income that the assets generate after deducting a notional debt cost.

Inflation

Our leases for tenants of operating real estate are either:

• net leases where the tenants are responsible for all real estate taxes, insurance and operating expenses and the leases provide for increases in rent either based on changes in the Consumer Price Index, or CPI, or pre-negotiated increases; or

• operating leases which provide for separate escalations of real estate taxes and operating expenses over a base amount, and/or increases in the base rent based on changes in the CPI.

We believe that inflationary increases in expenses will generally be offset by the expense reimbursements and contractual rent increases described above to the extent of occupancy.

We believe that the risk associated with an increase in market interest rates on the floating rate debt used to finance our investments in our investment grade CDOs and our direct investments in real estate debt, is largely offset by our strategy of matching the terms of our assets with the terms of our liabilities and through our use of hedging instruments.

See “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of the Annual Report on Form 10-K for additional information on our exposure to market risk.

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Funds from Operations and Adjusted Funds from Operations

Management believes that funds from operations, or FFO, and adjusted funds from operations, or AFFO, each of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income or loss (computed in accordance with GAAP), excluding gains or losses from sales of depreciable properties, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, and after adjustments for unconsolidated/uncombined partnerships and joint ventures. AFFO is a computation often made by REIT industry analysts and investors to measure a real estate company's cash flow generated from operations. We believe that AFFO is helpful to investors as a measure of our liquidity position because, along with cash generated from operating activities, this measure provides investors with an understanding or our ability to pay dividends. In addition, because this measure is commonly used in the REIT industry, our use of AFFO may assist investors in comparing our liquidity position with that of other REITs. We calculate AFFO by subtracting from (or adding) to FFO:

• normalized recurring expenditures that are capitalized by us and then amortized, but which are necessary to maintain our properties and revenue stream, e.g., leasing commissions and tenant improvement allowances;

• an adjustment to reverse the effects of straight-lining of rents and fair value lease revenue under SFAS 141; and

• the amortization or accrual of various deferred costs including intangible assets and equity based compensation.

Our calculation of AFFO differs from the methodology used for calculating AFFO by certain other REITs and, accordingly, may not be comparable to such other REITs.

We believe that FFO and AFFO are additional appropriate measures of our operating performance because they facilitate an understanding of our operating performance after adjustment for certain non-cash expenses, such as real estate depreciation, which assumes that the value of real estate assets diminishes predictably over time. Since FFO is generally recognized as industry standards for measuring the operating performance of an equity REIT, we also believe that FFO provides investors with an additional useful measure to compare our financial performance to other REITs.

Neither FFO nor AFFO is equivalent to net income or cash generated from operating activities determined in accordance with GAAP. Furthermore, FFO and AFFO do not represent amounts available for management's discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Neither FFO nor AFFO should be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.

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	The Company		The Company			The Predecessor
	Year Ended December 31, 2005		October 29, 2004 to December 31, 2004			January 1, 2004 to October 28, 2004		2003
Funds from operations:
Income (loss) before minority interests	$	10,389,000	$	(3,073,000	)	$	1,194,000	$	1,737,000

Adjustments:
Depreciation and amortization		4,352,000		190,000			—		—
Funds from discontinued operations		1,458,000		145,000			—		—
Real estate depreciation and amortization - unconsolidated ventures		—		—			1,608,000		2,204,000
Funds from operations	$	16,199,000	$	(2,738,000	)	$	2,802,000	$	3,941,000

Adjusted funds from operations:
Funds from Operations		16,199,000		$	(2,738,000	)	$	2,802,000		$	3,941,000
Straightline rental income, net		(252,000	)		(18,000	)		—			—
Straightline rental income - unconsolidated ventures		—			—			(456,000	)		(654,000	)
Straightline rental income, discontinued operations		(281,000	)		(133,000	)		—			—
Fair value lease revenue (SFAS 141 adjustment)		18,000			—			—			—
Amortization of deferred compensation		5,847,000			2,991,000			—			—
Adjusted funds from operations(1)	$	21,531,000		$	102,000		$	2,346,000		$	3,287,000

⁽¹⁾ FFO and AFFO for the period from October 29, 2004 through December 31, 2004 have been reduced by one-time formation and organization costs of $517,000.

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ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the exposure to loss resulting from changes in interest rates and equity prices. We are subject to credit risk and interest rate risk with respect to our investments in real estate debt and real estate securities. The primary market risk that we are exposed to is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Our interest rate risk sensitive assets, liabilities and related derivative positions are generally held for non-trading purposes. As of December 31, 2005, a hypothetical 100 basis point increase in interest rates applied to our variable rate assets would increase our annual interest income by approximately $6,888,000, offset by an increase in our interest expense of approximately $5,430,000 on our variable rate liabilities.

Real Estate Debt

We invest in real estate debt instruments secured by commercial and multifamily properties, including first lien mortgage loans, junior participations in first lien mortgage loans, which we also refer to as senior mortgage loans, second lien mortgage loans, mezzanine loans, and preferred equity interests in borrowers who own such properties. We generally hold these instruments for investment rather than trading purposes. These investments are either floating or fixed rate. The interest rates on our floating rate investments typically float at a fixed spread over an index such as LIBOR. These instruments typically reprice every 30 days based upon LIBOR in effect at that time. Given the frequent and periodic repricing of our floating rate investments, changes in interest rates are unlikely to affect the value of our floating rate portfolio. Changes in short-term rates will, however, affect earnings from our investments. Increases in LIBOR will increase the interest income received by us on our investments and therefore increase our earnings. Decreases in LIBOR have the opposite effect.

We also invest in fixed rate investments. The value of these investments may be affected by changes in long-term interest rates. To the extent that long-term interest rates increase, the value of long-term fixed rate assets is diminished. Any fixed rate real estate debt investments which we hold would be similarly impacted. We do not generally seek to hedge this type of risk unless the asset is leveraged as the costs of such a hedging transaction over the term of such an investment would generally outweigh the benefits. If fixed rate real estate debt is funded with floating rate liabilities, the funding cost will be fixed through the use of interest rate swaps, caps or other hedges. Because the interest rates on our fixed rate investments are generally fixed through maturity of the investment, changes in interest rates do not affect the income we earn from our fixed rate investments.

In our real estate debt business we are also exposed to credit risk, which is the risk that the borrower under our loan agreements cannot repay its obligations to us in a timely manner. While we have never experienced a payment default or even a late payment as of the date of this Annual Report on Form 10-K, our position in the capital structure may expose us to losses as a result of such default in the future. In the event that the borrower cannot repay our loan, we may exercise our remedies under the loan documents which may include a foreclosure against the collateral if we have a foreclosure right as a real estate debtholder under the loan agreement. The real estate debt that we intend to invest in will often allow us to demand foreclosure as a real estate debtholder if our loan is in default. To the extent the value of our collateral exceeds the amount of our loan (including all debt senior to us) and the expenses we incur in collecting on our loan, we would collect 100% of our loan amount. To the extent that the amount of our loan plus all debt senior to our position exceeds the realizable value of our collateral, then we would incur a loss. We also incur credit risk in our periodically scheduled interest payments which may be interrupted as a result of the operating performance of the underlying collateral.

We seek to manage credit risk through a thorough financial analysis of a transaction before we make such an investment. Our analysis is based upon a broad range of real estate, financial, economic and borrower-related factors which we believe are critical to evaluating the credit risk inherent in a transaction.

We expect our investments to be denominated in U.S. dollars or, if they are denominated in another currency, to be converted back to U.S. dollars through the use of currency swaps. It may not be possible to eliminate all of the currency risk as the payment characteristics of the currency swap may not exactly match the payment characteristics of the investments.

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Real Estate Securities

In our real estate securities business, we mitigate credit risk through credit analysis, subordination and diversification. The CMBS we invest in are generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate classes of securities or other form of credit support within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect comparable credit risk. Credit risk refers to each individual borrower's ability to make required interest and principal payments on the scheduled due dates. We believe that these securities offer attractive risk-adjusted returns with reasonable long-term principal protection under a variety of default and loss scenarios. While the expected yield on these securities is sensitive to the performance of the underlying assets, the more subordinated securities and certain other features of a securitization, in the case of mortgage backed securities, and the issuer's underlying equity and subordinated debt, in the case of REIT securities, are designed to bear the first risk of default and loss. The real estate securities portfolios of our investment grade CDOs are diversified by asset type, industry, location and issuer. We further minimize credit risk by monitoring the real estate securities portfolios of our investment grade CDOs and the underlying credit quality of their holdings.

At December 31, 2005, the real estate securities that serve as collateral for CDO I, CDO II, CDO III and CDO V each had an overall weighted average credit rating of approximately BBB- and approximately 75.3%, 72.9%, 69.1%, and 79.5%, respectively, of these securities are investment grade.

The real estate securities underlying our investment grade CDOs are also subject to spread risk. The majority of these securities are fixed rate securities, which are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the market, as based on their credit relative to U.S. Treasuries. An excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher or "wider" spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value these securities. Under these conditions, the value of our real estate securities portfolio would tend to decrease. Conversely, if the spread used to value these securities were to decrease or "tighten," the value of our real estate securities would tend to increase. Such changes in the market value of our real estate securities portfolio may affect our net equity or cash flow either directly through their impact on unrealized gains or losses on available-for-sale securities by diminishing our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.

Returns on our real estate securities are sensitive to interest rate volatility. If interest rates increase, the funding cost on liabilities that finance the securities portfolio will increase if these liabilities are at a floating rate or have maturities shorter than the assets.

Our general financing strategy focuses on the use of "match-funded" structures. This means that we seek to align the maturities of our debt obligations with the maturities of our investments in order to minimize the risk of being forced to refinance our liabilities prior to the maturities of our assets, as well as to reduce the impact of fluctuating interest rates on earnings. In addition, we generally match interest rates on our assets with like-kind debt, so that fixed rate assets are financed with fixed rate debt and floating rate assets are financed with floating rate debt, directly or through the use of interest rate swaps, caps or other financial instruments or through a combination of these strategies. Our investment grade CDOs utilize interest rate swaps to minimize the mismatch between their fixed rate assets and floating rate liabilities. We expect to hedge the interest rate risk in future investment grade CDOs in a similar manner.

Our financing strategy is dependent on our ability to place the match-funded debt we use to finance our real estate securities at spreads that provide a positive arbitrage. If spreads on the bonds issued by CDOs widen or if demand for these liabilities ceases to exist, then our ability to execute future CDO financings will be severely restricted.

Interest rate changes may also impact our net book value as our investments in debt securities are marked-to-market each quarter with changes in fair value reflected in other comprehensive income (a separate component of owners' equity). Generally, as interest rates increase, the value of fixed rate securities within the CDO, such as CMBS, decreases and as interest rates decrease, the value of these securities will increase. These swings in value have a corresponding impact on the value of our investment in the CDO. Within the CDO, we seek to hedge against changes in cash flows attributable to changes in interest rates by entering into interest rate swaps/caps and other derivative instruments as allowed by our predecessor's risk management policy. Such derivatives are designated as cash flow hedge relationships according to SFAS No. 133.

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During the warehouse period for CDOs, the market value of the securities in the warehouse is hedged, typically by short selling U.S. agency-sponsored (Federal National Mortgage Association or Federal Home Loan Mortgage Corp.) debentures or U.S. Treasury securities in the warehouse. Movements in interest rates are expected to result in a price movement for the hedge position that is opposite to and offsets the price movement of the fixed rate securities in the warehouse.

Debt Securities Held for Trading

Subsequent to the closing of our IPO, we temporarily invested a portion of the net proceeds of our IPO in primarily AAA-rated, short-term, floating rate commercial and residential mortgage-backed securities which are subject to fluctuations in market value. These securities are financed with leverage of up to 97% which may magnify this price volatility. If the market value of these securities were to decline, we would need to post additional collateral or liquidate a portion of these securities, possibly at a loss. The short-term securities that we have temporarily invested in have been selected to mitigate this risk to the extent possible. Their floating rate coupon, short duration, and high credit ratings all serve to maximize liquidity and to minimize the price volatility of these securities. Nevertheless, even a small decline in the price of these securities may be magnified by the leverage and result in a loss to us when the assets are liquidated. Unrealized losses may also occur even if the assets are not liquidated because these securities are held for trading purposes.

Net Lease Properties

Our ability to manage the interest rate risk and credit risk associated with the assets we acquire is integral to the success of our net lease properties investment strategy. Although we may, in special situations, finance our purchase of net lease assets with floating rate debt, our general policy will be to mitigate our exposure to rising interest rates by financing our purchases with fixed rate mortgages. We seek to match the term of fixed rate mortgages to our expected holding period for the underlying asset. Factors we consider to assess the expected holding period include, among others, the primary term of the lease as well as any extension options that may exist.

We expect the credit profiles of our tenants will primarily be unrated and below investment grade. In order to ensure that we have as complete an understanding as possible of a tenant's ability to satisfy its obligations under its lease, we expect to undertake a rigorous credit evaluation of each tenant prior to executing sale/leaseback or net lease asset acquisitions. This analysis will include an extensive due diligence investigation of the tenant's business as well as an assessment of the strategic importance of the underlying real estate to the tenant's core business operations. Where appropriate, we may seek to augment the tenant's commitment to the facility by structuring various protection mechanisms into the underlying leases. These mechanisms could include security deposit requirements or affiliate guarantees from entities we deem to be creditworthy.

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Derivatives and Hedging Activities

To limit the exposure to the variable LIBOR rate on our corporate debt, we entered into various swap agreements to fix the LIBOR rate on a portion of our variable rate debt. The fixed rates range from 4.18% to 5.03%. The following table summarizes the notional amounts and fair (carrying) values of our derivative financial instruments as of December 31, 2005 (in thousands):

	Notional Amount		Fair Value		Range of Maturity
Interest rate swaps, treated as hedges	$	53,242	$	726		March 2010 - August 2018

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ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated and combined financial statements of NorthStar Realty Finance Corp. and NorthStar Finance Corp. Predecessor, respectively, the consolidated financial statements of ALGM I Owners LLC and Subsidiaries for the two year period ended December 31, 2004 and the financial statements of NorthStar Funding LLC for the two year period ended December 31, 2004 and the notes related to each of the foregoing financial statements, each together with the independent registered public accounting firm's reports thereon, are set forth on pages F-1 through F-79 of this report.

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ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

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ITEM 9A.CONTROLS AND PROCEDURES

Attached as exhibits to this Form 10-K are certifications of the Company’s Chief Executive Officer and Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the Exchange Act). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications. Part II, Item 8 of this Form 10-K sets forth the report of Grant Thornton LLP, our independent registered public accounting firm, regarding its audit of the Company’s internal control over financial reporting and of management’s assessment of internal control over financial reporting set forth below in this section. This section should be read in conjunction with the certifications and the Grant Thornton report for a more complete understanding of the topics presented.

Disclosure Controls and Procedures

The management of the Company established and maintains disclosure controls and procedures that are designed to ensure that material information relating to the Company and its subsidiaries required to be disclosed in the reports that are filed or submitted under the 1934 Act are recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this report, the Company’s management conducted an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.

Internal Control over Financial Reporting

(a) Management’s annual report on internal control over financial reporting.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Exchange Act Rule 13a-15(f), internal control over financial reporting is a process designed by, or under the supervision of, the principal executive and principal financial officer and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2005 based on the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon this evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005.

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(b) Attestation report of the registered public accounting firm.

Our independent registered public accounting firm, Grant Thornton LLP, audited management’s assessment of the Company’s internal control over financial reporting as of December 31, 2005 and independently assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. Grant Thornton has issued an attestation report concurring with management’s assessment, which is included at the end of Part II, Item 8 of this Form 10-K.

(c) Changes in internal control over financial reporting.

There have been no changes in the Company’s internal control over financial reporting during the most recent quarter ended December 31, 2005 that have materially affected, or are reasonably likely to affect, internal controls over financial reporting.

Inherent Limitations on Effectiveness of Controls

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) or our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.

ITEM 9B. OTHER INFORMATION

Not applicable.

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PART III 

ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT*

Information relating to our code of business conduct and ethics and code of ethics for senior financial officers (as defined in the code) is included in Part I, Item 1 of this Annual Report on Form 10-K.

ITEM 11.EXECUTIVE COMPENSATION*

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS*

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS*

ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES*

(*) The information that is required by Items 10, 11, 12, 13 and 14 is incorporated herein by reference from the definitive proxy statement relating to the 2006 Annual Meeting of Stockholders of the Company, which is to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, no later than 120 days after the end of the Company’s fiscal year ending December 31, 2005.

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PART IV 

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) and (c) Financial Statements and Schedules.

Reference is made to the "Index to the Financial Statements" on page F-1 of this report.

All other financial statement schedules are not required under the related instructions, or they have been omitted either because they are not significant, the required information has been disclosed in the consolidated and combined financial statements and the notes related thereto.

(b) Exhibits

Exhibit Number	Description of Exhibit
2.1	Contribution Agreement, dated as of October 29, 2004, by and among NS Advisors Holdings LLC, Presidio Capital Investment Company, LLC and NorthStar Realty Finance Limited Partnership*
2.2	Contribution Agreement, dated as of October 29, 2004, by and among NorthStar Partnership, L.P., NorthStar Funding Managing Member Holdings LLC and NorthStar Realty Finance Limited Partnership*
2.3	Purchase and Sale Agreement, dated as of October 29, 2004, between NorthStar Realty Finance Limited Partnership and ALGM I Equity, LLC*
3.1	Articles of Amendment and Restatement of NorthStar Realty Finance Corp., as filed with the State Department of Assessments and Taxation of Maryland on October 20, 2004 (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
3.2	Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
3.3	Amendment No. 1 to the Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.3 to the Company's Current Report on Form 8-K, filed on April 27, 2005)
4.1	Registration Rights Agreement, dated as of October 29, 2004, by and among NorthStar Realty Finance Corp., NorthStar Partnership, L.P., NorthStar Funding Managing Member Holdings LLC and NS Advisors Holdings LLC*
10.1	Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of October 19, 2004, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time*
10.2	Non-Competition Agreement, dated as of October 29, 2004, by and among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership, NorthStar Capital Investment Corp. and NorthStar Partnership, L.P.*
10.3	Shared Facilities and Services Agreement, dated as of October 29, 2004, by and between NorthStar Realty Finance Corp. and NorthStar Capital Investment Corp.*

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Exhibit Number Description of Exhibit

10.4	Amended, Restated and Consolidated Fee and Leasehold Mortgage, Assignment of Leases and Rents and Security Agreement, dated as of December 4, 2002, by and among 729 Demi-Tasse LLC, 1552 Lonsdale LLC, ALGM Leasehold II LLC, ALGM Leasehold III LLC, ALGM Leasehold VI LLC, ALGM Leasehold VIII LLC, ALGM Leasehold IX LLC, ALGM Leasehold X LLC, ALGM Leasehold XII LLC and Greenwich Capital Financial Products, Inc. (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.5	Executive Employment Agreement, dated as of October 22, 2004, between David T. Hamamoto and NorthStar Realty Finance Corp.*
10.6	Executive Employment Agreement, dated as of October 22, 2004, between Mark E. Chertok and NorthStar Realty Finance Corp.*
10.7	Executive Employment Agreement, dated as of October 22, 2004, between Jean-Michel Wasterlain and NorthStar Realty Finance Corp.*
10.8	Executive Employment Agreement, dated as of October 22, 2004, between Daniel R. Gilbert and NorthStar Realty Finance Corp.*
10.9	NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan*
10.10	LTIP Unit Vesting Agreement under the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and NRF Employee, LLC*
10.11	Form of Vesting Agreement for Units of NRF Employee, LLC, each dated as of October 29, 2004, between NRF Employee, LLC and certain employees and co-employees of NorthStar Realty Finance Corp.*
10.12	Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.7(a) to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.13	NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan*
10.14	Form of Notification under NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan*
10.15	Form of Indemnification Agreement for directors and officers of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-11 (File No. 333-114675))
10.16	Amended and Restated Master Repurchase Agreement, dated as of March 21, 2005, between NRFC DB Holdings, LLC and Deutsche Bank AG, Cayman Islands Branch (incorporated by reference to the like-numbered exhibit to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2004)

86

Exhibit Number Description of Exhibit

10.17	Amended and Restated Junior Subordinated Indenture dated as of September 16, 2005, between NorthStar Realty Finance Limited Partnership and JPMorgan Chase Bank, National Association, as trustee (incorporated by reference to the like-numbered exhibit to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.18	Second Amended and Restated Trust Agreement, dated as of September 16, 2005, among NorthStar Realty Finance Limited Partnership, as depositor, JPMorgan Chase Bank, National Association, as property trustee, Chase Bank USA, National Association, as Delaware trustee and Mark Chertok, David Hamamoto and Richard McCready, each as administrative trustees (incorporated by reference to the like-numbered exhibit to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.19	Master Repurchase Agreement, dated as of July 13, 2005, between NRFC WA Holdings, LLC and Wachovia Bank, National Association (incorporated by reference to Exhibit 10.21 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005)
10.20	First Amendment to the Master Repurchase Agreement, dated as of August 24, 2005, between NRFC WA Holdings, LLC and Wachovia Bank, National Association (incorporated by reference to Exhibit 10.22 to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.21	Second Amendment to the Master Repurchase Agreement, dated as of September 20, 2005, between NRFC WA Holdings, LLC and Wachovia Bank, National Association (incorporated by reference to Exhibit 10.23 to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.22	Master Loan, Guarantee and Security Agreement, dated as of September 28, 2005, between NorthStar Realty Finance Limited Partnership, NorthStar Realty Finance Corp., NS Advisors LLC and Bank of America, N.A. (incorporated by reference to Exhibit 10.24 to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.23	Third Amendment to the Master Repurchase Agreement, dated as of September 30, 2005, between NRFC WA Holdings, LLC and Wachovia Bank, National Association (incorporated by reference to Exhibit 10.25 to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.24	Omnibus Amendment to the Master Repurchase Agreement, dated as of October 21, 2005, between NRFC WA Holdings, LLC, NRFC WA Holdings II, LLC and Wachovia Bank, National Association (incorporated by reference to Exhibit 10.26 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)
10.25	Agreement of Purchase and Sale, dated as of October 25, 2005, between 1552 Lonsdale LLC and 1552 Bway Owner, LLC (incorporated by reference to Exhibit 10.27 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)
10.26	Fourth Amendment to the Master Repurchase Agreement, dated October 28, 2005, by and among NRFC WA Holdings, LLC, NRFC WA Holdings II, LLC and Wachovia Bank, National Association (incorporated by reference to Exhibit 10.28 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)

87

Exhibit Number Description of Exhibit

10.27	Sublease, dated as of November 7, 2005, between NorthStar Realty Finance Limited Partnership and NorthStar Partnership, L.P. (incorporated by reference to Exhibit 10.29 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)
10.28	Junior Subordinated Indenture, dated as of November 22, 2005, between NorthStar Realty Finance Limited Partnership and JPMorgan Chase Bank, National Association, as trustee (incorporated by reference to Exhibit 10.30 to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.29	Amended and Restated Trust Agreement, dated as of November 22, 2005, between NorthStar Realty Finance Limited Partnership, as depositor, JPMorgan Chase Bank, National Association, as property trustee, Chase Bank USA, National Association, as Delaware trustee and Mark Chertok, David Hamamoto and Richard McCready, each as administrative trustees (incorporated by reference to Exhibit 10.31 to the Company's Registration Statement on Form S-11 (File No. 333-128962))
10.30	Fifth Amendment to the Master Repurchase Agreement, dated February 28, 2005, by and among NRFC WA Holdings, LLC, NRFC WA Holdings II, LLC and Wachovia Bank, National Association
10.31	Junior Subordinated Indenture, dated as of March 10, 2006, between NorthStar Realty Finance Limited Partnership, NorthStar Realty Finance Corp. and Wilmington Trust Company, as trustee
10.32	Amended and Restated Trust Agreement, dated as of March 10, 2006, between NorthStar Realty Finance Limited Partnership, as depositor, NorthStar Realty Finance Corp. , a guarantor, Wilmington Trust Company, as property trustee and Delaware trustee and Mark Chertok, David Hamamoto and Richard McCready, each as administrative trustees
10.33	Form of NorthStar Realty Finance Corp. 2006 Outperformance Plan Award Agreement
10.34	Amendment No. 1 to Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of March 14, 2006, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time
10.35	Executive Employment Agreement, dated as of March 14, 2006, between Richard J. McCready and NorthStar Realty Finance Corp.
12.1	Ratio of Earnings
21.1	Subsidiaries of the Registrant
23.1	Consent of Ernst & Young LLP
23.2	Consent of Grant Thornton LLP
31.1	Certification by the Chief Executive Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification by the Chief Financial Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification by the Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification by the Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

_______________________

*Incorporated by reference to the like-numbered exhibit to the Company’s Quarterly Report on Form 10-Q for the quarter ending September 30, 2004.

88

INDEX TO FINANCIAL STATEMENTS

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES AND

NORTHSTAR REALTY FINANCE CORP. PREDECESSOR

Consolidated and Combined Financial Statements	Page
Reports of Independent Registered Public Accounting Firms	F-2
Consolidated Balance Sheets as of December 31, 2005 and 2004	F-5
Consolidated and Combined Statements of Operations for the year ended December 31, 2005, for the period from October 29, 2004 to December 31, 2004, for the period from January 1, 2004 to October 28, 2004, and for the year ended December 31, 2003	F-6
Consolidated Statement of Stockholders' Equity for the year ended December 31, 2005 and the period from October 29, 2004 to December 31, 2004	F-7
Combined Statement of Owners' Equity for the period from January 1, 2004 to October 28, 2004 and the year ended December 31, 2003	F-8
Consolidated and Combined Statements of Cash Flows for the year ended December 31, 2005, for the period from October 29, 2004 to December 31, 2004, for the period from January 1, 2004 to October 28, 2004 and for the year ended December 31, 2003	F-9
Notes to Consolidated and Combined Financial Statements	F-11
Schedule II—Valuation and Qualifying Accounts as of December 31, 2005	F-46
Schedule III—Real Estate and Accumulated Depreciation as of December 31, 2005	F-47
Schedule IV—Loans and other Lending Investments as of December 31, 2005	F-48

ALGM I OWNERS LLC AND SUBSIDIARIES

Consolidated Financial Statements	Page
Index	F-50
Report of Independent Registered Public Accounting Firm	F-51
Consolidated Balance Sheet as of December 31, 2004	F-52
Consolidated Statements of Income for the years ended December 31, 2004 and 2003	F-53
Consolidated Statements of Members' Equity for the years ended December 31, 2004 and 2003	F-54
Consolidated Statements of Cash Flows for the years ended December 31, 2004 and 2003	F-55
Notes to Consolidated Financial Statements	F-56
Schedule II—Valuation and Qualifying Accounts as of December 31, 2004	F-65
Schedule III—Real Estate and Accumulated Depreciation as of December 31, 2004	F-66

NORTHSTAR FUNDING LLC

Financial Statements	Page
Index	F-68
Report of Independent Registered Public Accounting Firm	F-69
Balance Sheet as of December 31, 2004	F-70
Statements of Income for the years ended December 31, 2004 and 2003	F-71
Statements of Members' Equity for the years ended December 31, 2004 and 2003	F-72
Statements of Cash Flows for the years ended December 31, 2004 and 2003	F-73
Notes to Financial Statements	F-74
Schedule IV—Loans and other Lending Investments as of December 31, 2004	F-79

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

NorthStar Realty Finance Corp.

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting as of December 31, 2005, that NorthStar Realty Finance Corp. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for the year ended December 31, 2005 and our report dated March 7, 2006 expressed an unqualified opinion thereon.

/s/ GRANT THORNTON LLP

New York, New York

March 7, 2006

F-2

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

NorthStar Realty Finance Corp.

We have audited the accompanying consolidated balance sheet of NorthStar Realty Finance Corp. and subsidiaries (the “Company”) as of December 31, 2005 and the related consolidated statement of operations, stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NorthStar Realty Finance Corp. and subsidiaries as of December 31, 2005, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2006 expressed an unqualified opinion thereon.

/s/ GRANT THORNTON LLP

New York, New York

March 7, 2006

F-3

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of

NorthStar Realty Finance Corp.

We have audited the accompanying consolidated balance sheet of NorthStar Realty Finance Corp. and Subsidiaries (“the Company”) as of December 31, 2004, the related consolidated statements of operations, stockholders’ equity and cash flows of NorthStar Realty Finance Corp. and Subsidiaries for the period from October 29, 2004 (commencement of operations) through December 31, 2004 and the related combined statements of operations, owners’ equity and cash flows of NorthStar Realty Finance Corp. Predecessor, as defined in Note 1, for the period from January 1, 2004 through October 28, 2004 and for the year ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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 consolidated financial position of NorthStar Realty Finance Corp. and Subsidiaries at December 31, 2004, the consolidated results of operations and cash flows of NorthStar Realty Finance Corp. and Subsidiaries for the period from October 29, 2004 (commencement of operations) through December 31, 2004, and the combined results of operations and cash flows of NorthStar Realty Finance Corp. Predecessor for the period from January 1, 2004 through October 28, 2004 and for the year ended December 31, 2003, in conformity with U.S. generally accepted accounting principles.

/s/ ERNST & YOUNG LLP

New York, New York

March 30, 2005,

except for Note 3(d), as to which the date is

March 6, 2006

F-4

Northstar Realty Finance Corp. and Subsidiaries

Consolidated Balance Sheets

	December 31, 2005			December 31, 2004
Assets:
Cash and cash equivalents	$	27,898,000		$	47,733,000
Restricted cash		27,501,000			2,713,000
Debt securities held for trading		—			826,611,000
Operating real estate — net		198,708,000			43,544,000
Debt securities available for sale		149,872,000			37,692,000
CDO deposit and warehouse agreements		9,458,000			2,988,000
Collateral held by broker		—			24,831,000
Real estate debt investments		681,106,000			70,569,000
Investments in and advances to unconsolidated ventures		5,458,000			5,363,000
Receivables, net of allowance of $4,000 and $1,000 in 2005 and 2004		5,218,000			1,926,000
Unbilled rents receivable, net of allowance $0 and $4,137,000 in 2005 and 2004		1,117,000			5,567,000
Receivables – related parties		528,000			176,000
Deferred costs and intangible assets, net		38,745,000			4,233,000
Assets of properties held for sale		2,918,000			—
Other assets		4,912,000			4,132,000
Total assets	$	1,153,439,000		$	1,078,078,000
Liabilities and Stockholders' Equity:
Liabilities:
Mortgage notes and loans payable	$	174,296,000		$	40,557,000
Liability to subsidiary trusts issuing preferred securities		108,258,000			—
CDO bonds payable		300,000,000			—
Credit facilities		243,002,000			27,821,000
Repurchase obligations		7,054,000			800,418,000
Securities sold, not yet purchased		—			24,114,000
Obligations under capital leases		3,375,000			3,303,000
Accounts payable and accrued expenses		9,091,000			5,603,000
Due to affiliates		26,000			250,000
Liabilities of properties held for sale		360,000			—
Escrow deposits payable		11,571,000			—
Other liabilities		3,703,000			256,000
Total liabilities		860,736,000			902,322,000
Minority interest		44,278,000			32,447,000
Commitments and contingencies
Stockholders' Equity:
Common stock, $0.01 par value, 500,000,000 shares authorized, 30,464,930 and 21,249,736 shares issued and outstanding at December 31, 2005 and 2004, respectively		305,000			212,000
Additional paid-in capital		213,625,000			145,697,000
Retained earnings (deficit)		35,233,000			(2,439,000	)
Accumulated other comprehensive income		(738,000	)		(161,000	)
Total stockholders’ equity		248,425,000			143,309,000
Total liabilities and stockholders' equity	$	1,153,439,000		$	1,078,078,000

See accompanying notes to the consolidated and combined financial statements.

F-5

Northstar Realty Finance Corp. and Subsidiaries and

Northstar Realty Finance Corp. Predecessor

Consolidated and Combined Statements of Operations

	The Company (consolidated)						The Predecessor (combined)
	Year Ended December 31,			Period from October 29, 2004 to December 31,			Period from January 1, 2004 to October 28,			Year Ended December 31,
	2005			2004			2004			2003
Revenues and other income:
Rental and escalation income	$	11,403,000		$	510,000		$	—		$	—
Advisory and management fee income		112,000			38,000			185,000			64,000
Advisory and management fee income — related parties		4,813,000			665,000			2,437,000			1,026,000
Interest income		40,043,000			3,990,000			31,000			—
Interest income — related parties		8,374,000			727,000			1,828,000			502,000
Other revenue		352,000			—			—			—
Total revenues		65,097,000			5,930,000			4,481,000			1,592,000
Expenses:
Real estate properties — operating expenses		1,911,000			100,000			—			—
Interest expense		32,568,000			3,352,000			285,000			—
Management fees — related parties		62,000			85,000			—			—
General and administrative:
Direct:
Salaries and other compensation		5,490,000			797,000			953,000			1,289,000
Shared services—related party		1,145,000			231,000			—			—
Equity based compensation		5,847,000			2,991,000			—			—
Insurance		916,000			148,000			—			—
Auditing and professional fees		3,634,000			790,000			—			—
Formation and organization costs		—			517,000			—			—
Other general and administrative		2,036,000			378,000			181,000			203,000
Allocated:
Salaries and other compensation		—			—			3,060,000			2,146,000
Insurance		—			—			318,000			252,000
Other general and administrative		—			—			925,000			1,098,000
Total general and administrative		19,068,000			5,852,000			5,437,000			4,988,000
Depreciation and amortization		4,352,000			190,000			—			—
Total expenses		57,961,000			9,579,000			5,722,000			4,988,000
Income (loss) from operations		7,136,000			(3,649,000	)		(1,241,000	)		(3,396,000	)
Equity in earnings of unconsolidated/uncombined ventures		226,000			83,000			1,520,000			2,048,000
Unrealized gain on investments and other		867,000			200,000			279,000			1,219,000
Realized gain on investments and other		2,160,000			293,000			636,000			1,866,000
Net income (loss) before minority interest		10,389,000			(3,073,000	)		1,194,000			1,737,000
Minority interest		(2,116,000	)		(632,000	)		—			—
Income (loss) from continuing operations		8,273,000			(2,441,000	)		1,194,000			1,737,000
Income from discontinued operations, net of minority interest		547,000			2,000			—			—
Gain on sale of discontinued operations, net minority interest		28,852,000			—			—			—
Net income (loss)	$	37,672,000		$	(2,439,000	)	$	1,194,000		$	1,737,000
Net income (loss) per share from continuing operations
Basic/Diluted	$	0.38		$	(0.12	)
Income per share from discontinued operations
Basic/Diluted	$	0.03			—
Gain on sale of discontinued operations
Basic/Diluted	$	1.33			—
Net income (loss) available to common shareholders
Basic/Diluted	$	1.74		$	(0.12	)
Weighted average number of shares of common stock:
Basic		21,660,993			20,868,865
Diluted		27,185,013			(1	)

(1) See note 2 -Earnings Per Share

See accompanying notes to the consolidated and combined financial statements.

F-6

Northstar Realty Finance Corp. and Subsidiaries

Consolidated Statement of Stockholders' Equity

	Shares of Common Stock		Common Stock at par		Additional Paid-in Capital			Accumulated Other Comprehensive Income (loss)			Retained Earnings			Total Stockholders’ Equity			Comprehensive Income
Balance at October 29, 2004	—		—		—			—			—			—			—
Net proceeds from IPO of common stock		20,050,100	$	200,000	$	159,904,000		$	—		$	—		$	160,104,000		$	—
Issuance of shares of common stock, net of expense (underwriter's over-allotment)		1,160,750		12,000		9,703,000			—			—			9,715,000			—
Adjustment to rebalance minority interests in operating partnership		—		—		(23,930,000	)		—			—			(23,930,000	)		—
Comprehensive loss — unrealized loss on debt securities available for sale		—		—		—			(161,000	)		—			(161,000	)		(161,000	)
Issuance of restricted shares of common stock		38,886		—		—			—			—			—			—
Amortization of equity based compensation		—		—		20,000			—			—			20,000			—
Net loss		—		—		—			—			(2,439,000	)		(2,439,000	)		(2,439,000	)
Balance at December 31, 2004		21,249,736		212,000		145,697,000			(161,000	)		(2,439,000	)		143,309,000			(2,600,000	)
Issuance of restricted shares of common stock		15,194		1,000		—			—			—			1,000			—
Net proceeds from secondary offering of common stock		9,200,000		92,000		78,920,000			—			—			79,012,000			—
Comprehensive loss — unrealized loss on debt securities available for sale		—		—		—			(577,000	)		—			(577,000	)		(577,000	)
Amortization of equity based compensation		—		—		276,000			—			—			276,000			—
Cash dividends on common stock		—		—		(11,268,000	)		—			—			(11,268,000	)		—
Net income		—		—		—			—			37,672,000			37,672,000			37,672,000
Balance at December 31, 2005		30,464,930	$	305,000	$	213,625,000		$	(738,000	)	$	35,233,000		$	248,425,000		$	34,495,000

See accompanying notes to the consolidated and combined financial statements.

F-7

Northstar Realty Finance Corp. Predecessor

Combined Statements of Owners' Equity

Balance at December 31, 2002	$	25,304,000
Contributions		5,431,000
Distributions		(2,834,000	)
Allocated general and administrative expenses, net of fee income		2,910,000
Other comprehensive loss — unrealized loss on debt securities available for sale		(55,000	)
Net income		1,737,000
Balance at December 31, 2003		32,493,000
Contributions		9,392,000
Distributions		(6,853,000	)
Other comprehensive income — unrealized gain on debt securities available for sale		2,004,000
Allocated general and administrative expenses, net of fee income		3,651,000
Net income		1,194,000
Balance at October 28, 2004 (contribution to Operating Partnership)	$	41,881,000

See accompanying notes to the consolidated and combined financial statements.

F-8

Northstar Realty Finance Corp. and Subsidiaries and

Northstar Realty Finance Corp. Predecessor

Consolidated and Combined Statements of Cash Flows

	The Company (consolidated)						The Predecessor (combined)
		Year Ended December 31, 2005			Period from October 29, 2004 to December 31, 2004			Period from January 1, 2004 to October 28, 2004			Year Ended December 31, 2003
Cash flows from operating activities:
Net income (loss)	$	37,672,000		$	(2,439,000	)	$	1,194,000		$	1,737,000
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Gains on sale of real estate		(35,930,000	)		—			—			—
Equity in (earnings) of unconsolidated/uncombined ventures		(199,000	)		(83,000	)		(1,520,000	)		(2,048,000	)
Depreciation and amortization		5,038,000			411,000			—			—
Amortization of acquisition fees/costs and deferred financing costs		2,009,000			147,000			—			—
Minority interest		9,328,000			(632,000	)		—			—
Equity based compensation		5,846,000			2,991,000			—			—
Unrealized gain on investments and other		(867,000	)		(200,000	)		(279,000	)		(1,219,000	)
Realized gain on sale of investments and other		(2,160,000	)		(293,000	)		(636,000	)		—
Amortization of premium on securities held for trading		—			433,000			—			—
Amortization of bond discount		(1,715,000	)		(28,000	)		(55,000	)		—
Allocated general and administrative expenses		—			—			4,302,000			3,496,000
Distributions from equity investments		199,000			—			—			—
Capital lease		72,000			—			—			—
Amortization-above/below market leases		28,000			—			—			—
Allocated advisory fee		—			—			(651,000	)		(586,000	)
Unbilled rents receivable		(406,000	)		(91,000	)		—			—
Other		—			(18,000	)		—			—
Changes in assets and liabilities:
Restricted cash		—			234,000			—			—
Receivables		(3,908,000	)		(1,575,000	)		(187,000	)		(16,000	)
Debt securities held for trading		826,382,000			(826,814,000	)		—			—
Deferred costs and intangible assets		—			(864,000	)		—			—
Other assets		958,000			(3,753,000	)		—			—
Due to affiliates		(224,000	)		141,000			—			(397,000	)
Accounts payable and accrued expenses		3,432,000			3,994,000			92,000			322,000
Due from affiliates		(175,000	)		—			—			—
Restricted cash- escrows		(11,429,000	)		—			—			—
Escrow deposit payable		11,571,000			—			—			—
Origination fees		892,000			272,000
Other liabilities		3,211,000			(616,000	)		180,000			—
Net cash provided by (used in) operating activities		849,625,000			(828,783,000	)		2,440,000			1,289,000
Cash flows from investing activities:
Additions to operating real estate, net		(219,664,000	)		(1,507,000	)		—			—
Net proceeds from sales of real estate		74,141,000			—			—			—
Real estate debt acquisition costs		(815,000	)		—			—			—
Real estate investments - repayments		84,915,000			—			—			—
Purchase of initial investments		—			(37,078,000	)		—			—
Purchase of debt securities available for sale		(137,309,000	)		—			(26,863,000	)		(9,500,000	)
CDO warehouse deposits		(10,000,000	)		(2,500,000	)		(3,034,000	)		(10,766,000	)
Purchase of real estate debt investments		(694,297,000	)		(70,841,000	)		—			—
Proceeds from CDO warehouse		30,464,000			—			9,500,000			10,000,000
Cash receipts from CDO issuer		879,000			—			884,000			1,275,000
CDO IV restricted cash		(12,538,000	)		—			—			—
Cash recorded on initial consolidation of ALGM		—			3,012,000			—			—
Deferred lease costs		(29,000	)		—			—			—
Contributions to unconsolidated/uncombined ventures		(6,000	)		—			(1,048,000	)		(3,673,000	)
Distributions of capital from unconsolidated/uncombined ventures		3,169,000			882,000			1,364,000			2,834,000
Net cash (used in) investing activities		(881,090,000	)		(108,032,000	)		(19,197,000	)		(9,830,000	)

See accompanying notes to the consolidated and combined financial statements.

F-9

Northstar Realty Finance Corp. and Subsidiaries and

Northstar Realty Finance Corp. Predecessor

Consolidated and Combined Statements of Cash Flows — (continued)

	The Company (consolidated)						The Predecessor (combined)
		Year Ended December 31, 2005			Period from October 29, 2004 to December 31, 2004			Period from January 1, 2004 to October 28, 2004			Year Ended December 31, 2003
Cash flows from financing activities:
Proceeds from securities sold, not yet purchased	$	24,131,000		$	11,377,000		$	12,336,000		$	—
Proceeds from Collateral held by broker		24,831,000			(11,725,000	)		(13,106,000	)		—
Due from affiliates		—			2,134,000			(1,094,000	)		6,957,000
Capital contributions by owners of the Predecessor		—			—			9,392,000			5,431,000
Settlement of short sales		(48,306,000	)		—			—			—
Mortgage borrowings		174,600,000			—			—			—
Proceeds from bonds payable		300,000,000			—			—			—
Settlement of derivative		(301,000	)		—			—			—
Collateral held by swap counter-party		(1,017,000	)		—			—			—
Mortgage principal repayments		(40,861,000	)		(228,000	)		—			—
Proceeds from credit facilities		529,893,000			27,821,000			—			—
Credit facilities – repayments		(314,712,000	)		—			—			—
Repurchase obligation borrowings		7,054,000			1,253,557,000			17,694,000			—
Repurchase obligation repayments		(800,418,000	)		(470,833,000	)		—			—
Proceeds from offerings		85,100,000			190,447,000			—			—
Proceeds from trust preferred securities		105,000,000			—			—			—
Deferred financing costs		(13,079,000	)		—			—			—
Dividends and distributions		(14,197,000	)		—			—			—
Payment of offering costs		(6,088,000	)		(20,627,000	)		—			—
Distributions to owners of the Predecessor		—			—			(6,853,000	)		(2,834,000	)
Net cash provided by financing activities		11,630,000			981,923,000			18,369,000			9,554,000
Net (decrease) increase in cash & cash equivalents		(19,835,000	)		45,108,000			1,612,000			1,013,000
Cash and cash equivalents — beginning of period		47,733,000			2,625,000			1,013,000			—
Cash and cash equivalents — end of period	$	27,898,000		$	47,733,000		$	2,625,000		$	1,013,000
Supplemental disclosure of cash flow information:
Cash paid for interest	$	31,180,000		$	2,913,000		$	130,000			—
Supplementary disclosure of non-cash investing and financing activities:
Consolidation of the accounts of ALGM I Owners LLC ("ALGM") as a result of purchasing controlling interest:
Investment in uncombined entities prior to consolidation:	$	—		$	(10,578,000	)	$	—		$	—
Operating real estate, net		—			43,855,000			—			—
Restricted cash		—			2,947,000			—			—
Receivables		—			217,000			—			—
Unbilled rents receivable		—			5,476,000			—			—
Deferred costs, net		—			2,195,000			—			—
Other assets		—			326,000			—			—
Mortgage loan		—			(40,785,000	)		—			—
Obligations under capital leases		—			(3,292,000	)		—			—
Accounts payable and accrued expenses		—			(1,081,000	)		—			—
Other liabilities		—			(692,000	)		—			—
Net cash received in purchase transaction(1)		—			1,412,000			—			—
Reclassification of Predecessor’s equity to minority interest in connection with contribution of Initial Investments		—		$	41,881,000			—			—
Reclassification of CDO deposits to debt securities available for sale	$	2,988,000			—			—			—
Write off of deferred costs and unbilled rents receivable in connection with the disposition of operating real estate	$	4,955,000			—			—			—
Reclassifications to assets held for sale:
Operating real estate		1,493,000			—			—			—
Restricted cash		196,000			—			—			—
Receivables		439,000			—			—			—
Unbilled rents receivable		356,000			—			—			—
Deferred cost and intangibles, net		190,000			—			—			—
Other assets		244,000			—			—			—
Accounts payable and accrued expenses		(79,000	)		—			—			—
Other liabilities		(281,000	)		—			—			—
Purchase price allocation from operating real estate:
Deferred cost and intangibles, net		25,187,000			—			—			—
Other assets		1,288,000			—			—			—
Other liabilities		(509,000	)		—			—			—

See accompanying notes to the consolidated and combined financial statements.

(1) Represents ALGM cash consolidated of $3,012,000 less the purchase price of remaining equity in ALGM of $1,600,000.

F-10

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

1. Formation and Organization

NorthStar Realty Finance Corp., a Maryland corporation (the "Company"), is a self-administered and self-managed real estate investment trust ("REIT"), which was formed in October 2003 in order to continue and expand the subordinate real estate debt, real estate securities and net lease businesses conducted by NorthStar Capital Investment Corp. ("NCIC"). Substantially all of the Company's assets are held by, and it conducts its operations through, NorthStar Realty Finance Limited Partnership, a Delaware limited partnership and the operating partnership of the Company (the "Operating Partnership"). On October 29, 2004, the Company closed its initial public offering (the "IPO") pursuant to which it issued 20,000,000 shares of common stock, with proceeds to the Company of approximately $160.1 million, net of issuance costs of $19.9 million. On November 19, 2004, the Company issued an additional 1,160,750 shares of common stock pursuant to the exercise of the overallotment option by the underwriters of the IPO, with proceeds to the Company of $9.7 million, net of issuance costs of $0.7 million. In connection with the IPO, the Company also issued 50,000 shares of common stock, as partial compensation for underwriting services, to the lead underwriter of the IPO. In addition, 38,886 shares of restricted common stock were granted to the Company's non-employee directors. Simultaneously with the closing of the IPO on October 29, 2004, three majority-owned subsidiaries of NCIC (the "NCIC Contributing Subsidiaries") contributed certain controlling and non-controlling interests in entities through which NCIC conducted its subordinate real estate debt, real estate securities and net lease businesses (collectively the "Initial Investments") to the Operating Partnership in exchange for an aggregate of 4,705,915 units of limited partnership interest in the Operating Partnership (the "OP Units") and approximately $36.1 million in cash (the "Contribution Transactions") and an agreement to pay certain related transfer taxes on behalf of NCIC in the amount of approximately $1.0 million. From their inception through October 29, 2004, neither the Company nor the Operating Partnership had any operations.

The combination of the Initial Investments contributed to the Operating Partnership represents the predecessor of the Company (the "Predecessor"). The Company succeeded to the business of the Predecessor upon the consummation of the IPO and the contribution of the initial investments on October 29, 2004. The ultimate owners of the entities which comprise the Predecessor were NCIC and certain other persons who held minority ownership interests in such entities (collectively, the "Participants").

F-11

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

The following table lists the entities that comprise the Predecessor, the Predecessor's ownership and voting interests in and control of such entities and the accounting basis for the inclusion of such entities in the combined financial statements of the Predecessor.

Entity	Predecessor's Ownership and Voting Interest	Control	Predecessor Accounting Basis(1)	Ownership Interest Type
Real Estate Securities Business:
NS Advisors LLC ("NSA")	100%	Yes	Combined	Managing Member
NS CDO Holdings I, LLC	100%	Yes	Combined	Managing Member
NS CDO Holdings II, LLC	100%	Yes	Combined	Managing Member
Subordinate Real Estate Debt Business:
NorthStar Funding Managing Member LLC ("NFMM")	75%	Yes	Combined	Managing Member
NorthStar Funding Management LLC(2)	37.5%	No	Uncombined	Co-Managing Member
NorthStar Funding Investor Member LLC	100%	Yes	Combined	Managing Member
NorthStar Funding LLC (the "NSF Venture")	4.995%	No	Uncombined	Member
Net Lease Business: ALGM I Owners LLC ("ALGM")	97.50%	No	Uncombined	Member

⁽¹⁾ The uncombined equity interests are held either directly or indirectly by the Predecessor and are accounted for under the equity method as further described in Note 2.

⁽²⁾ Owns 0.01% of NorthStar Funding LLC, the joint venture through which NCIC conducted its subordinate real estate debt business.

Prior to October 29, 2004, the Company and the Operating Partnership were majority-owned and controlled subsidiaries of NCIC and therefore the contribution of the Initial Investments by the NCIC Contributing Subsidiaries to the Operating Partnership for cash and OP Units was accounted for at NCIC's historical cost basis as reflected in the accompanying combined financial statements of the Predecessor, with the exception of certain minority interests.

F-12

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

A summary of the Contribution Transactions and the accounting treatment by the Company for the minority interests in the Operating Partnership on consummation of the Contribution Transactions is as follows:

	Percentage Ownership Contributed by the Participants(d)	Percentage Ownership of Controlled Subsidiaries Owned by Third Parties and Participating in the Contribution Transactions	Percentage of Contributed Subsidiaries Acquired from Employee Prior to the Contribution Transactions	Basis at which Participants/ Employees Interest were Contributed
Real Estate Securities Business:
NSA	100%	23%(a)	—%(b)	Fair Value
NS CDO I Holding, LLC	100%	23%(a)		Fair Value
NS CDO II Holding, LLC	100%	23%(a)		Fair Value
Subordinate Real Estate Debt Business:
NFMM	100%	0%(c)	25%(c)	Fair Value
NorthStar Funding Investor Member LLC	100%	0%		N/A
Net Lease Business:
ALGM	97.50%	0%		N/A

 

(a) Represents minority interest in Presidio Capital Investment Company LLC, a majority-owned and controlled subsidiary of NorthStar Partnership, L.P. ("NPLP") which directly owned and controlled the real estate securities business of NCIC.

(b) An employee of NCIC held a 15% profit sharing right in NSA, which was acquired by an NCIC majority-owned and controlled subsidiary immediately prior to the Contribution Transactions. This profit sharing right was a compensation arrangement and does not represent legal ownership, or a minority interest.

(c) A 25% profits interest in NFMM was held by two employees of NCIC and was acquired by an NCIC majority-owned and controlled subsidiary immediately prior to the Contribution Transactions.

(d) NPLP has a minority ownership interest of approximately 26.7%. However, such interest did not directly participate in the Contribution Transactions with the NCIC Contributing Subsidiaries, the Company and the Operating Partnership. Accordingly, such minority interest, together with all of the interests of NCIC Contributing Subsidiaries, were contributed to the Operating Partnership on a historical cost basis, except as described above.

2. Summary of Significant Accounting Policies

Basis of Accounting

The accompanying consolidated and combined financial statements of the Company and the Predecessor, respectively, are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States.

Principles of Consolidation and Combination

The Company

The consolidated financial statements include the accounts of the Company, its majority-owned subsidiaries and variable interest entities (“VIE”) where the Company is the primary beneficiary in accordance with the provisions and guidance of Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), “Consolidation of Variable Interest Entities”(“Fin 46(R)”). All significant intercompany balances have been eliminated in consolidation.

F-13

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

The Predecessor

The combined and uncombined interests in entities contributed to the Operating Partnership have been aggregated to form the Predecessor. The interests in entities contributed to the Operating Partnership, which were controlled by NCIC, and variable interest entities where the Predecessor is deemed the primary beneficiary in accordance with the provisions and guidance of Fin 46 (R) are reflected in the Predecessor on a combined basis. All intercompany accounts have been eliminated in combination.

Variable Interest Entities

Fin 46 (R) requires a VIE to be consolidated by its primary beneficiary. The primary beneficiary is the party that absorbs a majority of the VIE’s anticipated losses and or a majority of the expected returns. The Company has evaluated its real estate debt investments and its investments in each of its’ five CDO issuers to determine whether they are VIE’s. For each of these investments, the Company has evaluated (1) the sufficiency of the fair value of the entity’s equity investment at risk to absorb losses, (2) whether as a group the holders of the equity investment at risk have (a) the direct or indirect ability through voting rights to make decisions about the entity’s significant activities, (b) the obligation to absorb the expected losses of the entity and their obligatons are not protected directly or indirectly, (c) the right to receive the expected residual return of the entity and their rights are not capped, (3) whether the voting rights of these investors are proportional to their obligations to absorb the expected losses of the entity, their rights to recieve the expected returns of their equity, or both and (4) whether substantially all of the entity’s activities involve or are conducted on behalf of an investor that has disproportionately fewer voting rights.

As of December 31, 2005, the Company identified eight interests in entities which were determined to be VIE’s under FIN 46 (R). They are as follows: CDO I, CDO II, CDO III, CDO V, NorthStar Realty Finance Trust I, II, and III and a preferred equity investment in a net lease property.

Based on management's analysis, neither the Company nor the Predecessor is the primary beneficiary since neither absorbs a majority of the expected losses, nor is entitled to a majority of the expected residual returns. Accordingly, these VIE’s are not consolidated into the Company's financial statements as of December 31, 2005 or 2004.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that could affect the amounts reported in the consolidated financial statements. Actual results could differ from these estimates.

Operating Real Estate

Operating real estate properties are carried at historical cost less accumulated depreciation. Cost directly related to the acquisition are capitalized. Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred. Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their useful life.

Properties are depreciated using the straight-line method over the estimated useful lives of the assets.

The estimated useful lives are as follows:

Category	Term
Building (fee interest)	39 years
Building Improvements	Lesser of the remaining life of building or useful life
Building (leasehold interest)	Lesser of 39 years or the remaining term of the lease
Property under capital lease	Lesser of 40 years or the remaining term of the lease
Tenant Improvements	Lesser of the useful life or the remaining term of the lease
Funiture and fixtures	Four to seven years

F-14

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Depreciation expense amounted to approximately $3.8 million and $362,000 for the year ended December 31, 2005 and the period of October 29, 2004 to December 31, 2004, of which a portion is included in income from discontinued operations for each of these periods.

In accordance with Statement of Financial Accounting Standards (“SFAS”) 144 “Accounting for the impairment or Disposal of Long-Lived Assets” a property to be disposed of is reported at the lower of its carrying value or its estimated fair value less the cost to sell. Once an asset is determined to be held for sale, depreciation and straight-line rental income are no longer recorded. In addition, the asset is reclassified to assets held for sale on the consolidated balance sheet and the results of operations are reclassified to income (loss) from discontinued operations in the consolidated statements of operations.

In accordance with SFAS No. 141 “Business Combinations”(“SFAS 141”) the Company allocates the purchase price of operating properties to land, building, tenant improvements, deferred lease cost for the the origination costs of the in-place leases and to intangibles for the value of the above or below market leases. The Company amortizes the value allocated to the in-place leases over the remaining lease term. The value allocated to the above or below market leases are amortized over the remaining lease term as an adjustment to rental income.

As a result of the Company’s evaluation under SFAS No. 141 of acquisitions made, as of December 31, 2005, the Company has recorded $25.1 million in deferred costs and intangible assets, net, related to the in-place leases and $1.2 million related to the above market leases which is recorded in other assets and $0.5 million related to the below market leases in other liabilities in the consolidated balance sheet. Approximately $0.9 million was recorded in depreciation expense related to the in-place leases. Rental income was decreased by approximately $18,000 related to the amortization of the intangible related to above/below market leases for the year ended December 31, 2005, in the consolidated statement of operations.

Investments in and Advances to Unconsolidated/Uncombined Ventures

The Company and the Predecessor have various investments in unconsolidated/uncombined ventures. In circumstances where the Company and the Predecessor have a non-controlling interest but are deemed to be able to exert influence over the affairs of the enterprise the Company and the Predecessor utilize the equity method of accounting. Under the equity method of accounting, the initial investment is increased each period for additional capital contributions and a proportionate share of the entity's earnings and decreased for cash distributions and a proportionate share of the entity's losses.

Management periodically reviews its investments for impairment based on projected cash flows from the venture over the holding period. When any impairment is identified, the investments are written down to recoverable amounts.

Debt Securities Available for Sale

The Company determines the appropriate classification of its investment in debt securities at the time of purchase and reevaluates such determination at each balance sheet date. Debt securities for which the Company does not have the intent or the ability to hold to maturity are classified as available for sale securities. The Company and the Predecessor have designated their investments in CDO I, II, III and V (described in Note 6) as available for sale securities as they meet the definition of a debt instrument due to their redemption provisions. Debt securities available for sale are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in the consolidated statements of stockholders' equity. The Company's investments in CDO I, II, III and V are relatively illiquid, and their value must be estimated by management. Fair value is based primarily upon broker quotes or management's estimates. These estimated values are subject to significant variability based on market conditions, such as interest rates and current spreads. Changes in the valuations do not affect either the Company's or the Predecessor's reported income or cash flows, but impact stockholders' equity and owners' equity, respectively.

F-15

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Debt Securities Held for Trading

The Company has designated certain securities as assets held for trading at the time of purchase and reevaluates such determination at each balance sheet date. Marketable securities that are bought and held principally for the purpose of selling them in the near future are classified as trading securities and are reported at fair market value with unrealized gains and losses reognized in earnings.

Real Estate Debt Investments

Investments in unsecuritized loans, either direct or participating interests, are recorded at their cost net of unamortized loan origination costs and fees, discounts and premiums. Discounts and premiums on purchased assets are amortized over the life of the investment using the effective interest method. The origination cost and fees are deferred and amortized using the effective interest method over the life of the related unsecuritized loan investment. The amortization is reflected as a reduction of interest income.

Cash and Cash Equivalents

The Company and the Predecessor consider all highly liquid investments that have remaining maturity dates of three months or less when purchased to be cash equivalents. Cash, including amounts restricted, exceeded the Federal Deposit Insurance Corporation deposit insurance limit of $100,000 per institution at December 31, 2005 and 2004. The Company mitigates its risk by placing cash and cash equivalents with major financial institutions.

Restricted Cash

Restricted cash consists of escrows for taxes, insurance, leasing costs, capital expenditures, tenant security deposits, payments required under certain leases agreements, esrow deposits collected in connection with whole loan originations and deposits with the trustee related to CDO IV primarily from proceeds of loan repayments which will be used to reinvest in collateral for CDO IV. The Company mitigates its risk by placing restricted cash with major financial institutions.

Deferred Costs and Intangible Assets, Net

Deferred lease costs consist of fees incurred to initiate and renew operating leases. Lease costs are being amortized using the straight-line method over the terms of the respective leases.

Deferred financing costs represent commitment fees, legal and other third party costs associated with obtaining financing. These costs are amortized over the term of the financing. Unamortized deferred financing costs are expensed when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financing transactions, which do not close, are expensed in the period the financing transaction was terminated.

The Company has recorded purchased intangible assets related to the acquisition of minority interests in NFMM and NSA, which are being amortized over the life of the revenue stream giving rise to the valuation of these interests.

Short Sales

The Company may sell securities that it does not own ("short sales"). Short sales are typically entered into by the Company as a hedge to offset a future liability or changes in the market value of an asset resulting from changes in interest rates. To complete a short sale, the Company will arrange through a broker to borrow the securities to be delivered to the buyer. The proceeds received by the Company from the short sale are retained by the broker until the Company replaces the borrowed securities. In borrowing the securities to be delivered to the buyer, the Company becomes obligated to replace the securities borrowed at their market price at the time of the replacement, whatever that price may be. A gain, limited to the price at which the Company sold the security short, or a loss, unlimited as to dollar amount, will be realized upon the termination of a short sale if the market price is less than or greater than the proceeds originally received. The Company's liability under the short sales is recorded at fair value, which is the market price of the security to be acquired to effect repayment. Unrealized gains or losses on such short sale obligations are included in unrealized loss on investments in the consolidated statement of operations. The Company is exposed to credit loss in the event of nonperformance by the broker that holds a deposit as collateral for securities borrowed. However, the Company does not anticipate nonperformance by the broker. The Company has recorded approximately $0 and $24.1 million as of December 31, 2005 and 2004, respectively in short sales as securities sold not yet purchased on the consolidated balance sheets.

F-16

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Comprehensive Income

Comprehensive income or (loss) is recorded in accordance with the provisions of SFAS No. 130, "Reporting Comprehensive income" ("SFAS 130"). SFAS 130 establishes standards for reporting comprehensive income and its components in the financial statements. Comprehensive income (loss), is comprised of net income, as presented in the consolidated statements of operations, adjusted for changes in unrealized gains or losses on debt securities available for sale and changes in the fair value of derivative financial instruments accounted for as cash flow hedges.

Underwriting Commissions and Costs

Underwriting commissions and direct costs incurred in connection with the Company's IPO in 2004 and the Company’s secondary public offering in 2005 are reflected as a reduction of additional paid-in-capital.

Revenue Recognition

Rental income from leases is recognized on a straight-line basis over the noncancelable term of the respective leases. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in unbilled rent receivable in the accompanying consolidated balance sheets.

Tenant reimbursement income is recognized in the period in which the related expense is incurred. Rental revenue, which is based upon a percentage of the sales recorded by the Company's tenants is recognized in the period such sales were earned by the respective tenants.

Interest income from the Company's unsecuritized loan investments is recognized on an accrual basis over the life of the investment using the effective interest method. Additional interest to be collected at payoff is recognized over the term of the loan as an adjustment to yield.

Interest income from debt securities available for sale and held for trading is recognized on the accrual basis of accounting over the life of the investment on a yield-to-maturity basis.

In connection with its investment in CDO I, II, III and V the Company recognizes interest income on these investments pursuant to Emerging Issues Task Force (‘‘EITF") 99-20, ‘‘Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," . Interest income is recognized on an estimated effective yield to maturity basis. Accordingly, on a quarterly basis, the Company calculates a revised yield on the current amortized cost of the investment and a current estimate of cash flows based upon actual and estimated prepayment and credit loss experience. The revised yield is then applied prospectively to recognize interest income.

Advisory fee income from both third parties and affiliates are recognized on the accrual basis as services are rendered and the fee income is contractually earned in accordance with the respective agreements. Fees from affiliated ventures accounted for under the equity method, such as from the NSF Venture, are partially eliminated against the related equity in earnings in such affiliated ventures to the extent of the Company's ownership.

F-17

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

The Company earns incentive income related to the performance of the NSF Venture through NFMM, who, as the managing member of the NSF Venture, is entitled to a promoted interest (i.e., the distribution of a disproportionate allocation of cash flow) after other members have obtained a specified return threshold and return of capital. The Company follows Method 1 of EITF Topic D-96 for recording such incentive income. Under Method 1 of EITF Topic D-96, no incentive income is recorded until all contingencies have been eliminated. Incentive income distributions received by NFMM, which are subject to refund to the NSF Venture if certain return thresholds are not met, are recorded as unearned income (a liability) on the consolidated balance sheets. In 2004, the Predecessor and Company, through NFMM, received incentive income distributions from the NSF Venture in the amount of approximately $180,000 and $47,000 in the periods January 1, 2004 through October 28, 2004 and October 29, 2004 through December 31, 2004, respectively. In 2005 the Company received incentive income in the amount of $925,000. These distributions are included in Other liabilities in the accompanying consolidated balance sheets.

Credit Losses, Impairment and Allowance for Doubtful Accounts

The Company assesses whether unrealized losses on the change in fair value on their debt securities reflect a decline in value which is other than temporary. If it is determined the decline in value is other than temporary the impaired securities are written down through earnings to their fair values. Significant judgment of management is required in this analysis, which includes, but is not limited to, making assumptions regarding the collectibility of the principal and interest, net of related expenses, on the underlying loans.

Allowances for real estate debt investment losses are established based upon a periodic review of the loan investments. Income recognition is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the suspended loan becomes contractually current and performance is demonstrated to be resumed. In performing this review, management considers the estimated net recoverable value of the loan as well as other factors, including the fair market value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic situation of the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized from the loan investments may differ materially from the carrying value at the balance sheet date.

The Company reviews long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Upon determination that an impairment exists, the related asset is written down through earnings to its estimated fair value.

Allowance for doubtful accounts for tenant receivables are established based on periodic review of aged receivables resulting from estimated losses due to the inability of its tenants to make required rent and other payments contractually due. Additionally, the Company establishes, on a current basis, an allowance for future tenant credit losses on billed and unbilled rents receivable based upon an evaluation of the collectibility of such amounts.

Rent Expense

Rent expense, which is included in real estate properties operating expenses in the consolidated statement of operations, is recorded on a straight-line basis over the term of the respective leases. The excess of rent expense incurred on a straight-line basis over rent expense, as it becomes payable according to the terms of the lease, is recorded as rent payable and is included in other liabilities in the consolidated balance sheets at December 31, 2005 and 2004, respectively.

F-18

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Risks and Uncertainties

In the normal course of business, the Company encounters primarily two significant types of economic risk: credit and market. Credit risk is the risk of default on the Company's securities, loans, leases, and derivatives that result from a borrower's, lessee's or derivative counterparty's inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of investments in securities, loans and real estate, or in derivatives, such as the CDO Deposit and Warehouse Agreement (described in Note 5) and the Company's investment in the CDO Issuers, due to changes in interest rates, spreads or other market factors, including the value of the collateral underlying loans and securities and the valuation of real estate held by the Company. Management believes that the carrying values of its investments are fairly stated, taking into consideration these risks along with estimated collateral values, payment histories and other market information.

Income Taxes

The Company has elected to be treated as a REIT under Internal Revenue Code Sections 856 through 859 and intends to remain so qualified. As a REIT, the Company generally is not subject to Federal income tax. To maintain its qualification as a REIT, the Company must distribute at least 90% of its REIT taxable income to its stockholders and meet certain other requirements. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to Federal income tax on its taxable income at regular corporate rates. The Company may also be subject to certain state, local and franchise taxes. Under certain circumstances, Federal income and excise taxes may be due on its undistributed taxable income.

Pursuant to amendments to the Code that became effective January 1, 2001, the Company has elected or may elect to treat certain of its existing or newly created corporate subsidiaries as taxable REIT subsidiaries (each a "TRS"). In general, a TRS of the Company may perform non-customary services for tenants of the Company, hold assets that the Company cannot hold directly and generally may engage in any real estate or non-real estate related business. A TRS is generally subject to regular corporate income tax. However, the Company has established its TRS in a jurisdiction for which no taxes are assessed on corporate earnings.

The Predecessor's combined entities were limited liability companies and as such, the income of such entities was reportable in the income tax returns of the members. Accordingly, no income tax provision is recorded in the accompanying combined financial statements of the Predecessor.

Derivatives and Hedging Activities

The Company accounts for its derivatives and hedging activities in accordance with SFAS No. 133, ‘‘Accounting for Derivative Instruments and Hedging Activities," which requires the Company to recognize all derivatives as either assets or liabilities in the consolidated balance sheet and to measure those instruments at fair value. Additionally, the fair value adjustments of each period will affect the consolidated financial statements of the Company differently depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity.

The Company generally enters into cash flow hedges and must designate them at the time of entering into the derivative. The derivatives entered into by the Company are intended to qualify as hedges under accounting principles generally accepted in the United States, unless specifically stated otherwise. Toward this end, the terms of hedges are matched closely to the terms of hedged items. The Company assesses the effectiveness of the cash flow hedges both at inception and on an on-going basis and determines whether the hedge is highly effective in offsetting changes in cash flows of the hedged item. The Company records the effective portion of changes in the estimated fair value in accumulated other comprehensive income (loss) and subsequently reclassifies the related amount of accumulated other comprehensive income (loss) to earnings when the hedging relationship is terminated. If it is determined that a derivative has ceased to be a highly effective hedge, the Company will discontinue hedge accounting for such transaction.

With respect to derivative instruments that have not been designated as hedges, any net payments under, or fluctuations in the fair value of, such derivatives are recognized currently in income.

F-19

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

The Company's derivative financial instruments contain credit risk to the extent that its bank counterparties may be unable to meet the terms of the agreements. The Company minimizes such risk by limiting its counterparties to major financial institutions with good credit ratings. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored.

Stock Based Compensation

The Company has adopted the fair value method of accounting prescribed in SFAS No. 123 "Accounting for Stock Based Compensation" ("SFAS 123") (as amended by SFAS No. 148) for its equity based compensation awards. SFAS 123 requires an estimate of the fair value of the equity award at the time of grant rather than the intrinsic value method. All fixed equity based awards to employees and directors, which have no vesting conditions other than time of service, will be amortized to compensation expense over the award's vesting period based on the fair value of the award at the date of grant.

Recently Issued Pronouncements

In December 2004, the FASB issued SFAS No. 123, (revised 2004) Share-Based Payment, or SFAS No. 123 (R), which supersedes APB opinion No. 25, Accounting for Stock Issued to Employees and its related implementation guidance. SFAS No. 123 (R) established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123 (R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123 (R) is effective for fiscal years beginning after June 15, 2005. The impact of adopting SFAS No. 123 (R) is not expected to have a material effect on the Company’s financial condition or results of operations.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections – A Replacement of APB Opinion No. 20 and SFAS No. 3. SFAS No. 154 changes the requirements for the accounting and reporting of a change in accounting principle by requiring that a voluntary change in accounting principle be applied retrospectively with all prior periods’ financial statements presented on the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also requires that a change in depreciation or amortization for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle and corrections of errors in previously issued financial statements should be termed a “restatement”. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material effect on the Company’s consolidated financial statements.

In June 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on Issue No. 04-05, “Determining Whether a General Partner, or General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-05”). EITF 04-05 provides a framework for determining whether a general partner controls, and should consolidate, a limited partnership or a similar entity. EITF 04-05 became effective on June 29, 2005, for all newly formed or modified limited partnership arrangements and January 1, 2006 for all existing limited partnership arrangements. The adoption of EITF 04-05 is not expected to have a material effect on the Company’s consolidated financial statements.

Earnings Per Share

The Company's basic earnings per share ("EPS") is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding. For purposes of calculating earnings per share, the Company considered all unvested restricted stock which participate in the dividends of the Company to be outstanding. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted to common stock, where such exercise or conversion would result in a lower EPS amount.

F-20

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

This also includes units of limited partnership interest in the Operating Partnership. The dilutive effects of units of limited partnership interest and their equivalents are computed using the "treasury stock" method. For the period of October 29, 2004 through December 31, 2004, the Company did not present diluted EPS as a result of a net loss available to common shareholders for the period.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.

3. Operating Real Estate

At December 31, 2005 and 2004, the Operating real estate, net consists of the following (in thousands):

		December 31,		December 31,
		2005		2004
Land	$	25,449	$	7,597
Buildings and Improvements		152,293		30,368
Leasehold interests		8,391		12,518
Tenant Improvements		16,547		687
Capital leases		3,028		3,028
		205,708		54,198
Less accumulated depreciation		7,000		10,654
Operating real estate, net	$	198,708	$	43,544

(a) Acquisitions

Chatsworth, California

On January 14, 2005, the Company closed the acquisition of a portfolio of three net-leased office properties, totaling 257,336 square feet of rentable space in Chatsworth, CA (the "Chatsworth properties"), for $63.5 million. The properties are net leased to Washington Mutual Bank under leases that expire in September 2015. The Company financed the acquisition with a $44 million first mortgage, and a $13 million mezzanine loan. This mezzanine loan currently constitutes a portion of the portfolio of securities owned by CDO III. One of the properties is subject to a ground lease. The ground lease has an initial remaining term of 35 years and two five-year extension options. The ground lease also provides for periodic increases in base rent based on the change in the Consumer Price Index.

Salt Lake City Property

On August 2, 2005, the Company closed a $22.0 million acquisition of a 117,553 square foot office building in Salt Lake City, Utah, (the "Salt Lake City property") which is 100% leased to the General Services Administration ("Salt Lake City") under a lease that expires in April 2012. The property is financed with a $17 million non-recourse first mortgage.

EDS Portfolio

On September 30, 2005, the Company closed the acquistion of a portfolio of four office buildings with 387,842 square feet of rentable space located in Rancho Cordova, California, Auburn Hills, Michigan and Camp Hill, Pennsylvania for $61.4 million. The four office properties are net leased to Electronic Data Systems Corp., (the "EDS Portfolio"), under leases expiring in 2015. The Company financed the acquisition with a $49.1 million non-recourse first mortgage.

Executive Centre Portfolio

In December 2005, the Company acquired a portfolio of three class A office buildings, located in Springdale, Ohio, with 486,963 square feet of rentable space for $68.5 million. Two of the properties are 100% and 96% leased to General Electric Company under leases expiring in 2009 and 2010. The remaining building is leased 100% to Cincom Systems, Inc. under a lease that expires in 2011. The Company financed the acquisition with a $51.5 million non-recourse first mortgage.

F-21

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

The Company has made a preliminary allocation of the purchase price to property components based on a preliminary appraisal and expects to make a final allocation of the purchase price in accordance with SFAS 141 during the first quarter of 2006.

(b) Dispositions

729 Seventh Avenue

The Company sold its interest in a 19,618 square foot retail condominium unit at 729 Seventh Avenue ("729") in New York City for $29.0 million. The transaction closed on June 30, 2005. The gain on sale was approximately $8.6 million, net of minority interest. For the year ended December 31, 2005 and the period of October 29, 2004 to December 31, 2004 the operations were classified as discontinued operations in the consolidated statements of operations.

The proceeds of the sale were used to pay down approximately $25.1 million of an existing mortgage and the remaining balance was reinvested into a similar property acquisition to effectuate a Section 1031-tax free exchange under the Internal Revenue Code.

In connection with the sale, 729 7th Realty Corp., an affiliate of the Riese Organization's National Restaurant Management Inc., agreed to discontinue the legal action that it had brought against the Company, settling the Company's only material pending legal action.

1552 Broadway

The Company sold its interest in a four-story, 12,091 square foot building is located at 1552 Broadway (“1552”) in New York City for a purchase price of $48 million, or $3,970 per square foot. The transaction closed on November 30, 2005. The gain on sale was approximately $20.3 million, net of minority interest. . For the year ended December 31, 2005 and the period of October 29, 2004 to December 31, 2004 the operations were classified as discontinued operations in the consolidated statements of operations.

The proceeds of the sale were used to pay off the balance of existing mortgage and the remaining proceeds were reinvested into a similar property acquisition to effectuate a Section 1031-tax free exchange under the Internal Revenue Code.

27 West 34th and 1372 Broadway

The Company formally initiated an effort to market two of its leasehold interests located at 27 West 34th Street (“27 West”) and 1372 Broadway ("1372") and on December 30, 2005 entered into a definitive sale contract. The Company has met the held for sale criteria in accordance with SFAS No. 144 and accordingly, the leaseholds were classified as held for sale in the consolidated balance sheet at December 31, 2005 and its operations were classified as discontinued operations in the consolidated statements of operations for the year ended December 31, 2005 and the period of October 29, 2004 to December 31, 2004.

(c) Discontinued Operations- 2005

The following table summarizes income from discontinued operations, net of minority interest and related gain on sale of discontinued operations, net of minority interest, for the year ended December 31, 2005 (in thousands):

	For the year ended December 31, 2005
Revenue:
Rental and escalation income	$	5,618
Interest and other		518
Total revenue	$	6,136
Operating Expenses:
Real estate property operating expenses		1,589
Management fee -affiliates		229
General and administrative		591
Interest expense		2,269
Depreciation and amortization		777
Total expenses		5,455
Income from discontinued operations		681
Gain on disposition of discontinued operations		35,930
Income from discontinued operations before minority interest		36,611
Minority interest		(7,212	)
Income from discontinued operations, net of minority interest	$	29,399

F-22

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

(d) Discontinued Operations-2004

The assets and liabilities of the properties subsequently sold or in contract for sale were $42.4 million and $41.6 million, respectively, at December 31, 2004. 

The following table summarizes income from discontinued operations, net of minority interest for the period of October 29, 2004 to December 31, 2004 (in thousands):

	For the period of October 29, 2004 - December 31, 2004
Revenue:
Rental and escalation income	$	1,649
Interest and other		3
Total revenue	$	1,652
Operating Expenses:
Real estate property operating expenses		358
Management fee -affiliates		430
General and administrative		69
Interest expense		570
Depreciation and amortization		222
Total expenses		1,649
Income from discontinued operations		3
Gain on disposition of discontinued operations		—
Income from discontinued operations before minority interest		3
Minority interest		(1	)
Income from discontinued operations, net of minority interest	$	2

These properties were held within an equity method investment by the Predecessor, accordingly there are no corresponding discontinued operations in the consolidated statements of operations for the period January 1, 2004 through October 28, 2004 or for the year ended December 31, 2003.

4.Pro Forma Financial Information-(Unaudited)

As discussed in Note 3, the Company acquired and disposed of interests in certain operating real estate properties during the year ended December 31, 2005. The pro forma financial information set forth below is based upon the Company's historical consolidated statements of operations for the years ended December 31, 2005 and for the period of October 29, 2004 to December 31, 2004, adjusted to give effect of these transactions as of October 29, 2004 (date of IPO).

The pro forma financial information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the tranactions occurred October 29, 2004 (date of IPO), nor does it purport to represent the results of future operations.

F-23

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

(In thousands, except per share amounts)		For the year ended December 31, 2005		For the period October 29, 2004 - December 31, 2004
Pro forma revenues	$	79,278	$	8,797
Pro forma net income (loss)		35,574(1)		(2,450	)
Pro forma net income (loss) per common share - basic		1.72		(.12	)
Pro forma net income (loss) per common share - diluted		1.72		—

(1) The gain on sale of 729 and 1552 in the amount of $28.9 million is reflected in the period of the sale and was not reflected in the pro-forma net income for the period of October 29, 2004 to December 31, 2004.

5. CDO Deposit and Warehouse Agreements

The Company enters into warehouse agreements with major commercial banks whereby the banks agree to purchase CMBS and other real estate debt securities under the Company’s direction, with the expectation of selling such securities to a CDO issuance. The Company is required to pledge cash or other collateral as security for the purpose of covering a portion of any losses or costs associated with the accumulation of these securities under the warehouse agreement. The warehouse agreements also provide for the Company's notional participation in the income that the assets generate after deducting a notional debt cost. These agreements are treated as non-hedge derivatives for accounting purposes and are therefore marked to market through current income. Although the Company currently anticipates completing the most recent CDO in the near term, there is no assurance that such CDO will be consummated or on what terms it will be consummated.

In September 2004, the Predecessor entered into a warehouse arrangement with a major commercial bank whereby the bank has agreed to purchase up to $400 million of CMBS and other real estate debt securities under the Predecessor's direction, with the expectation of selling such securities to the Predecessor's third CDO issuer ("CDO III"). The Predecessor was required to pledge up to $10 million as security for the purpose of covering a portion of any losses or costs associated with the accumulation of these securities under the warehouse agreement. This security was in the form of a pledge of the Predecessor's preferred shares of CDO I for acquisitions of securities up to $150 million and cash deposits of up to $5.7 million to cover the accumulation of securities from $150 million to the maximum of $400 million. In November 2004, the Company made a $2.5 million cash deposit as required under this warehouse agreement. The CDO III warehouse agreement also provides for the Predecessor's and the Company's notional participation in the income that the assets generate after deducting a notional debt cost. An unrealized gain on the warehouse agreement for CDO III of $0.3 million was recognized for the period January 1, 2004 through October 28, 2004 by the Predecessor and $0.2 million was recognized for the period October 29, 2004 to December 31, 2004, by the Company, which is shown in the combined and consolidated statements of operations.

In January 2005, the pledge of the Company’s approximately 83% equity interest in CDO I was replaced with an additional cash deposit of $15.0 million, for a total cash deposit of $17.5 million, which represented the purchase price for the $23 million face amount of unrated Class E Subordinate Income Notes of CDO III which the Company acquired at the closing on March 10, 2005. The Company also purchased the BB-rated Class D Notes, with a face amount of $16.0 million, for $14.1 million. The Company partially financed the acquisition of the Class D Notes with a $9.1 million advance from its DBAG Facility, defined herein.

On September 27, 2005, the Company entered into a warehouse arrangement with a major commercial bank whereby the bank has agreed to purchase up to $400 million of CMBS and other real estate debt securities under the Company’s direction, with the expectation of selling such securities to the Company’s fifth investment grade CDO issuance or CDO VII. As of December 31, 2005, the Company has deposited $10 million as security for the purpose of covering a portion of any losses or costs associated with the accumulation of these securities under the warehouse agreement and will be required to deposit additional equity based on accumulations of securities that will be made under the warehouse agreement. The bank had accumulated $156.4 million of real estate securities under the terms of the warehouse agreement as of December 31, 2005. An unrealized loss on the warehouse house agreement for CDO VII of $0.5 million was recognized for the year ended December 31, 2005.

F-24

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

6. Debt Securities Available for Sale

The following is a summary of the Company’s available for sale securities at December 31, 2005 (in thousands):

Security	Contractual Maturity		Face Value		Amortized Cost		Unrealized Gain/(Loss)			Estimated Fair Value
SBM7 2000-C3 H	12/18/33	$	6,200	$	6,058		($158	)	$	5,900
PNCMA 2000-C2 L	10/12/33		5,500		4,567		(74	)		4,493
DLJCM 2000-CKP1 B4	11/10/33		8,000		7,505		(113	)		7,392
BSCMS 2000-WF1 J	02/15/32		1,110		861		4			865
NSTAR CDO III 2005-1 D	04/05/40		15,999		14,145		(382	)		13,763
FUNBC 2001-C4 N	12/12/33		1,406		1,149		(12	)		1,137
JPMCC 2003-C1 L	01/12/37		4,273		3,693		(97	)		3,596
MLMI 1998-C1 E	11/15/26		3,691		3,848		49			3,897
BACM 2003-1 J	09/11/36		7,132		6,723		206			6,929
BACM 2003-1 L	09/11/36		2,000		1,743		(8	)		1,735
GMACC 2000-C1 H	03/15/33		4,500		4,325		(57	)		4,268
COMM 2005-LP5 G	05/01/43		5,000		4,954		(138	)		4,816
COMM 2001-J1A F	02/14/34		1,000		1,041		(14	)		1,027
NSTAR CDO V - Class F	09/05/45		12,750		12,750		(291	)		12,459
NSTAR CDO V - Class E	09/05/45		5,000		5,000		(81	)		4,919
NSTAR CDO I - Preferred Equity	08/01/38		10,518		8,540		1,252			9,792
NSTAR CDO II - Income Note	06/01/39		15,067		15,011		(1,100	)		13,911
NSTAR CDO II - BB	06/01/39		5,000		4,217		189			4,406
NSTAR CDO III - Income Note	06/01/40		23,000		18,212		1,873			20,085
NSTAR CDO V - Income Note	09/05/45		26,154		24,921		(439	)		24,482
Total		$	163,300	$	149,263	$	609		$	149,872

During the year ended December 31, 2005, proceeds from the sales of available for sale securities to an affiliate was $21.5 million. The realized gain on the sale was $361,000 of which $436,000 was the unrealized gain which was included in other comprehensive income.

For the year ended December 31, 2004 the Company and the Predecessor’s investments in debt securities available for sale are as follows;

CDO I

On August 21, 2003, the first CDO Offering was completed by the Predecessor through its majority-owned subsidiaries, N-Star Real Estate CDO I Ltd. and N-Star Real Estate CDO I Corp., the issuer and co-issuer, respectively (collectively "CDO I"). CDO I purchased all of the securities accumulated under the CDO Deposit and Warehouse Agreement and financed the purchase through the issuance of collateralized debt obligations and the issuance of certain equity securities. The Predecessor, through NS CDO Holdings I LLC, acquired 15,833 preferred shares of CDO I with a liquidation preference of $15.8 million for $10 million. These preferred shares represent 83.33% of the preferred equity of CDO I. The Company's and the Predecessor's interest in CDO I is accounted for as a debt security available for sale pursuant to EITF 99-20. The Predecessor has recorded an unrealized gain of approximately $2.0 million for the period of January 1, 2004 through October 28, 2004 and the Company recognized an unrealized loss of $0.1 million for the period of October 29, 2004 through December 31, 2004, which was recorded as a component of other comprehensive income in owners' equity and stockholders' equity, respectively. The Company's potential loss in CDO I is limited to its investment in CDO I of approximately $10.4 million, which is included in the Company's consolidated balance sheet at December 31, 2004.

F-25

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

CDO II

In July 2004, the Predecessor completed its second CDO issuance through a majority-owned subsidiary, NS CDO II, Ltd., the issuer of the CDO ("CDO II"). CDO II acquired approximately $400 million of securities accumulated by a major commercial bank under the CDO II warehouse agreement and financed the purchase through the issuance of collateralized debt securities and unrated income notes. The Predecessor purchased $35.0 million of subordinated securities of this CDO issuance at a price of $27.4 million. This investment was recorded at $27.5 million as it includes the rollover of the Predecessor's share of the unrealized gains on the warehouse agreement accumulated during the warehouse period. These securities consist of the "BB" rated junior classes of debt securities and the unrated income notes, which effectively represent the residual interest in CDO II. The warehouse facility was terminated upon closing of CDO II in July 2004. The Predecessor's deposit was applied to the purchase price, $17.4 million was borrowed under a short-term facility with the warehouse bank and the balance of the purchase price was paid from working capital and an additional capital contribution by NSA. The Predecessor has recorded an unrealized loss of approximately $0.2 million for the period of January 1, 2004 through October 28, 2004 and the Company has recorded an unrealized gain of $0.1 million for the period of October 29, 2004 through December 31, 2004, related to the change in the fair value of CDO II's residual equity and the BB notes, which has been recorded as a component of other comprehensive income in owners equity and stockholders' equity, respectively.

The Predecessor's and the Company's investment in the unrated income notes of CDO II is accounted for as a debt security available for sale pursuant to EITF 99-20. The Company's potential loss in CDO II is limited to its investment in CDO II of approximately $27.3 million, which is included in the consolidated balance sheet at December 31, 2004.

7. Debt Securities Held forTrading

Subsequent to the IPO in October 2004, the Company made temporary investments in $1.31 billion of primarily AAA-rated, short-term, floating rate securities, which are backed by commercial or residential mortgage loans. These investments were financed through repurchase agreements with Citigroup Global Markets, Inc. and Greenwich Capital Markets, Inc. whereby the Company borrowed approximately $1.25 billion and funded the remaining balance of approximately $55 million in cash. The repurchase obligations generally mature and reinvest every thirty days with an interest rate of LIBOR plus 0.13% to 0.65% with a weighted average aggregate interest rate of 2.367% at December 31, 2004. These repurchase agreements are being accounted for as secured borrowings since the Company maintains effective control of the financed assets. (See Note 24 under Recent Accounting Developments). In December 2004, the Company sold $432.1 million of these temporary investments and repaid the associated repurchase obligations, recognizing a gain on the sale of approximately $0.3 million.

As of December 31, 2004, the Company's debt securities held for trading had a market value of $826.6 million and the remaining obligations under the related repurchase agreements amounted to $790.2 million. Two issuers of these debt securities represent 11% and 19%, respectively, of the total market value of the debt securities held for trading at December 31, 2004. For the period October 29, 2004 through December 31, 2004, the Company recorded an unrealized loss related to the change in fair value of these securities of $0.1 million, interest income of $3.1 million and interest expense in the amount of $3.0 million, related to the repurchase obligations. The Company's temporary investment strategy was designed to generate sufficient qualifying income during the two-month period before the Company's December 31, 2004 fiscal year-end so that the Company would be able to meet all of the REIT compliance requirements in advance of deploying capital pursuant to the Company's long-term business plan.

F-26

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

The Company fully liquidated the portfolio of these short term investments and repaid the associated repurchase agreements in 2005. The net realized gain on the portfolio from the sale of these short term investments was $80,000 for the year ended December 31, 2005.

8. Real Estate Debt Investments

At December 31, 2005 and 2004, the Company's investments in real estate debt investments are as follows (dollars in thousands):

December 31, 2005		Carrying Value(1)	Allocation by Investment Type		Average Spread Over LIBOR		Average Fixed Rate		Number of Investments
Whole loans, floating rate	$	178,775	26.3	%	3.06	%	—		10
Whole loans, fixed rate		13,082	1.9	%	—		5.27	%	3
Subordinate mortgage interests, floating rate		237,276	34.8	%	4.97	%	—		17
Mezzanine loans, floating rate		223,621	32.8	%	4.86	%	—		11
Mezzanine loan, fixed rate		151	0.0	%	—		15.00	%	1
Preferred equity, fixed rate		28,201	4.2	%	—		9.36	%	2
Total / Average	$	681,106	100.0	%	4.40	%	8.09	%	44

(1) Approximately $320 million of these investments serve as collateral for the CDO bonds of CDO IV (as defined in Note 11) and the balance are financed under the Wachovia Facility (as defined in Note 11) or other Repurchase Agreements.

December 31, 2004		Carrying Value(1)		Allocation by Investment Type		Average Spread Over LIBOR		Average Fixed Rate	Number of Investments
Subordinate mortgage interests, floating rate	$	48,515		68.5	%	4.69	%	N/A	2
Mezzanine loans, floating rate		22,054		31.5	%	4.75	%	N/A	1
Total / Average	$	70,569(2	)	100.0	%	4.71	%	N/A	3

(1) These investments served as collateral for the DBAG facility (defined in Note 11).

(2) The carrying amounts differ from the contractual amounts due to the deferred loan originations fees and acquisition cost in the amount of ($347,000) and $75,000 respectively.

As of December 31, 2005 and 2004, all loans were performing in accordance with the terms of the loan agreements.

Contractual maturities of real estate debt investments at December 31, 2005 are as follows (in thousands):

Years ending December 31:
2006	$	169,087
2007		310,635
2008		128,956
2009		32,969
2010		28,530
Thereafter		12,299
Total	$	682,476

Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay with or without prepayment penalties. The contractual amounts differ from the carrying amounts due to unamortized origination fees and costs and unamortized premiums and discounts being reported as part of the carrying amount of the investments.

9. Investments in and Advances to Unconsolidated/Uncombined Ventures

The Company and Predecessor has a non-controlling, unconsolidated/uncombined ownership interest in entities that are accounted for using the equity method. Capital contributions, distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated percentage interests, if any, in such entities as a result of preferred returns and allocation formulas as described in such agreements.

F-27

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

ALGM

Prior to the IPO the Predecessor owned a 97.5% non-controlling interest in ALGM until October 28, 2004. ALGM owned leasehold interests in eight net leased retail properties and fee simple interests in two retail/office properties. Prior to the contribution of the Initial Investments, the Predecessor accounted for its investment in ALGM under the equity method of accounting.

Concurrently with the contribution of the Initial Investments to the Operating Partnership and the IPO, the Company purchased the remaining 2.5% managing equity interest for $1.6 million from an affiliate with a portion of the proceeds of the IPO. As of October 29, 2004, ALGM is a wholly-owned subsidiary, and accordingly, has been consolidated in the Company's financial statements.

NSF Venture

The NSF Venture was formed to acquire and originate subordinate debt instruments on real estate assets. This was accounted for under the equity method by the Company and the Predecessor.

At December 31, 2005 and 2004, the Company has an investment of approximately $2.2 million and $5.4 million, respectively, which is included in investments in and advances to unconsolidated ventures in the accompanying consolidated balance sheets.

Northstar Realty Finance Trusts

The Company owns all of the common stock of Northstar Realty Finance Trust, Northstar Realty Finance Trust II and Northstar Realty Finance Trust III (collectively, “the Trusts”). The Trusts were formed to issue preferred securities. Under the provisions of FIN 46 (R), the Company determined that the holders of the trust preferred securities were the primary beneficiaries of the Trusts. As a result, the Company did not consolidate the Trusts and has accounted for the investment in the common stock of the Trusts under the equity method of accounting, which is reflected in Investments in and advances to unconsolidated ventures in the consolidated balance sheet. At December 31, 2005, the Company had an investment in the Trusts of approximately $3.3 million.

Reconciliation between the operating data for all unconsolidated/uncombined ventures and equity in earnings is as follows : (in thousands)

	The Company						The Predecessor
		For the year ended			For the period ended			For the period ended			For the year ended
		December 31, 2005			October 29, 2004 -December 31, 2004			January 1, 2004 - October 28, 2004			2003
Net income	$	7,328		$	2,136		$	11,515		$	7,854
Other partners' share of income		(7,054	)		(2,063	)		(10,032	)		(5,832	)
Elimination entries		(48	)		10			44			35
Step up costs		—			—			(7	)		(9	)
Earnings from unconsolidated/ uncombined ventures	$	226		$	83		$	1,520		$	2,048

Reconciliation between the Company's investment in unconsolidated entities as of December 31, 2005 and December 31, 2004 is as follows: (in thousands)

F-28

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

		December 31, 2005			December 31, 2004
Company's equity in unconsolidated entities	$	5,546		$	5,274
Elimination entry		(88	)		89
Purchase price basis difference		—			—
Investment in and advances to unconsolidated ventures	$	5,458		$	5,363

10. Deferred Costs and Intangible Assets, Net

Deferred costs and intangible assets as of December 31, 2005 and 2004 consisted of the following: (in thousands)

	December 31, 2005			December 31, 2004
Deferred lease costs	$	26,407		$	1,803
Deferred loan costs		13,523			3,360
Intangible assets		1,396			1,396
Pending deal costs		402			—
Accumulated amortization		(2,983	)		(2,326	)
Deferred costs and intangible assets, net	$	38,745		$	4,233

Deferred lease cost includes the allocation of a portion of the purchase price, in accordance with SFAS 141, to lease origination costs associated with the in-place leases. Appoximately $25.1 million was allocated to lease origination costs associated with the in-place leases for the year ended December 31, 2005, relating to the new acquisitions. See Note 3.

Intangible assets were recorded in connection with the acquisition of employee ownership interests in the subordinate real estate debt business and the minority interest in the real estate securities businesses as part of the Contribution Transactions. The Company purchased a 25% interest in NFMM from two former employees of NCIC. The excess of the fair value of the employee interest over the historical book value was $558,000, which was recorded as a step-up in basis and recorded as an intangible asset. The intangible asset is being amortized on a straight line basis over the remaining life of the underlying assets giving rise to the revenue stream used in the valuation with an estimated lfe of 3.2 years. The Company also purchased a 23% minority interest in NSA. The excess of the fair value of the minority interest over the historical book value of $839,000, was recorded as a step-up in basis and allocated to an intangible asset. The intangible asset is being amortized on a straight line basis over the remaining life of the underlying assets giving rise to the revenue stream used in the valuation with an estimated life of 7.7 years. The Company recognized $283,000 and $48,000 as amortization expense, relating to both acquisitions, which is reflected in the consolidated statement of operations for the year ended December 31, 2005 and for the period of October 29, 2004 through December 31, 2004, respectively.

F-29

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

11. Borrowings

The following is a table of the Company's outstanding borrowings as of December 31, 2005 and December 31, 2004:

	Stated Maturity	Interest Rate	Balance 12/31/05 (in thousands)	Balance 12/31/04 (in thousands)
Mortgage notes payable (non-recourse)
ALGM	1/01/2006	The greater of LIBOR or 2% +  3.60%	$ —	$ 40,557
Chatsworth	5/1/2015	5.65%	43,777	—
Salt Lake City	9/1/2012	5.16%	16,919	—
EDS	10/8/2015	5.37%	49,120	—
Executive Centre	1/1/2016	5.85%	51,480	—
Mezzanine loan payable (Chatsworth) (non-recourse)	5/1/2014	6.64%	13,000	—
Repurchase obligations	See below	See below	7,054	800,418
DBAG facility	12/21/2007	LIBOR + 0.75% to 2.25%	—	27,821
Wachovia credit facility	7/12/2008	LIBOR + 0.20% to 3.00%	243,002	—
Bank of America credit facility	9/27/2006	LIBOR + 3.25%	—	—
CDO bonds payable - CDO IV	7/1/2040	LIBOR + 0.62% (average spread)	300,000	—
Liability to subsidiary trusts issuing preferred securities
Trust I	3/30/2035	8.15%	41,240	—
Trust II	6/30/2035	7.74%	25,780	—
Trust III	6/30/2035	7.81%	41,238	—
			$ 832,610	$ 868,796

Scheduled principal payment requirements on the Company's borrowings are as follows as of December 31, 2005 (in thousands):

		Total		Mortgage and Mezzanine Loans		Credit Facilities		Liability to Subsidiary Trusts Issuing Preferred Securities		Repurchase Obligations		CDO Bonds Payable
2006	$	8,778	$	1,724	$	—	$	—	$	7,054	$	—
2007		2,580		2,580		—		—		—		—
2008		245,724		2,722		243,002		—		—		—
2009		2,910		2,910		—		—		—		—
2010		3,091		3,091		—		—		—		—
Thereafter		569,527		161,269		—		108,258		—		300,000
Total	$	832,610	$	174,296	$	243,002	$	108,258	$	7,054	$	300,000

At December 31, 2005, the Company was in compliance with all covenants under its Borrowings.

Mortgage Notes Payable

ALGM Mortgage

F-30

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

On December 4, 2002, ALGM and its subsidiaries, as Borrowers, and NPLP, as guarantor, entered into a loan agreement (the "Loan") with Greenwich Capital Financial Products, Inc. (the "Lender") for a mortgage in the principal amount of $43.0 million. The Loan is secured by a first mortgage lien and security interests on the ALGM Properties, including the fee owned properties, six leasehold interests and all other property collateral therein, including assignments of leases and rents. Pursuant to the contribution agreement between NPLP and the Operating Partnership, the Operating Partnership provided full indemnification of any liability to NPLP under this limited guaranty. At December 31, 2004, NorthStar Partnership had a maximum exposure of $40.6 million under its "bad boy" guaranty to the Lender. NorthStar Partnership also provided the Lender with a limited repayment guaranty that may be triggered by the termination of a lease related to one of the ALGM Properties. The maximum exposure for such lease termination was equal to $2.5 million at December 31, 2004.

ALGM and the Lender have allocated the Loan to the ALGM Properties as agreed to and the allocated amounts will be the basis for the calculation of the mandatory prepayment amount (as defined) which would be required upon sale of any one or more of the ALGM Properties. The mortgage was fully paid off in 2005 in connection with the sales of 1552 and 729.

Chatsworth Mortgage

In connection with the acquisition of the Chatsworth Properties, the Company entered into a loan agreement (the "Chatsworth Mortgage") with German American Capital Corporation for a non-recourse mortgage in the principal amount of $44.0 million (the "Loan"). The Loan is secured by first mortgage liens and security interests on the Chatsworth Properties, including two fee owned properties and the leasehold interest in the other property, including assignments of leases and rents.

The Chatsworth Mortgage matures on May 1, 2015 and bears interest at a fixed rate of 5.65%. The Loan requires monthly payments of $230,906 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $40.5 million at maturity, as well as monthly escrow deposits for ground lease payments required under the ground lease for the leasehold property. Commencing on the 112th payment date all excess cash flow, as defined in the Chatsworth Mortgage, is required to be deposited into a cash sweep reserve until $3.0 million has been deposited, through maturity of the mortgage. The Chatsworth Mortgage is not prepayable prior to maturity, but is subject to yield maintenance for any unscheduled principal prepayments prior to maturity.

The Company and its subsidiaries have agreed to comply with environmental laws and have indemnified the Lender against all liabilities and expenses related thereto.

Salt Lake City Mortgage

In connection with the acquisition of the Salt Lake City property, the Company entered into a loan agreement (the "Salt Lake City Mortgage") with CIBC, Inc. for a non-recourse mortgage in the principal amount of $17.0 million. The Salt Lake City Mortgage matures on September 1, 2012 and bears interest at a fixed rate of 5.16%. The loan requires monthly payments of $100,971 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $14.3 million at maturity, as well as monthly escrow deposits for real estate taxes.

EDS Mortgage

In connection with the acquisition of the EDS portfolio, the Company entered into a loan agreement with Countrywide Commercial Real Estate Finance, Inc. for a non-recourse mortgage in the principal amount of $49.1 million. The mortgage matures on October 8, 2015 and bears interest at a fixed rate of 5.37%. The loan requires monthly payments of $274,997 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $41.9 million at maturity, as well as monthly escrow deposits for real estate taxes.

Executive Centre Mortgage

In connection with the acquisition of the Executive Centre portfolio the Company entered into a mortgage with a principal amount of $51.5 million that matures on January 1, 2016 and bears interest at a fixed rate of 5.85%. This non-recourse loan requires monthly payments of $303,732 representing interest in arrears and principal sufficient to amortize the loan to a balance of approximately $48.1 million at maturity, as well as monthly escrow deposits for real estate taxes.

F-31

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Mezzanine Loan Payable

In connection with the acquisition of the Chatsworth Properties, the Company entered into a non-recourse mezzanine loan agreement (the "Chatsworth Mezzanine Loan") which was assigned to, then funded by, the warehouse provider for CDO III (the "Chatsworth Mezzanine Lender") for a mezzanine loan in the principal amount of $13.0 million. The Chatsworth Mezzanine Loan bears interest at a fixed rate of 6.64%, and requires monthly payments of interest only of $71,955 for the period from February 1, 2005 through February 1, 2006. Principal and interest payments of $170,914 are due thereafter, which will fully amortize the Chatsworth Mezzanine Loan by maturity, May 1, 2014. The Chatsworth Mezzanine Loan is secured by a pledge of the Company’s equity interest in an affiliate under the borrower of the Chatsworth Mortgage. The Chatsworth Mezzanine Loan currently constitutes a portion of the portfolio of securities owned by CDO III.

CDO Bonds Payable

In June 2005, the Company closed its fourth CDO issuance ("CDO IV") and the Company acquired all of the below investment grade securities and income notes. The CDO IV issuer issued $300 million face amount of the CDO bonds and sold them in a private placement to third parties. The proceeds of the CDO issuance were used to repay the entire outstanding principal balance of the DBAG Facility (as defined below) of $233.6 million at closing. The CDO bonds are collateralized by real estate debt investments, consisting of junior participations, mezzanine loans, whole loans, CMBS and CDO bonds.

Repurchase Obligations

On July 21, 2004, NS CDO Holdings II, LLC entered into a financing arrangement with Citigroup Global Markets Inc. ("Citigroup") and originally borrowed $17.4 million under a repurchase agreement that is being accounted for as a secured borrowing since the Company maintains effective control of the financed assets. This financing is secured by the "BB" rated junior classes of debt securities and unrated income notes of CDO II. The financing matures on July 21, 2005 and bears interest at LIBOR plus 125 basis points. On November 3, 2004, the Company repaid $7.3 million of its short-term loan payable to Citigroup, which was secured by the unrated income notes. The principal amount outstanding at December 31, 2005 and 2004 is $3.3 million and $10.2 million, respectively and the aggregate interest rate was 5.63% and 3.67% (LIBOR + 1.25%), respectively.

The Company's temporary investments, which are primarily AAA-rated, short-term, floating rate securities, backed by commercial or residential mortgage loans, were financed with repurchase agreements with Citigroup and Greenwich Capital Markets, Inc. The Company initially borrowed approximately $1.25 billion under repurchase agreements, of which $790.2 million was outstanding at December 31, 2004, approximately $754.3 million with Citigroup and $35.9 million with Greenwich. The Company fully liquidated its short term security portfolio in 2005 and fully repaid the associated repurchase agreements.

In 2005 the Company used repurchase agreements with Citigroup to finance certain available for sale securities. At December 31, 2005 there was approximately $3.7 million outstanding with Citigroup. These repurchase obligation matures and reinvest every thirty days with an aggragate interest rate of 4.98% (LIBOR plus 0.60%) at December 31, 2005. This repurchase agreements are being accounted for as secured borrowings since the Company maintains effective control of the financed assets.

Wachovia Credit Facility

On July 13, 2005, a subsidiary of the Company, entered into a master repurchase agreement with Wachovia Bank, National Association (the "Wachovia Facility"). The Wachovia Facility was amended in September 2005 and currently the Company may borrow up to $350 million under this credit facility in order to finance the acquisition of primarily real estate debt and other real estate loans and securities. The additional capacity and flexibility under the amendment will allow the Company to accumulate sufficient collateral for a contemplated subordinate debt CDO ("CDO VI") and to continue to finance other investments.

F-32

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Advance rates under the Wachovia Facility range from 55% to 95% (subject to increase under certain circumstances) of the value of the assets for which the advance is made. Amounts borrowed under the Wachovia Facility bear interest at one-month LIBOR plus a spread which ranges from 0.20% to 3.00%, depending on the type of asset for which the amount is borrowed. The Wachovia Facility has an initial term of three years, except that certain advances under the Wachovia Facility are required to be repaid by February 24, 2006. If a securitization transaction is not consummated by March 30, 2006, advances under the facility in excess of $150 million will be subject to a 0.48% commitment fee and a 0.25% unused facility fee. The Wachovia Facility has an initial maturity date of July 12, 2008 and, in addition, the Company must pay an unused facility fee equal to 0.25% of the unused portion of the Wachovia Facility up to $150 million (subject to the preceding sentence), commencing 120 days after July 13, 2005, payable quarterly in arrears. The Company may extend the term of the Wachovia Facility for one year if it is not in default and must pay an extension fee of 0.25% of the aggregate amount then outstanding under the facility. If the Company extends the facility's term, it will be required to retire 25% of the aggregate amount then outstanding under the facility during each quarter of the remaining year of the term. The Company paid Wachovia a $750,000 structuring fee in connection with the execution of the Wachovia Facility.

The debt outstanding under the Wachovia Facility is subject to a number of terms, conditions and restrictions including, without limitation, scheduled interest payments and the maintenance of certain margin percentages on amounts outstanding under the facility. If the market value of an asset securing outstanding debt declines, the Company may be required to satisfy a margin call by paying cash or providing additional collateral. Failure to meet any margin call could result in an event of default which would enable Wachovia to exercise various rights and remedies including acceleration of the maturity date of the debt outstanding under the facility and the sale of the collateral. For the year ended December 31, 2005, the weighted average interest rate on the Wachovia Facility was 5.95%.

Bank of America Facility

On September 28, 2005, the Company entered into a master loan, guarantee and security agreement with Bank of America, N.A., the Operating Partnership and NS Advisors LLC (the "BOA Master Loan Agreement"). The BOA Master Loan Agreement provides for an unsecured, $50 million revolving credit facility. The term of the unsecured facility is one year, with up to two one-year extensions at the discretion of Bank of America. If the unsecured facilty is not extended by Bank of America, the Company has the option in lieu of immediate repayment to amortize the outstanding principal balance of the unsecured facility in equal quarterly installments over twelve months, upon payment of a quarterly 12.5 basis point fee on the outstanding balance under the unsecured facility at September 27, 2006 and each quarter thereafter. The interest rate on the unsecured facility is LIBOR, plus 325 basis points. For the year ended December 31, 2005, the weighted average interest rate on this facility was 7.22%. In connection with the facility the Company paid a origination fee of 0.50% and, in addition, must pay an unused facility fee equal to 0.50% of the unused portion of the facility.

The BOA Master Loan Agreement contains certain covenants, including, among other things, financial covenants requiring minimum cash liquidity, minimum tangible net worth, maximum debt to tangible net worth and minimum debt service coverage. The BOA Master Loan Agreement also contains certain customary representations and warranties and events of default. The obligations of the Operating Partnership, which is the borrower under the unsecured facility, are guaranteed by the Company, NS Advisors LLC and any subsidiary of the Operating Partnership whose assets are included in the borrowing base for the unsecured facility.

DBAG Credit Facility

On December 21, 2004, the Company entered into a $150 million master repurchase agreement with Deutsche Bank AG, Cayman Islands Branch. On March 21, 2005, this facility was amended and restated (as amended, the "DBAG Facility") to allow the Company to borrow up to $300 million in order to finance the acquisition of primarily subordinate real estate debt and other real estate loans and securities. The additional capacity and flexibility under the amendment of the DBAG Facility allowed the Company to accumulate sufficient collateral for CDO IV, and to continue to finance other investments. Pursuant to the terms of the DBAG Facility, the availability under the DBAG Facility was reduced to $150 million upon closing of CDO IV on June 14, 2005.

F-33

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

The DBAG Facility has an initial three-year term, which may be extended for one additional year if the Company is not in default and pays an extension fee of 0.25% of the aggregate outstanding amount under the facility. If the Company extends the term of the facility, it will be required to retire 25% of the aggregate outstanding amount each quarter during the remaining year of the term.

Under the terms of the DBAG Facility, the Company is able to finance the acquisition of mortgage loans secured by first liens on commercial or multifamily properties, junior participation interests in mortgage loans secured by first or second liens on commercial or multifamily properties, mezzanine loans secured by a pledge of the entire ownership interest in a commercial or multifamily property, B- or higher rated commercial mortgage backed securities and BB or higher rated real estate CDOs, debt securities issued by a REIT and syndicated bank loans.

Effective April 1, 2005, the covenants under the DBAG Facility require the Company to remain at a certain minimum tangible net worth, a certain minimum debt service coverage ratio, a certain range of ratios of recourse indebtedness to net worth and certain minimum amounts of cash or marketable securities based on our ratio of recourse indebtedness to net worth.

Prior to June 14, 2005, the Company had financed the acquisition of securities for CDO IV through borrowings under the DBAG Facility. The Company used a portion of the proceeds from the sale of the transferred assets to repay the amount outstanding under the DBAG Facility.

Liability to Subsidiary Trusts Issuing Preferred Securities

On April 12, 2005, May 25, 2005 and November 22, 2005 NorthStar Realty Finance Trust I, NorthStar Realty Finance Trust II and NorthStar Realty Finance Trust III (collectively “The Trusts") sold, in three private placements, trust preferred securities for an aggregate amount of $40 million, $25 million and $40 million, respectively. The Company owns all of the common stock of the Trusts. The Trusts used the proceeds to purchase the Company's junior subordinated notes which mature on March 30, 2035, June 30, 2035 and January 30, 2036, respectively. These notes represent all of the Trusts' assets. The terms of the junior subordinated notes are substantially the same as the terms of the trust preferred securities. The trust preferred securities have a fixed interest rate of 8.15%, 7.74% and 7.81% per annum, respectively, during the first ten years, after which the interest rate will float and reset quarterly at the three-month LIBOR rate plus 3.25% per annum for Trusts I and II and three-month LIBOR rate plus 2.83% per annum on Trust III.

The Company may redeem the notes, in whole or in part, for cash, at par, after March 30, 2010, June 30, 2010 and January 30, 2011, respectively. To the extent the Company redeems notes, the Trusts are required to redeem a corresponding amount of trust preferred securities. On September 16, 2005, we amended the trust agreements and indentures to modify some of the payment dates for a portion of the junior subordinated notes.

The ability of the Trusts to pay dividends depends on the receipt of interest payments on the notes. The Company has the right, pursuant to certain qualifications and covenants, to defer payments of interest on the notes for up to six consecutive quarters. If payment of interest on the notes is deferred, the Trust will defer the quarterly distributions on the trust preferred securities for a corresponding period. Additional interest accrues on deferred payments at the annual rate payable on the notes, compounded quarterly.

F-34

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

12. Obligations Under Capital Leases and Operating Lease Agreements

The Company is the lessee of two locations under capital leases. The following is a schedule of minimum future rentals under capital leases as of December 31, 2005 (in thousands):

Years ending December 31:
2006	$	262
2007		262
2008		342
2009		382
2010		382
Thereafter		14,887
Total minimum lease payments		16,517
Less amounts representing interest		13,142
Present value of future minimum lease payments	$	3,375

Interest on the above capital leases was imputed at the incremental borrowing rate of 10% at the acquisition date of each lease. Interest expense incurred on the above capital leases totaled $334,000 and $58,000 for year ended December 31, 2005 and the period October 29, 2004 to December 31, 2004, respectively.

Under one of the capital leases, the Company also pays rent equal to 15% of the minimum rental income received from the sub-tenant. In addition the Company pays rent for its corporate offices in connection with its Sublease with NCIC. The Sublease expires in 2006.

The following is a schedule of minimum future rentals due as of December 31, 2005 (in thousands):

Years ending December 31:
2006	$	90
2007		98
2008		105
2009		105
2010		105
Thereafter		758
Total minimum lease payments	$	1,261

Under one of its operating real estate properties the Company pays ground rent. In addition the Company pays rent for its corporate offices in connection with its Sublease with NCIC. The Sublease expires in October 2006.

The following is a schedule of minimum future rental payments as of December 31, 2005 (in thousands):

Years ending December 31:
2006	$	967
2007		497
2008		497
2009		497
2010		497
Thereafter		14,133
	$	17,088

13.    Rental Income Under Operating Leases

Rental income from real estate is derived from the leasing and sub-leasing of space to commercial tenants. The leases are for fixed terms of varying length and provide for annual rentals and expense reimbursements to be paid in monthly installments.

The following is a schedule of future minimum rental income under non-cancelable leases at December 31, 2005 (in thousands):

F-35

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Years ending December 31:
2006	$	19,507
2007		19,769
2008		20,505
2009		20,626
2010		18,063
Thereafter		67,422
	$	165,892

Included in rental income is percentage rent of $559,000 and $110,000 for the year ended December 31, 2005 and the period October 29, 2004 to December 31, 2004, respectively.

14. Related Party Transactions

Shared Facilities and Services Agreement

Upon consummation of the IPO, the Company entered into a one-year agreement with NCIC pursuant to which NCIC agreed to provide the Company, directly or through its subsidiaries, with facilities and services as follows: 1) fully-furnished office space for the Company’s employees at NCIC's corporate headquarters; 2) use of common facilities and office equipment, supplies and storage space at NCIC's corporate headquarters; 3) accounting support and treasury functions; 4) tax planning and REIT compliance advisory services; and 5) other administrative services, for an annual fee of $1.57 million, payable in monthly installments, plus additional charges for out-of-pocket expenses and taxes. This fee was subject to reduction by the amount that the Company paid certain employees of NCIC who became co-employees upon consummation of the IPO.

On October 29, 2005, the Company terminated the agreement and entered into a more limited sublease agreement with NorthStar Capital. Under the new sublease effective November 1, 2005, the Company rents from NorthStar Capital office space currently used by its accounting, legal and administrative personnel on a month to month basis. The sublease rent is calculated as a per person monthly charge, based on a "turn key" office arrangement (computer, network, telephone and furniture supplied) for each person utilizing NorthStar Capital facilities. These direct costs are reflected in other general and administrative expenses. Total rent expense incurred by the Company under the Sublease to $0.1 million for the period November 1, 2005 to December 31, 2005.

Total fees and expenses incurred by the Company under the shared facilities and services agreement amounted to $1.1 million and $0.2 million for the year ended December 31, 2005 and for the period from October 29, 2004 to December 31, 2004. No amounts were payable to NCIC at December 31, 2005 and 2004.

Advisory Fees

In August 2003, July 2004, March 2005 and September 2005, the Company and Predecessor entered into agreements with CDO I, CDO II, CDO III and CDO V, respectively, to perform certain advisory services.

The Company and Predecessor earned total fees of approximately $4,296,000, $471,000, $1,595,000 and $504,000 for the year ended December 31, 2005, for the period October 29 to December 31, 2004, for the period January 1 to October 28, 2004 and for the year ended December 31, 2003, respectively, of which $224,000 and $82,000 is unpaid and included in the Company's balance sheets as of December 31, 2005 and December 31, 2004, respectively, as receivables from related parties.

The Predecessor also earned structuring fees of $500,000 in connection with the closing of both CDO I and II in August 2003 and July 2004, respectively, which was used to reduce its investments in debt securities available for sale.

The Company also earned a structuring fee of $500,000 in connection with the closing of CDO III in March 2005, which was used to reduce its investment in CDO III which is included in debt securities available for sale in the consolidated balance sheet.

F-36

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

NSF Venture

In 2001, NCIC entered into an advisory agreement with the NSF Venture, whereby it receives as compensation for its management of the origination and underwriting of the investments of the NSF Venture, an advisory fee equal to 1% per annum of the capital invested by the NSF Venture. In November 2003, NCIC assigned the right to receive such fees to NFMM. For years prior to such assignment, the advisory fees have been reflected as part of the Predecessor with a corresponding decrease in contributed capital. The Company and Predecessor earned and recognized fees of approximately $517,000, $192,000, $876,000, and $522,000 for the year ending December 31, 2005 and the periods October 29, 2004 to December 31, 2004, January 1 to October 28, 2004, and for the year ended December 31, 2003, respectively. For the period prior to the IPO, the Predecessor recorded such fees as deemed distributions.

Management fees-related parties

On December 28, 2004, ALGM terminated its existing asset management agreement with Emmes Asset Management Co. LLC ("Emmes"), an affiliate of NCIC. Pursuant to the termination provisions of the agreement, ALGM paid Emmes a contractual termination payment of approximately $385,000, which is equal to two quarters of payments of the annual existing fee. In addition, ALGM and Emmes entered into a new asset management agreement, which is cancelable on 30 days notice. The annual asset management fee under the new agreement is equal to 3.5% of gross collections from tenants of the properties not to exceed $350,000 or be less than $300,000 per year, except that in the event the assets under management are decreased the fee shall not have a minimum subject to certain provisions. Total fees incurred under this agreement amounted to $291,000 and $516,000, including the termination payment of $385,000, for the year ended December 31, 2005 and the period from October 29, 2004 to December 31, 2004, repectively. A portion of the management fee was allocated to the properties sold or held for sale and was classified in income from discontinued operations in the consolidated statement of operations. See Note 3.

EDS portfolio

In connection with the acquisition of the EDS portfolio, Koll Development Company, an affiliate of NCIC, received a brokerage commission of $921,000. The acquisition and the associated brokerage fees payable to Koll Development Company were approved in advance by all of the disinterested members of the board of directors.

Legacy Fund

On September 1, 2005, the Company entered into a loan agreement, as lender, with a subsidiary of Legacy Partners Realty Fund I, LLC, (the "Legacy Fund"), as borrowers, in the original principal amount of $66.6 million, secured by a first-priority mortgage lien on an office property located in San Jose, California. At the closing of this loan the Company funded $60.9 million of the original principal amount and has an additional $5.7 million of future funding commitments. Simultaneously with the closing of this loan, the Company entered into a participation and servicing agreement with a major financial institution pursuant to which the Company sold a 50% participation in this loan and the future funding commitments.

Additionally, on September 8, 2005, the Company entered into a loan agreement with another subsidiary of the Legacy Fund in the original principal amount of $47.4 million, secured by a first-priority mortgage lien on an office property located in San Jose, California. The Company funded $32.6 million at closing and has an additional $14.8 million of future funding commitments. Simultaneously with the closing of this loan, the Company entered into a participation and servicing agreement with a major financial institution pursuant to which the Company sold a 50% participation in this loan and the future funding commitments.

One of the Company's directors, Preston Butcher, is the chairman of the board of directors and chief executive officer and owns a significant interest in Legacy Partners Commercial, LLC, which indirectly owns an equity interest in, and owns the manager of, the Legacy Fund. The disinterested members of the Company's board of directors approved this transaction.

F-37

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

15. Fair Value of Financial Instruments

The following disclosures of estimated fair value were determined by management, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

In 2004, cash equivalents, accounts receivable, accounts payable, repurchase agreements with major banks and securities firms and the master repurchase agreement balances reasonably approximate their fair values due to the short-term maturities of these items. The CDO deposit and warehouse agreement, debt securities available for sale and securities sold, not yet purchased are carried on the balance sheet at their estimated fair value. Due to the floating rate, mortgage notes payable and loan receivables are carried at amounts that reasonably approximate their fair value.

In 2005, cash equivalents, accounts receivable, accounts payable, repurchase agreements with major banks and securities firms and the master repurchase agreement balances reasonably approximate their fair values due to the short-term maturities of these items. The CDO deposit and warehouse agreement, debt securities available for sale are carried on the balance sheet at their estimated fair value. The credit facilities and the variable rate mortgage receivables are carried at amounts which reasonably approximate their fair value, due to their floating rates.

For fixed rate loan receivables fair value is estimated using quoted market prices or by discounting future cash flows using current rates at which similar loans would be made to similar borrowers with similar credit risk. Since The Company’s fixed rate loan receivables had an estimated fair value of $41.4 million which approximated the carrying value.

For fixed rate mortgage loans payable the Company uses rates currently available to them with similar terms and remaining maturities to estimate their fair value. The fair value of the mortgage notes payable was $172.0 million with a carrying amount of $174.2 million.

Disclosure about fair value of financial instruments is based on pertinent information available to management as of December 31, 2005 and 2004. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.

16. Equity Based Compensation

Employee Buy-Outs

NSA Advisors Profit Sharing Buy-Out

In connection with the Contribution Transactions, the Company agreed to buy-out the vested and unvested profit sharing arrangement of an employee of NSA for 206,850 OP Units and $88,000 in cash. The OP Units are subject to a vesting schedule identical to the one the employee had with the profit sharing arrangement (one third vested at July 31, 2003, and one third vests on each of the anniversaries following). The OP Units received were recorded as compensation expense in accordance with SFAS 123. The fair value of the award was $1,862,000 based upon the fair market value of the OP Units at the date of the buy-out. In connection with the buy-out, the Company recognized $1,572,000 in compensation expense for the period of October 29, 2004 through December 31, 2004 in the consolidated statement of operations. The remaining balance of $378,000 was recognized into compensation expense for the year ended December 31, 2005.

NFMM Employee Ownership Interests Buy-Out

In connection with the Contribution Transactions, the Company agreed to acquire a 25% ownership interest in NFMM held by an employee of NCIC and a former employee of NCIC for 173,128 OP Units. The fair value of OP Units issued in excess of the fair value of the ownership interest received was recorded as compensation expense in accordance with SFAS 123. The fair value of the award was $1,558,000 and the estimated fair value of the ownership interest was $558,000, which resulted in $1,000,000 of compensation expense recorded in the consolidated statement of operations for the period of October 29, 2004 through December 31, 2004. The fair value of the ownership interest acquired in excess of historical costs basis of the minority interest was recorded as a purchase adjustment, which was allocated to an intangible asset on the consolidated balance sheet. See Note 10.

F-38

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Omnibus Stock Incentive Plan

On September 14, 2004, the board of directors of the Company adopted the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (the "Stock Incentive Plan"). The Stock Incentive Plan provides for the issuance of stock-based incentive awards, including incentive stock options, non-qualified stock options, stock appreciation rights, shares of common stock of the Company, including restricted shares, and other equity-based awards, including OP Units which are structured as profits interests ("LTIP Units") or any combination of the foregoing. The eligible participants in the Stock Incentive Plan include directors, officers and employees of the Company, co-employees of the Company and NCIC and employees of NCIC who will provide services to the Company pursuant to the shared facilities and services agreement. An aggregate of 1,433,038 shares of common stock of the Company are currently reserved and authorized for issuance under the Stock Incentive Plan, subject to equitable adjustment upon the occurrence of certain corporate events. On October 29, 2004, an aggregate of 38,886 shares of restricted common stock were granted to the Company's non-employee directors pursuant to the Stock Incentive Plan. In addition, an aggregate of 798,582 LTIP Units have been granted to the Company's officers, employees and co-employees of the Company and NCIC pursuant to the Stock Incentive Plan. LTIP Units vest to the individual recipient at a rate of one-twelfth of the total amount granted as of the end of each quarter, beginning with the quarter ended January 29, 2005, for the three-year vesting period so long as the recipient continues to be an eligible recipient. In addition, the LTIP Unit holders are entitled to dividends on the entire grant. Dividends or dividend equivalents paid on the portion of the grant that vested will be charged to retained earnings. Non forfeitable dividends or dividend equivalents paid on shares of stock that are not vested will be recognized as additional compensation cost.

The awards granted to the NCIC employees who provided services to the Company pursuant to the shared facilities and services agreement and certain co-employees were accelerated and became fully vested upon the termination of the shared facility and service agreement on October 29, 2005. The additional compensation expense related to the accelerated vesting was approximately $0.4 million.

The Company has recognized compensation expense of $3.2 million and $0.4 million related to the amortization of awards granted under this plan for the year ended December 31, 2005 and the period October 29, 2004 through December 31, 2004, respectively.

Long-Term Incentive Bonus Plan

On September 14, 2004, the board of directors of the Company adopted the NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (the ‘‘Incentive Bonus Plan"), in order to retain and incentivize officers and certain key employees of the Company, co-employees of the Company and NCIC and employees of NCIC who will provide services to the Company pursuant to the shared facilities and services agreement. Up to 2.5% of the Company's total capitalization as of consummation of the IPO is available to be paid under the Incentive Bonus Plan in cash, shares of common stock of the Company or other share-based form at the discretion of the compensation committee of the Company's board of directors, if certain return hurdles are met.

An aggregate of 698,142 shares of common stock of the Company are currently reserved and authorized for issuance under the Incentive Bonus Plan, subject to equitable adjustment upon the occurrence of certain corporate events. On November 19, 2004, an aggregate of 665,346 shares of common stock of the Company were allocated to officers, employees and co-employees of the Company and NCIC for awards under the Incentive Bonus Plan if the Company achieves the return hurdles established by the compensation committee. The Company's compensation committee has established the return hurdle for these performance periods as an annual return on paid in capital as defined in the plan, equal to or greater than 12.5%. If the Company achieves these return hurdles, the vested awards may be paid in cash, shares of common stock, LTIP Units or other share based form.

F-39

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Each of the participants will be entitled to receive half of his or her total reserved amount if the Company meets the return hurdle for the one-year period beginning October 1, 2005 and such participant is employed through the end of this first performance period. Each of the participants will be entitled to the other half of his or her total reserved amount if the Company meets the return hurdle for the one-year period beginning on October 1, 2006 and such participant is employed through the end of this second performance period. If the Company does not meet the performance hurdles for either period, the award amounts are generally forfeited, provided that, if the Company does not meet the return hurdle for the one-year period beginning October 1, 2005, but the Company meets the return hurdle for the two-year period beginning October 1, 2005 (determined by averaging the Company's performance over the 2-year period) and a participant is employed through the end of this two-year period, such participant will be entitled to receive his or her total reserved amount.

At December 31, 2005 , management has made its best estimate of the Company's performance during the performance periods, based on the facts and information currently available and assumptions regarding the investment of the remaining proceeds of the Company's IPO and the proceeds from its secondary offering pursuant to its stated business strategy and returns on future investments. On the basis of the foregoing, management has estimated that the Company would meet the return hurdle in each of these performance periods. Compensation expense, with respect to provisional awards under the 2004 Long-Term Incentive Bonus Plan, has been recognized in the consolidated financial statements of the Company for the year ended December 31, 2005 of $2.2 million which included a catch-up adjustment of $1.7 million in accordance with the provisions of SFAS 123.

Employee Outperformance Plan

In connection with the employment agreement of the Company's chief investment officer, he is eligible to receive incentive compensation equal to 15% of the annual net profits from the Company's real estate securities business in excess of a 12% return on invested capital (the annual bonus participation amount). The Company will have the option of terminating this incentive compensation arrangement at any time after the third anniversary of the date of its IPO by paying the Company's chief investment officer an amount based a multiple of the estimated annual bonus participation amount, at the time it exercises this buyout option. If the Company exercises this buyout option, the fixed amount due for terminating this arrangement will vest ratably and be paid in four installments over a three-year period with 25% paid on termination. If the Company's chief investment officer voluntarily terminates his employment with the Company prior to any exercise of the Company's buyout option, he will be eligible to receive future annual payments based on the future real estate securities annual net profits in excess of the 12% return hurdle on invested capital. The portion of the annual benefit to which the chief investment officer is eligible after voluntary termination increases with each year of employment until the fifth anniversary, at which point the chief investment officer is 100% vested in the full amount of the payment that would be due related to the annual bonus participation amount on the real estate securities business income earned on, business initiated five years earlier, over the return hurdle. Compensation has been earned by the Company's chief investment officer under this plan for the year ended December 31, 2005 of $0.2 million and there was no compensation earned for the period October 29, 2004 through December 31, 2004.

17. Stockholders' Equity

Common Stock

On June 24, 2005, the Company granted a total of 15,194 shares to the members of its Board of Directors as part of their annual grants.

In December 2005, the Company closed a secondary public offering of 9.2 million common shares at $9.25 per share, which included 1.2 million shares to cover the underwriters’ over-allotment. Net proceeds from the offering were approximately $78.9 million. The proceeds from the offering were used to pay down short term debt and to fund new investments.

F-40

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Dividends

On April 21, 2005, the Company declared a cash dividend of $0.15 per share of common stock. The dividend was paid on May 16, 2005 to the shareholders of record as of the close of business on May 2, 2005.

On July 28, 2005, the Company declared a cash dividend of $0.15 per share of common stock. The dividend was paid on August 15, 2005 to the shareholders of record as of the close of business on August 8, 2005.

On October 6, 2005, the Company declared a dividend of $0.23 per share of common stock, payable to stockholders of record as of October 14, 2005. The Company made this payment on October 21, 2005.

18. Minority Interest

Minority interest represents the aggregate limited partnership interests or OP Units in the Operating Partnership held by limited partners (the “Unit Holders”). Income allocated to the minority interest is based on the Unit Holders ownership percentage of the Operating Partnership. The ownership percentage is determined by dividing the numbers of OP Units held by the Unit Holders by the total OP Units outstanding. The issuance of additional shares of beneficial interest (the ‘‘Common Shares’’ or ‘‘Share”) or OP Units changes the percentage ownership of both the Unit Holders and the Company. Since a unit is generally redeemable for cash or Shares at the option of the Company, it is deemed to be equivalent to a Share. Therefore, such transactions are treated as capital transactions and result in an allocation between shareholders' equity and minority interest in the accompanying consolidated balance sheet to account for the change in the ownership of the underlying equity in the Operating Partnership.

In conjunction with the formation of the Company, certain persons and entities contributing ownership interests in the Predecessor to the Operating Partnership received OP Units. Upon consummation of the IPO, 19.0% of the carrying value of the net assets of the Operating Partnership was allocated to minority interest. As a result of the exercise of the underwriters' over-allotment option of 1,160,750 shares on November 19, 2004, the minority interests were reduced to 18.2%.

Under their respective contribution agreements, NCIC and affiliates directly and/or indirectly received 4,705,915 OP Units.

Minority interest at December 31, 2005 and 2004 represents 15.3% and 18.2%, respectivly, of all vested Unit Holders.

19. Derivatives and Hedging Activities

In 2005 the Company in an effort to limit the exposure to the variable LIBOR interest rate, the Company entered into various swap agreements to fix the LIBOR rate on a portion of the Company's variable rate debt. The fixed LIBOR rate ranged from 4.18 % to 5.03%. The following table summarizes the notional amounts and fair (carrying) values of the Company's derivative financial instruments as of December 31, 2005 (in thousands):

	Notional Amount		Fair Value		Range of Maturity
Interest rate swaps, treated as hedges	$	53,242	$	726		March 2010 - August 2018

20. Contingency

On August 21, 2003, an action was filed against ALGM in New York State Supreme Court, New York County (the "Complaint"). The Complaint was brought by 729 7th Realty Corp. (the "Tenant"), a subsidiary of the net lessee of the Condominium, to enforce certain rights it claims to have under its net lease with ALGM (the "Net Lease").

F-41

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

In connection with the sale of 729, the Tenant agreed to discontinue the legal action that it had brought against the Company, settling the Company's only material pending legal action, at no cost to the Company.

21. Off Balance Sheet Arrangements

The Company has interests in four CDO issuances, whose CDO notes are primarily collateralized by investment grade real estate securities. The Company generally purchases the preferred equity or the income notes of each CDO, which are the equity securities of the CDO issuances, and, with the exception of CDO I, all of the below investment grade CDO Notes of each CDO issuance. In addition, the Company earns a fee of 0.35% of the outstanding principal balance of the assets backing each of these CDO issuances as an annual collateral management fee. The Company's and the Predecessor's interests in CDO I, CDO II, CDO III and CDO V are each accounted for as a single debt security available for sale pursuant to EITF 99-20.

The following table describes certain terms of the collateral for and the notes issued by CDO I, CDO II, CDO III and CDO V as follows:

		CDO Collateral - December 31, 2005				CDO Notes - December 31, 2005
Issuance	Date Closed	Par Value ofCDO Collateral (in thousands)	Weighted Average Interest Rate	Weighted Average Rating	Weighted Average Expected Life (years)	OutstandingCDO Notes (in thousands)(1)	WeightedAverage Interest Rate at 12/31/05(3)	Stated Maturity	CarryingValue 12/31/05(in thousands)(4(i)	CarryingValue 12/31/04 (in thousands)(4)
CDO I(2)	8/21/03	$ 352,041	6.62%	BBB/BBB-	6.01	$    332,831	6.13%	8/1/2038	$ 9,792	$ 10,411
CDO II	7/1/04	392,841	6.25%	BBB/BBB-	6.65	356,170	5.58%	6/1/2039	18,317	27,281
CDO III	3/10/05	401,790	6.06%	BBB-	6.69	360,973	5.59%	6/1/2040	20,085	--
CDO V	9/22/05	500,969	5.69%	BBB	9.08	461,500	2.89%	9/5/2045	41,860	--
Total		$  1,647,641				$ 1,511,474			$  90,054	$ 37,692

(1) Includes only notes held by third parties.

(2) The Company has an 83.33% interest in CDO I.

(3) Includes the effect of the interest rate swap held in each CDO. The weighted average interest rate for CDO V reflects the initial payment from the swap counterparty for CDO V. The effective interest rate on the CDO V Notes will increase in subsequent periods.

(4) The Company's potential loss in CDO I, CDO II, CDO III and CDO V is limited to the carrying value of its investment in CDO I, CDO II, CDO III and CDO V, respectively, at December 31, 2005 and 2004.

22. Quarterly Financial Information (Unaudited)

The tables below reflect the Company's selected quarterly information for the Company and the Predecessor for the years ended December 31, 2005 and 2004.

Consolidated and Combined Statements of Operations Information

(unaudited)

	Three Months Ended
		December 31,		September 30,		June 30,		March 31,	��
		2005		2005		2005		2005
Total revenue	$	23,233	$	17,232	$	13,345	$	11,287
Income before minority interests		2,095		5,620		1,261		1,413
Net income		22,178		4,616		9,823		1,055
Net income per share-basic/diluted	$	0.96	$	0.22	$	0.46	$	0.05
Weighted-average shares outstanding — basic		23,164,930		21,264,930		21,250,240		21,249,736
diluted		28,708,507		26,790,161		26,766,315		26,760,770

F-42

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

	Three Months Ended
					Predecessor
		December 31, 2004 (1)			September 30, 2004		June 30, 2004			March 31, 2004
Total revenue	$	6,620		$	1,937	$	945		$	908
Income (loss) before minority interests		(3,002	)		350		(183	)		955
Net income (loss)		(2,367	)		350		(183	)		955
Net income per share-basic(2)		($0.12	)		—		—			—
Weighted-average shares outstanding — basic (2)		20,868,865			N/A		N/A			N/A

(1) In order to present quarterly information for the quarter ended December 31, 2004, the Company has combined our predecessor’s results for the period from September 1, 2004 to October 28, 2004 with the results of its operations for the period from October 29, 2004 to December 31, 2004.

(2) Net income per share and the weighted average shares outstanding is for the period of October 29, 2004 (Date of IPO) to December 31, 2004.

23. Segment Reporting

The Company and the Predecessor (prior to the IPO) were engaged in three lines of business (i) real estate debt, (ii) real estate securities and (iii) operating real estate investments. These lines of business make up our reportable segments.

In real estate debt business the Company acquires, originates and structures senior and subordinate debt investments secured primarily by income-producing real estate properties. Revenues generated from this segment is interest income with operating expenses consistng of interest expense. The Company evaluates performance and allocates resources based upon earnings contributions to income from continuing operations.

In the real estate securities business the Company invests in commercial real estate debt securities, including commercial mortgage backed securities, or CMBS, REIT unsecured debt, and credit tenant loans. Revenues generated from this segment is interest income and advisory fees with operating expenses consistng of interest expense. The Company evaluates performance and allocates resources based upon earnings contributions to income from continuing operations.

In the operating real estate segment the Company acquires properties that are primarily net leased to corporate tenants located through out the United States, currently the geographical locations are New York, Ohio, California, Utah, Pennsylvania, and Michigan. Revenues generated from this segment is rental income with operating expenses consisting of real estate taxes, insurance, repairs and maintenance, utilities and ground rent. The Company evaluates performance and allocates resources based upon earnings contributions to income from continuing operations.

These operating segments were determined based upon the investment activity of the Company. The reportable segments are managed separately due to the differing nature of the business operations.

General and administrative expenses were not allocated by management to various segments and therefore are presented as unallocated.

The following tables set forth certain segment information for the Company and Predecessor on a combined basis, as of and for the year ended December 31, 2005 and 2004 (in thousands):

F-43

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

		Operating Real Estate		Real Estate Debt		Real Estate Securities		Unallocated(1)			Consolidated Total
Total revenues for the years ended
December 31, 2005	$	11,451	$	33,304	$	11,737	$	8,605		$	65,097
December 31, 2004		526		1,677		4,687		3,521			10,411
Income (loss) from continuing operations for the year ended
December 31, 2005		274		18,254		12,411		(20,550	)		10,389
December 31, 2004		1,179		2,217		4,044		(9,319	)		(1,879	)
Net income(loss) for the year ended
December 31, 2005		29,673		18,254		12,411		(22,666	)		37,672
December 31, 2004		1,182		2,217		4,044		(8,688	)		(1,245	)
Total assets as of
December 31, 2005	$	237,312	$	775,324	$	82,615	$	58,188		$	1,153,439
December 31, 2004	$	57,262	$	78,358		57,001	$	885,457		$	1,078,078

(1) Unallocated includes interest income and interest expense related to our temporary investments and also includes corporate level and general & administrative expenses

24. Subsequent Events (Unaudited)

Real estate debt

The Company has made investments in unsecuritized loans subsequent to December 31, 2005 as follows, (dollars in thousands):

Subsequent to December 31, 2005		Carrying Value (in thousands)	Allocation by Investment Type		Average Spread Over LIBOR		Average Fixed Rate		Number of Investments
Whole loans, floating rate	$	92,335	54.06	%	3.33	%	—		5
Whole loans, fixed rate		—	—		—		—		—
Mezzanine loans, floating rate		66,580	38.98	%	9.34	%	—		2
Mezzanine loan, fixed rate		11,880	6.96	%	—		8.00	%	1
Total / Average	$	170,795	100.0	%	5.85	%	8.00	%	8

NSF Venture

On February 1, 2006, the Company sold its interests in the NSF Venture to the institutional pension fund which had an equity interest in the NSF Venture and terminated the associated advisory agreements for total consideration of $2.9 million. The Company will recognize incentive income of approximately $1.2 million which was deferred at December 31, 2005. Subsequent to January 31, 2006, we will no longer earn management or incentive fees from the NSF venture or from loans owned directly by the NSF venture investor.

Timarron Acquisition

On October 20, 2005, the Company entered into a definitive purchase agreement with Allied Capital to acquire Timarron Capital Corporation. Timarron, based in Dallas, Texas, was organized by former senior executives of Principal Financial and other leading financial institutions to develop a nationwide commercial mortgage loan origination platform. The Company closed on the acquisition on January 19, 2006. The purchase price was approximately $2.7 million. Timarron was renamed NRF Capital LP. NRF Capital LP will originate commercial mortgage loans for our commercial real estate debt portfolio.

Operating Real Estate

Acquisitions

On February 6, 2006, through a 50% owned joint venture interest with an institutional investor, the Company acquired a portfolio of three adjacent class A office/flex buildings located in Colorado Springs, CO, with 406,204 square feet of rentable space for $54.25 million. The properties are 100% leased to Quantum Corp. under leases expiring in 2021 (59%), 2013 (11%), 2011 (13%) and 2009 (17%). 

F-44

NorthStar Realty Finance Corp. and Subsidiaries and Northstar Realty Finance Corp. Predecessor

Notes to Consolidated and Combined Financial Statements (Continued)

Dispositions

On January 31, 2006, the Company sold its leasehold interests in 27 West 34th Street and 1372 Broadway, both located in New York City, for $2.3 million.

Dividends

On January 26, 2006, the Company declared a dividend of $0.27 per share of common stock to stockholders of record as of February 3, 2006. The dividend was paid on February 10, 2006.

Wachovia Credit Facility Amendment

On February 28, 2006, the Company amended the Wachovia Credit to increase the Company’s maximum borrowings under the facility to $400 million from $350 million.

Issuance of Preferred Securities

On March 10, 2006, a subsidiary of the Company, NorthStar Realty Finance Trust IV, completed a private placement of $50 million of trust preferred securities. The sole assets of the trust consist of a like amount of junior subordinated notes due June 30, 2036 issued by the Operating Partnership and guaranteed by the Company.  The proceeds of the issuance of the notes were used to repay short term debt and to fund new investments. The trust preferred securities and the notes both have a 30-year term, ending June 30, 2036, and bear interest at a fixed rate of 7.95% for the first ten years, ending June 2016, whereupon the rate floats at three-month LIBOR plus 2.80%. The securities are redeemable at par beginning on June 30, 2011.

Recent Accounting Developments

In 2004, the Company purchased securities and simultaneously financed the acquisition of the securities through repurchase agreements, collateralized with the same securities purchased, with the selling broker. The Company currently records on the consolidated balance sheet, the acquisition of these securities as trading securities which are carried at fair value and the related repurchase agreements as liabilities at contract value which approximates their fair market value due to the extremely short term nature and the floating rates. Interest income earned on the securities and interest expense incurred on the repurchase obligations are reported on a gross basis on the statement of operations.

Presently, the accounting for these transactions is being discussed among the standard setters which may be resolved through a FASB Staff Position (FSP) or other guidance addressing an alternative view that under SFAS 140 such transactions, as described above, may not qualify as purchases by the Company because the securities purchased may not be deemed legally isolated from the counterparty after they are transferred under the repurchase agreement. Under this view, the Company would present the net investment in these transactions as derivatives on the balance sheet, with the corresponding change in fair value being recorded in the statement of operations. As of December 31, 2004, the Company has entered into transactions aggregating approximately $ 351.0 million in securities, and $333.4 million in repurchase agreements described above. The portfolio was fully liquidated in 2005. This alternate view would not have a material impact on stockholders, equity or net income of the Company for the years ended December 31, 2005 or December 31, 2004.

F-45

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS

AS OF DECEMBER 31, 2005

Description		Balance at Beginning of the period (in thousands)		Charged to Costs and Expenses (in thousands)			Additions/ Charges to Other Accounts		Deductions (2) (in thousands)		Balance at End of Period (in thousands)
For the Period October 29, 2004 through December 31, 2004
Provision for loan losses	$	—	$	—		$	—	$	—	$	—
Allowance for doubtful accounts — SL(1)		4,050		87			—		—		4,137
Allowance for doubtful accounts(1)		5		(4	)		—		—		1
Total	$	4,055	$	83		$	—	$	—	$	4,138
Year Ended December 31, 2005
Provision for loan losses		—
Allowance for doubtful accounts — SL(1)		4,137		126			—		4,263		—
Allowance for doubtful accounts(1)		1		153			—		150		4
Total	$	4,138	$	279		$	—	$	4,413	$	4

Explanatory Notes:

(1)See Note 2 to the Company's Consolidated Financial Statements.

(2)The deductions are a result of the sale of two operating real estate properties and the two leaseholds which are classified as discontinued operations. See Note 3.

F-46

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

SCHEDULE III — REAL ESTATE AND ACCUMULATED DEPRECIATION

DECEMBER 31, 2005 (in thousands)

Column A		Column B		Column C Initial Cost				Column D Cost Capitalized Subsequent To Acquisition
Description		Encumbrances		Land		Buildings & Improvements		Land		Buildings & Improvements
987 Eighth Avenue, NY		—		—		2,645		—		—
36 West 34 Street, NY		—		—		4,410		—		7
991 Third Avenue(1)NY		—		—		1,703		—		—
701 Seventh Avenue(1) NY		—		—		3,246		—		—
Chatsworth properties		56,777		5,837		55,030		—		—
Salt Lake City		16,918		672		19,740		—		21
EDS Portfolio		49,120		11,940		37,477		—		—
Executive Center		51,480		7,000		55,980		—		—
	$	174,295	$	25,449	$	180,231	$	—	$	28

Column E Gross Amount at Which Carried atClose of Period							Column F	Column G	Column H	Column I
	Land		Buildings & Improvements		Total		Accumulated Depreciation	Date of Construction	Date Acquired	Life on Which Depreciation is Computed
	—		2,645		2,645		580		Mar-99	Various
	—		4,417		4,417		759		Mar-99	Various
	—		1,703		1,703		1,703		Mar-99	Various
	—		3,246		3,246		1,579		Mar-99	Various
	5,837		55,030		60,867		1,612		Jan-05	Various
	672		19,761		20,433		297		Aug-05	Various
	11,940		37,477		49,417		393		Sept-05	Various
	7,000		55,980		62,980		77		Dec-05	Various
$	25,499	$	180,259	$	205,708	$	7,000

⁽¹⁾ Represents a leasehold interest amortized over the life of the underlying lease.

The changes in real estate for the year ended December 31, 2005, are as follows (in thousands):

		2005			2004
Balance at beginning of period	$	54,198		$	54,191(1	)
Property acquisitions		193,669
Improvements		28			7
Retirements/disposals		(37,965	)
Assets held for sale		(4,222	)
Balance at end of period	$	205,708		$	54,198

(1) These assets were acquired in connection with our IPO. See Note 1.

The changes in accumulated depreciation, exclusive of amounts relating to equipment, and furniture and fixtures, for the year ended December 31, 2005 are as follows:

		2005			2004
Balance at beginning of period	$	10,654		$	10,292
Depreciation for the period		3,786			362
Retirements/disposals		(4,707	)
Assets held for sale		(2,733	)
Balance at end of period	$	7,000		$	10,654

F-47

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

SCHEDULE IV — LOANS AND OTHER LENDING INVESTMENTS

DECEMBER 31, 2005

Description	Location	Interest Rate	Final Maturity Date	Periodic Payment Terms (1)	Prior Liens	Carrying Amount of Loans	Principal Amount of Loans
Whole Loans:
Industrial	New Jersey	5.10%	7/1/2015	P& I	$                                          -	$ 3,700	$ 3,775
Industrial	California	5.78%	6/1/2015	P& I	-	3,569	3,576
Office	California	LIBOR + 2.85%	9/11/2008	I/O	-	16,089	16,300
Office	California	LIBOR + 2.85%	9/9/2008	I/O	-	27,653	27,950
Office	California	LIBOR + 5.00%	9/9/2008	I/O	-	2,500	2,500
Office	Houston	LIBOR + 3.15%	12/1/2008	I/O	-	24,000	24,000
Office	New Jersey	LIBOR + 3.00%	1/1/2007	I/O	-	8,000	8,000
Office	Houston	LIBOR + 3.50%	1/1/2009	I/O	-	32,750	32,750
Warehouse	New Jersey	5.07%	7/8/2015	P& I	-	5,813	5,971
Hotel	California	LIBOR + 2.15%	6/8/2007	I/O	-	24,506	24,500
Hotel	California	LIBOR + 3.12%	8/9/2007	I/O	-	17,428	17,420
Retail	Alabama	LIBOR + 3.25%	5/1/2008	I/O	-	12,849	12,849
Office	North Carolina	LIBOR + 3.75%	12/1/2008	I/O	-	5,000	5,000
Office	New Jersey	LIBOR + 3.50%	7/1/2007	I/O	-	8,000	8,000
					$                                         -	$ 191,857	$192,591
Junior Participation:
Multi-family	Various Locations	LIBOR + 5.25%	8/9/2007	I/O	$515,000	$35,000	$35,000
Office	Chicago	LIBOR + 1.84%	5/15/2006	I/O	550,000	24,456	25,000
Retail / Hotel	Various Locations	LIBOR + 1.70%	6/6/2007	I/O	80,000	7,013	7,000
Land	Florida	LIBOR + 9.65%	6/1/2008	I/O	112,300	15,026	15,000
Hotel	California	LIBOR + 9.75%	10/1/2007	I/O	17,500	4,956	5,000
Office	New York	LIBOR + 3.75%	8/9/2006	I/O	44,000	23,911	24,000
Multi-family	Florida	LIBOR + 5.50%	7/31/2006	I/O	25,000	21,214	21,200
Hotel	New York	LIBOR + 5.55%	12/9/2006	I/O	140,000	30,020	30,000
Hotel	Boston	LIBOR + 5.15%	4/1/2007	I/O	19,000	13,014	13,000
Storage	Various Locations	LIBOR + 4.68%	11/1/2007	I/O	15,000	7,834	7,820
Hotel	Various Locations	LIBOR + 6.90%	9/1/2006	I/O	8,000	4,482	4,474
Retail	New York	LIBOR + 2.40%	9/9/2006	I/O	49,000	10,012	10,000
Office	New York	LIBOR + 2.50%	1/8/2007	I/O	18,750	4,260	4,250
Office	Georgia	LIBOR + 7.00%	7/9/2007	I/O	18,000	10,013	10,000
Retail	Chicago	LIBOR + 7.58%	12/9/2006	I/O	24,000	11,053	11,000

F-48

NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

SCHEDULE IV — LOANS AND OTHER LENDING INVESTMENTS

DECEMBER 31, 2005

(Continued)

Description	Location	Interest Rate	Final Maturity Date	Periodic Payment Terms (1)	Prior Liens	Carrying Amount of Loans	Principal Amount of Loans
Office	Indiana	LIBOR + 3.25%	7/9/2007	I/O	40,200	15,012	15,000
					$1,675,750	$237,276	$237,744
Mezzanine:
Office	Chicago	LIBOR + 6.25%	11/1/2007	P & I	$200,000	$31,093	$31,075
Hotel	Various Locations	LIBOR + 3.25%	7/13/2008	I/O	4,050,000	25,018	25,000
Hotel	Various Locations	LIBOR + 4.50%	9/11/2007	I/O	2,305,000	31,451	31,416
Retail	Alabama	15.00%	5/1/2008	I/O	12,849	151	151
Various	Texas	LIBOR + 6.00%	11/9/2007	P & I	190,000	14,819	14,921
Hotel	Various Locations	LIBOR + 4.15%	10/12/2007	I/O	864,000	34,003	34,000
Hotel	Various Locations	LIBOR + 4.75%	7/9/2006	I/O	108,000	22,016	22,000
Hotel	Various Locations	LIBOR + 3.50%	2/9/2007	I/O	100,000	14,287	14,278
Office	New York	LIBOR + 4.51%	10/5/2006	I/O	80,000	19,962	20,000
Office	California	LIBOR + 5.35%	1/9/2007	I/O	112,000	17,956	18,000
Office	New York	LIBOR + 5.00%	1/8/2007	I/O	23,000	5,010	5,000
Office	Indiana	LIBOR + 6.36%	7/9/2007	I/O	55,200	8,006	8,000
					$8,100,049	$223,772	$223,841
Preferred:
Office	Georgia	11.00%	11/1/2010	I/O	$                  -	$5,123	$5,000
Office	Virginia	9.00%	1/1/2010	I/O	-	23,078	23,300
					$                  -	$28,201	$28,300
Subtotal					9,775,799	$ 681,106	$682,476
Provision for losses					-	-	-
Total					$9,775,799	$ 681,106	$682,476

F-48

	2005			2004
Balance at beginning of period	$	70,569		$	—
Additions during the year:
New loans and additional advances on existing loans		696,589			70,841
Acquisition cost and (fees)		(39	)		(284	)
Premiums/ (Discounts)		(2,118	)		—
Amortization of fees and discounts		1,241			12
Deductions:
Collection of principal		84,953			—
Amortization of acquisition cost and premiums		183			—
Balance at end of period	$	681,106		$	70,569

⁽¹⁾ Interest only or I/O; Principal and Interest or P&I.

F-49

ALGM I Owners LLC and Subsidiaries

Consolidated Financial Statements

Contents

	Page
Report of Independent Registered Public Accounting Firm	F-51
Consolidated Balance Sheet as of December 31, 2004	F-52
Consolidated Statements of Income for the years ended December 31, 2004 and 2003	F-53
Consolidated Statements of Members' Equity for the years ended December 31, 2004 and 2003	F-54
Consolidated Statements of Cash Flows for the years ended December 31, 2004 and 2003	F-55
Notes to Consolidated Financial Statements	F-56
Schedule II — Valuation and Qualifying Accounts	F-65
Schedule III — Real Estate and Accumulated Depreciation as of December 31, 2004	F-66

F-50

Report of Independent Registered Public Accounting Firm

To the Members of

ALGM I OWNERS LLC and Subsidiaries

We have audited the accompanying consolidated balance sheet of ALGM I OWNERS LLC and Subsidiaries (“the Company”) as of December 31, 2004, and the related consolidated statements of income, members’ equity, and cash flows for each of the two years in the period ended December 31, 2004. Our audits also included the financial statement Schedules II and III. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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 consolidated financial position of ALGM I OWNERS LLC and Subsidiaries at December 31, 2004, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG LLP

New York, New York

March 30, 2005,

except for Note 10, as to which the date is

March 6, 2006

F-51

ALGM I Owners LLC and Subsidiaries

Consolidated Balance Sheet

	December 31,
	2004
Assets
Real estate, at cost—net of accumulated depreciation	$	43,543,933
Cash and cash equivalents		2,342,819
Tenant receivables, net of allowance for doubtful accounts of $1,013		482,378
Prepaid expenses		469,407
Deferred leasing costs, net		1,182,084
Restricted deposits		2,239,133
Tenant security deposits		473,621
Deferred financing costs, net		846,660
Other assets		115,180
Unbilled rents receivable		5,566,850
Total assets	$	57,262,065
Liabilities and members' equity
Liabilities:
Mortgage payable	$	40,557,280
Obligations under capital leases		3,303,424
Accrued interest payable—mortgage payable		206,490
Accounts payable and accrued expenses including $28,378 to affiliates		1,006,703
Rent payable		29,158
Tenant security deposits		441,784
Total liabilities		45,544,839
Commitments and contingencies
Members' equity		11,717,226
Total liabilities and members' equity	$	57,262,065

See accompanying notes to consolidated financial statements.

F-52

ALGM I Owners LLC and Subsidiaries

Consolidated Statements of Income

	Year ended December 31,
	2004		2003
Revenues:
Minimum and percentage rent	$	2,580,591	$	3,021,073
Tenant reimbursements		130,464		204,709
Interest income and other		18,016		9,261
Total revenues		2,729,071		3,235,043
Expenses:
Rent—master leases		125,997		276,651
Real estate taxes		295,516		413,505
Operating expenses		177,737		165,250
Marketing, general and administrative including $16,702 (2004), and $30,587 (2003) to affiliates		27,346		111,344
Interest expense		326,706		320,664
Asset management fee—affiliate		188,985		140,271
Depreciation and amortization		775,443		1,030,247
Total expenses		1,917,730		2,457,932
Income before discontinued operations		811,341		777,111
Income from discontinued operations		404,099		900,104
Net Income	$	1,215,440	$	1,677,215

See accompanying notes to consolidated financial statements.

F-53

ALGM I Owners LLC and Subsidiaries

Consolidated Statements of Members' Equity

Years ended December 31, 2004 and 2003

	Total Members' Equity			Managing Member			Other Members
Capital balances, December 31, 2002	$	10,682,467		$	267,063		$	10,415,404
Distributions		(2,531,410	)		(63,285	)		(2,468,125	)
Net income		1,677,215			41,930			1,635,285
Capital balances, December 31, 2003		9,828,272			245,708			9,582,564
Distributions		(856,411	)		(606,411	)		(250,000	)
Net Income		1,215,440			166,067			1,049,373
Purchase of interest and push down of basis		1,529,925			11,911,862			(10,381,937	)
Capital balances, December 31, 2004	$	11,717,226		$	11,717,226		$	—

See accompanying notes to consolidated financial statements.

F-54

ALGM I Owners LLC and Subsidiaries

Consolidated Statements of Cash Flows

	Year ended December 31,
	2004			2003
Cash flows from operating activities:
Net income	$	1,215,440		$	1,677,215
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,011,114			2,260,073
Amortization of financing costs		822,038			812,553
Increase in obligation under capital lease		64,606			58,482
(Increase) decrease in operating assets:
Tenant receivables		(19,337	)		(170,509	)
Unbilled receivables		(562,638	)		(654,463	)
Prepaid expenses and other assets		(35,504	)		(345,739	)
Payments for leasing costs		(7,416	)		(333,664	)
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses		17,446			156,919
Rent payable		(19,441	)		(19,438	)
Accrued interest payable		4,530			201,960
Tenant security deposits—net		3,818			(28,405	)
Net cash provided by operating activities		3,494,656			3,614,984
Cash flows from investing activities:
Purchases of building and leasehold improvements		(321,230	)		(34,790	)
Withdrawals from (deposits to) restricted deposits—net		(337,901	)		(132,834	)
Net cash used in investing activities		(659,131	)		(167,624	)
Cash flows from financing activities:
Payment of financing costs		(9,845	)		(151,570	)
Principal repayments of mortgage		(1,323,854	)		(1,118,866	)
Distributions to members		(856,411	)		(2,531,410	)
Net cash used in financing activities		(2,190,110	)		(3,801,846	)
Net increase (decrease) in cash and cash equivalents		645,415			(354,486	)
Cash and cash equivalents—beginning of period		1,697,404			2,051,890
Cash and cash equivalents—end of period	$	2,342,819		$	1,697,404
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	2,350,432		$	2,565,700

See accompanying notes to consolidated financial statements.

F-55

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements

1.    Organization and Nature of Business

ALGM I Owners LLC and its wholly-owned limited liability companies were organized under the laws of the State of Delaware (collectively, the "Company" or the "Companies"). On June 30, 1998, the Company acquired through a series of transactions a $151,505,000 loan (the "Acquired Loan") for $56,500,000 from a commercial bank which was made to the Riese Organization Inc., National Restaurants Management Inc. and their various subsidiaries and affiliates (collectively referred to as "NRMI").

The Acquired Loan was secured by, among other things, (i) a first mortgage on two fee interests in real property located at 729 Seventh Avenue ("729" or the "Condominium") and 1552 Broadway ("1552"), New York, New York. 729 is a 19,618 square foot retail condominium and 1552 is a 12,091 square foot free standing building, both located in New York City's Times Square area and (ii) twenty-four retail leasehold interests. Thirteen of these leaseholds were secured by recorded leasehold mortgages with the remainder secured by a recorded collateral assignment of rents.

The Company commenced foreclosure actions against NRMI in order to gain control of the collateral securing the Acquired Loan, and on February 28, 1999, a settlement agreement was reached whereby the Company received, among other things, deeds in lieu of foreclosure for 729 and 1552 and an assignment of eleven of the twenty-four leasehold interests.

The Company commenced operations on June 4, 1998 and is to continue until December 31, 2028, unless sooner terminated pursuant to the Operating Agreement or by law.

The original members of the Company were NorthStar Partnership, L.P. (‘‘NorthStar’’) and ALGM Equity LLC (‘‘Equity’’), as managing member. On October 29, 2004 an affiliate of NorthStar, NorthStar Realty Finance Corp. (‘‘NRFC’’), acquired Equity’s interest for $1.6 million. Contemporaneously, NorthStar transferred its member interest to NRFC and, as a result of these transactions, NRFC became the sole member of the Company. The $1,333,615 cost in excess of Equity’s basis plus $196,310 of historical capitalized costs maintained on the books of NorthStar in excess of their member’s equity account have been pushed down to the Company and have been allocated to land, buildings and leaseholds based on their relative fair values.

Profits are allocated to the members in accordance with their membership interests until the members receive distributions in an amount equal to their total capital contributions and a cumulative return of 10% compounded quarterly on each member's capital contribution ("Preferred Return"). After the members have received distributions equal to their respective capital contributions and Preferred Return, available cash and profits shall be distributed/allocated 10% to Managing Member and 90% to all members, including Managing Member, in accordance with their membership interests. Losses are allocated to the members until the capital accounts of all members have reached a zero balance and thereafter in accordance with their membership interests.

2.    Summary of Significant Accounting Policies

Principles of Consolidation

The financial statements include the accounts of ALGM I Owners LLC and all of its wholly-owned single member limited liability companies. Intercompany balances and transactions have been eliminated in consolidation.

Revenue Recognition

Rental revenue is recognized on a straight-line basis over the noncancelable term of the respective leases. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in unbilled rents receivable in the accompanying consolidated balance sheet.

F-56

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Tenant reimbursement income is recognized in the period in which the related expense is incurred. Rental revenue which is based upon a percentage of the sales recorded by the Company's tenants is recognized in the period such sales were earned by the respective tenants.

The Company provides an allowance for doubtful accounts for estimated losses resulting from the inability of its tenants to make required rent and other payments as due. Additionally, the Company establishes, on a current basis, an allowance for future tenant credit losses on unbilled rents receivable based upon an evaluation of the collectibility of such amounts.

Real Estate

Real estate is carried at historical cost less accumulated depreciation and any write-downs for impairment.

Buildings are being depreciated by the straight-line method over 39 years. Leasehold interests and leasehold improvements are being depreciated by the straight-line method over the term of the respective master leases which range from approximately 1 to 25 years.

The Company reviews long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Upon determination that impairment exists, the related asset is written down to its estimated fair value. No impairment reserves have been recorded in the accompanying financial statements.

Property Under Capital Lease

The Company is the lessee of two retail locations under capital leases expiring in 2029 and 2072, respectively. The assets and liabilities under capital leases are recorded at the present value of the future minimum lease payments. The assets are being depreciated by the straight-line method over the shorter of their related lease terms or their estimated useful lives of 40 years. Depreciation of assets under capital leases is included in depreciation and amortization and totaled $85,420 in 2004 and 2003.

Leasing Costs

Leasing costs are being amortized by the straight-line method over the terms of the respective leases. Amortization of leasing costs was $152,575 and $192,132, of which a portion has been reclassified from depreciation and amortization to discontinued operations, for the years ended December 31, 2004 and 2003, respectively. Leasing costs are shown net of accumulated amortization of $620,146 on the consolidated balance sheet at December 31, 2004.

Financing Costs

Financing costs related to the Greenwich Capital Loan, as defined in Note 4, are being amortized over the life of the loan using the effective interest rate method. Amortization of financing costs was $822,038 and $812,554 for the years ended December 31, 2004 and 2003, respectively. See Note 10. Financing costs are shown on the consolidated balance sheet net of accumulated amortization of $1,646,649 at December 31, 2004.

Derivatives

The Company is party to certain interest rate cap agreements. These contracts are entered into as part of the Company's management of interest rate exposure and effectively limit the amount of interest rate risk on a portion of the Company's outstanding indebtedness. The interest rate cap agreements are included in deferred financing costs on the accompanying balance sheet at their estimated fair value. Changes in fair value are reflected as a component of interest expense each period.

Rent Expense

Rent expense is recorded on a straight-line basis over the noncancelable term of the respective leases. Rent payable represents the excess of rent expense incurred on a straight-line basis over rent expense as it becomes payable according to the terms of the lease.

F-57

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Cash Equivalents

The Company considers all highly liquid debt instruments purchased with maturities of three months or less and money market funds to be cash equivalents.

Restricted Deposits

Restricted deposits consist of escrows for taxes, insurance, leasing costs, capital expenditures and payments required under certain leases.

Income Taxes

The Companies were organized as limited liability companies under the laws of the State of Delaware. Although limited liability companies are unincorporated associations, the entity is classified as a partnership for federal income tax purposes. Accordingly, the Companies are not subject to federal and state income taxes and make no provision for income taxes in their financial statements. The Companies' taxable income or loss is reportable by their members.

Deposit Insurance

Cash, including restricted and tenant security deposits, exceeded the Federal Deposit Insurance Corporation deposit insurance limit of $100,000 per financial institution by approximately $4,856,000, at December 31, 2004.

Fair Value of Financial Instruments

Due to the variable rate nature of the mortgages payable, management believes that the carrying values of the mortgages approximate the fair values as of December 31, 2004. Due to the short-term nature of all other financial instruments, management believes that carrying values of those financial instruments approximate fair values.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect 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 revenue and expenses during the reporting period. Actual results could differ from those estimates.

The accounting policies most effected by judgments, estimates and assumptions are as follows.

Management is required to make subjective estimates as to whether there are impairments in the value of the Company's real estate assets. Such assessments are based upon multiple factors including, local market conditions, current cost of capital and tenant quality, which are inherently uncertain.

Management is also required to make subjective assessments about the collectibility of the deferred rent receivable that in many cases will not be billed to tenants for many years from the balance sheet date. Management's determination is based upon an assessment of credit worthiness of the private company tenants for which financial information is not readily available and as such is not subject to precise quantification.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

3.    Real Estate

On February 28, 1999, a settlement agreement was reached whereby the Company received deeds in lieu of foreclosure for 729 and 1552, and an assignment of leasehold interests in various retail and office properties located in New York City (the "Properties"). Two of the above mentioned leases were recorded as capital leases. The Company leases and subleases space in the Properties to various retail and commercial third party tenants.

F-58

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

In 2003, two of the leasehold interests expired, leaving six leasehold interests in the portfolio at December 31, 2004.

Real estate at December 31, 2004 is summarized as follows:

	Total		Fee Owned		Leasehold Interests		Capital Leases
Land	$	7,597,099	$	7,597,099	$	—	$	—
Buildings		33,395,796		30,367,662		—		3,028,134
Leasehold interests		12,517,646		—		12,517,646		—
Improvements		686,896		—		142,851		544,045
		54,197,437		37,964,761		12,660,497		3,572,179
Less accumulated depreciation		10,653,504		4,400,631		5,132,883		1,119,990
Net real estate	$	43,543,933	$	33,564,130	$	7,527,614	$	2,452,189

Depreciation expense totaled $1,858,539 and $2,067,941 for the years ended December 31, 2004 and 2003, respectively before consideration of the subsequent sales. See Note 10.

4.    Mortgage Payable

Greenwich Capital Loan Payable

On December 4, 2002, the Company and its subsidiaries, as Borrowers, and NorthStar Partnership, L.P. ("NSLP") (an affiliate of the Company), as guarantor, entered into a loan agreement (the ‘‘Greenwich Capital Loan") with Greenwich Capital Financial Products, Inc. (‘‘Greenwich Capital Lender") for a mortgage in the principal amount of $43,000,000. The loan is secured by a first mortgage lien and security interests on the Company's properties including the fee owned properties, six leasehold interests and all other property collateral therein, including assignments of leases and rents. Pursuant to the contribution agreement between NorthStar and the Operating Partnership, the Operating Partnership provided full indemnification of any liability to NorthStar under this guaranty.

The Greenwich Capital Loan was scheduled to mature on January 1, 2005 and bears interest at the greater of 2%, or thirty-day LIBOR, adjusted monthly, plus 3.60%, which aggregate rate was 5.91% and 5.60% at December 31, 2004 and 2003, respectively. The Greenwich Capital Loan requires monthly payments of interest in arrears and principal sufficient to amortize the loan over a period of 200 months using an assumed interest rate of 8.50% per annum, as well as monthly escrow deposits for real estate taxes, insurance, capital expenses and tenant rollover reserves, as defined. The Greenwich Capital Loan has three one-year extension periods that may be exercised by the Company, provided that the Company meets certain conditions, as defined, and, with respect to the second and third extension periods only, pays a fee equal to 0.75% of the then current loan amount payable. The Company exercised the first extension option for one year to January 1, 2006. The Loan is subject to an exit fee of 1%, as defined, which is due and payable upon any repayment or prepayment of principal. However, payment of exit fees with respect to the required amortization payments will be deferred and payable at the maturity date, as extended. Should the maturity date be extended beyond January 1, 2006, the exit fee will be waived. Based upon management's intent, the exit fee has been accrued and included in deferred financing costs and is being amortized over the life of the loan using the effective interest method. The Company was not permitted to make any prepayments on the loan prior to June 30, 2004 (the ‘‘Lockout Date"). Thereafter, prepayment of the loan is permitted subject to a prepayment premium, as defined. Notwithstanding the preceding, there will be no prepayment premium if the loan is repaid after July 1, 2005.

In accordance with the terms of the loan agreement, the Company purchased an interest rate cap on a notional amount of $43,000,000, which limited LIBOR to a maximum of 5%. The cost of this interest rate cap was $85,000 and expired on January 1, 2005. In connection with the extension of the loan agreement to January 1, 2006, the Company purchased a replacement interest rate cap on a notional amount of $43,000,000, which limited LIBOR to a maximum of 5%. The interest rate cap is included in deferred financing costs at its estimated fair market value of $0 at December 31, 2004. In the event the loan is extended, the Company has agreed to purchase an interest rate cap on a notional amount equal to the then outstanding loan amount which limits LIBOR to a maximum of 5% during the extension periods referred to above.

F-59

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The loan agreement includes various financial covenants and restrictions, the most restrictive of which is a debt service coverage ratio (as defined). The loan agreement requires the Company to establish and maintain certain escrowed reserve accounts for, among other things, payment of real estate taxes, capital expenditures and tenant rollover costs. Upon the occurrence of certain events at two of the Company's properties (a ‘‘Trigger Event") affecting either the Company's leases or the sub-leases entered into by the Company's tenant, the Company is required to deposit agreed upon amounts into a leasing reserve account. Such funds will be made available to the Company to pay for costs incurred to release the space. In the event the Company's tenant pays such leasing costs, the funds will be released to the Company. Required deposits to this reserve, under certain circumstances, may be accumulated over a six-month period. In 2003, a Trigger Event occurred when one of the NRMI sub-tenants vacated. On November 1, 2003 the Company made the first of six required monthly payments of $100,000 into this reserve based upon the occurrence of this Trigger Event. At December 31, 2004 the total of all escrow accounts amounted to $2,239,133 and is included in restricted deposits.

The Company and its subsidiaries have agreed to comply with environmental laws and have indemnified the Greenwich Capital Lender against all liabilities and expenses related thereto. The principal balance of the Greenwich Capital Loan was $40,557,280 at December 31, 2004. Interest expense incurred on the Greenwich Capital Loan was $2,354,962 and $2,409,900 for the years ended December 31, 2004 and 2003, respectively.

Scheduled principal payment requirements on the Greenwich Capital Loan as of December 31, 2004 are as follows:

Years ending December 31:
2005	$	1,441,000
2006		39,116,280
	$	40,557,280

The Company and the Greenwich Capital Lender have allocated the Greenwich Capital Loan to the Properties as agreed to and the allocated amounts will be the basis for the calculation of the mandatory prepayment amount (as defined) required upon sale of any one or more of the Properties.

5.    Obligations Under Capital Leases

The Company is the lessee of two locations under capital leases. The following is a schedule of minimum future rentals under capital leases as of December 31, 2004:

Years ending December 31:
2005	$	262,184
2006		262,184
2007		262,184
2008		342,184
2009		382,184
Thereafter		15,268,347
Total minimum lease payments		16,779,267
Less amounts representing interest		13,475,843
Present value of future minimum lease payments	$	3,303,424

F-60

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

Interest on the above capital leases was imputed at the Company's incremental borrowing rate of 10% at the acquisition date of each lease. Interest expense incurred on the above capital leases totaled $326,706 and $320,666 for the years ended December 31, 2004 and 2003, respectively.

Under one of the capital leases, the Company also pays rent equal to 15% of the minimum rental income received from the Company's sub-tenant. The following is a schedule of minimum future rentals due to the lessor based on the Company's existing sub-lease as of December 31, 2004.

Years ending December 31:
2005	$	90,000
2006		90,000
2007		97,750
2008		105,000
2009		105,000
Thereafter		862,750
Total minimum lease payments	$	1,350,500

6.    Related Party Transactions

The Company had an asset management agreement with Emmes Asset Management Company LLC ("EAMC"), an affiliate of NorthStar and the Company. The asset management agreement, which was terminated on December 28, 2004, provided for an annual fee equal to 1.5% of the sum of the aggregate capital contributed by members of the Company and principal indebtedness from borrowed funds, less any dispositions of property. A fee of $384,454 was paid in connection with the termination of this agreement. A replacement agreement was entered into on December 28, 2004, which provides for the Company to pay an annual fee equal to 3.5% of gross collections as defined. Notwithstanding this calculation, the fee shall not be less than $300,000 or greater than $350,000 for any given year, provided, however, in the event the assets under management are decreased in number or in size the fee shall not have a minimum. The asset management fee is payable quarterly in advance. In addition, the Company reimburses EAMC for expenses, as defined, incurred in the management of the properties. In the event that available cash is insufficient to pay the asset management fee in full, the Company has agreed that from time to time it will cause the members to contribute additional capital.

The Company has engaged Emmes Realty Services, LLC ("ERS"), an affiliate of NorthStar and the Company, as leasing broker for the properties. Under the terms of the brokerage agreement, the Company pays a commission to ERS for leases executed by the Company where ERS has acted as broker. No leasing commissions were paid or payable to ERS for the year ended December 31, 2004.

Total fees, and expenses incurred by the Company under the asset management agreement amounted to $1,252,512 and $833,501 for the years ended December 31, 2004 and 2003, respectively. Amounts payable, included in the December 31, 2004 balance sheet, to EAMC and ERS total $28,378.

7.    Commitments—Rent Under Operating Master Leases

At December 31, 2004, future minimum rental payments to be made by the Company under operating leases for the leasehold interests are as follows:

Years ending December 31:
2005	$	442,000
2006		245,000
2007		85,000
2008		85,000
2009		85,000
	$	942,000

F-61

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The Company's leasehold interests are generally pursuant to net leases whereby the Company is responsible for its allocable share of real estate taxes, for all operating expenses and for the general maintenance of the premises subject to the lease. Rents under such leases aggregated $422,299 and $572,954 for the years ended December 31, 2004 and 2003, respectively. The Properties under the operating leases are in turn subleased to unrelated parties.

8.    Rental Income Under Operating Leases

Rental income from real estate is derived from the leasing and sub-leasing of space to commercial tenants. The leases are for fixed terms of varying length and provide for annual rentals and expense reimbursements to be paid in monthly installments.

The Company's credit risk is primarily associated with its tenant leases. Revenues from NRMI, net of reserves, comprised approximately 78% of future minimum rental income at December 31, 2004. Unbilled rents receivable from NRMI, net of reserves, comprised approximately 75% of all unbilled rents receivable at December 31, 2004.

The following is a schedule of future minimum rental income under noncancelable leases at December 31, 2004 before consideration of subsequent property sales. See Note 10:

Years ending December 31:
2005	$	8,466,000
2006		7,866,000
2007		7,971,000
2008		8,234,000
2009		8,366,000
Thereafter		92,007,000
	$	132,910,000

In December 2001, the Company received notice from NRMI that it would be abandoning its master lease for 1552, thereby turning the property back to the Company subject to a sublease with its affiliate for a portion of the property. On analysis, management determined that it could not reasonably expect a recovery from NRMI of unbilled contractual rents if it were to bring suit, and as such decided to immediately accept the space NRMI was abandoning and lease it to other tenants. In connection with the abandonment of the lease in 2001, the Company wrote off all unbilled rents receivable related to the abandoned space. Additionally, management reevaluated the collectibility of all of its unbilled rent to NRMI and determined that an incremental reserve is required for all additional unbilled rent recorded related to NRMI. Accordingly, for the years ended December 31, 2004 and 2003, an incremental reserve is provided for 50% of all additional unbilled rent recorded related to NRMI.

The Company earned percentage rent of $868,000 and $839,000 for the years ended December 31, 2004 and 2003, respectively.

9.    Contingency

On August 21, 2003, an action was filed against the Company in New York State Supreme Court, New York County (the "Complaint"). The Complaint was brought by 729 7th Realty Corp. (the "Tenant"), a subsidiary of NRMI that is the net lessee of the Condominium, to enforce certain rights it claims to have under its net lease with the Company (the "Net Lease").

In its Complaint, Tenant asserts two causes of action against the Company. In the first cause of action, Tenant seeks specific performance of its alleged right to require the Company to provide a subordination, non-disturbance and attornment agreement (an "SNDA") to a subtenant (the "Subtenant") so that in the event the Net Lease is terminated, the proposed sublease (the "Sublease") would remain in effect. The second cause of action seeks a judgment in the amount of approximately $600,000 for damages the Tenant allegedly suffered by reason of the Company's refusal to provide the Subtenant with SNDA protection.

F-62

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The Company has refused to grant SNDA protection to the Subtenant on the grounds that the proposed Sublease is configured in such a way so as to extract the most economically desirable portion of the Condominium for the Subtenant (an affiliate of the Tenant) rendering the remaining space that would revert to the Company upon a termination of the Net Lease unmarketable. Under the terms of the Net Lease, the Company believes it has no obligation to provide SNDA protection to a proposed subtenant where, in the Company's discretion, the remaining space would be rendered unmarketable.

In response to the Complaint, on September 24, 2003, the Company moved to dismiss the second cause of action on the grounds that the Net Lease prohibits the recovery of monetary damages that may result from the Company's refusal to provide proposed subtenants with SNDA protection (the "Motion"). By decision and order of the court filed on March 29, 2004, the Company's Motion was granted. The Company is vigorously opposing Tenant's claim that it has the right to obtain SNDA protection for its Subtenant under the current circumstances. Although the ultimate outcome of this matter is uncertain, management does not believe it will have a material impact on the financial position or results of operations of the Company.

10.  Subsequent Events - Discontinued Operations

729 Seventh Avenue

On June 30, 2005, the Company sold 729 Seventh Avenue (‘‘729’’) and, in compliance with FASB 144, ‘‘Accounting for Impairment or Disposal of Long-Lived Assets’’ (‘‘FAS 144’’), the Company has reclassified previously reported revenues and expenses from this property as income (loss) from discontinued operations for the years ended December 31, 2004 and 2003.

1552 Broadway

On November 30, 2005, the Company sold 1552 Broadway (“1552”) and, in compliance with FASB 144, the Company has reclassified previously reported revenues and expenses from this property as income (loss) from discontinued operations for the years ended December 31, 2004 and 2003.

27 West 34th and 1372 Broadway

The Company formally initiated an effort to market two of its leasehold interests located at 27 West 34th Street (“27 West”) and 1372 Broadway ("1372") and on December 30, 2005 entered into a definitive sale contract. The Company has met the held for sale criteria in accordance with SFAS No. 144 and accordingly, its previously reported revenues and expenses for these properties have been reclassified as discontinued operations in the consolidated statements of income for the years ended December 31, 2004 and 2003.

F-63

ALGM I Owners LLC and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

The assets and liabilities of the properties subsequently sold or contracted for sale were $42.4 million and $41.6 million, respectively, at December 31, 2004. The reclassification of revenues and expenses to discontinued operations did not have an impact on net income in 2004 and 2003.

The table summarizes income from discontinued operations from 729, 1552, 27 West and 1372 for the two years ended December 31, 2004:

	2004		2003
Revenues:
Minimum & percentage rent	$	7,602,289	$	7,656,024
Tenant reimbursements		422,177		419,408
Interest income and other		12,235		8,270
Total revenues		8,036,701		8,083,702
Expenses:
Operating expense		1,480,248		1,419,161
Marketing, general and administrative		403,097		218,185
Allowance for uncollectible billed and unbilled rents		380,208		456,689
Interest expense		3,177,001		3,222,456
Asset management fee - affiliate		956,377		637,281
Depreciation and amortization		1,235,671		1,229,826
Total expenses		7,632,602		7,183,598
Net income from discontinued operations	$	404,099	$	900,104

F-64

ALGM I Owners LLC and Subsidiaries

Schedule II — Valuation and Qualifying Accounts

As of December 31, 2004

Description	Balance at Beginning of Period		Charged to Costs and Expenses			Additions/Charges to Other Accounts		Deductions			Balance at End of Period
For the Year Ended December 31, 2003
Provision for loan losses	$	—	$	—		$	—	$	—		$	—
Allowance for doubtful accounts — SL(1)		3,288,631		453,225			—		—			3,741,856
Allowance for doubtful accounts(1)		89,086		20,233			—		(89,948	)		19,371
	$	3,377,717	$	473,458		$	—	$	(89,948	)	$	3,761,227
For the Year Ended December 31, 2004
Provision for loan losses	$	—	$	—		$	—	$	—		$	—
Allowance for doubtful accounts — SL(1)		3,741,856		394,863			—		—			4,136,719
Allowance for doubtful accounts(1)		19,371		(18,358	)		—		—			1,013
	$	3,761,227	$	376,505		$	—	$	—		$	4,137,732

Explanatory Notes:

⁽¹⁾ See Note 2 to the Company's Consolidated Financial Statements.

F-65

ALGM I OWNERS LLC AND SUBSIDIARIES

SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION

DECEMBER 31, 2004

Column A	Column B	Column C Initial Cost				Column D Cost Capitalized Subsequent To Acquisition				Column E Gross Amount at Which Carried at Close of Period						Column F		Column G	Column H		Column I
Description (1)	Encumbrances	Land		Buildings & Improvements		Land		Buildings & Improvements		Land		Buildings & Improvements		Total		Accumulated Depreciation		Date of Construction	Date Acquired		Life on Which Depreciation is Computed
1552 Broadway		$	4,177,140	$	16,708,561	$	140,967		552,082	$	4,318,107	$	17,260,643	$	21,578,750	$	2,501,603			Mar-99		Various
729 Seventh Avenue			3,170,923		12,683,693		108,069		423,326		3,278,992		13,107,019		16,386,011		1,899,028			Mar-99		Various
987 Eighth Avenue			—		2,218,794		—		426,227		—		2,645,021		2,645,021		727,420			Mar-99		Various
36 West 34 Street			—		4,145,318		—		271,979		—		4,417,297		4,417,297		391,098			Mar-99		Various
1372 Broadway (2)			—		461,905		—		545		—		462,450		462,450		367,484			Mar-99		Various
991 Third Avenue (2)			—		1,642,327		—		59,792		—		1,702,119		1,702,119		1,442,564			Mar-99		Various
27 West 34 Street (2)			—		3,592,591		—		167,578		—		3,760,169		3,760,169		1,982,206			Mar-99		Various
701 Seventh Avenue (2)			—		3,179,364		—		66,256		—		3,245,620		3,245,620		1,342,101			Mar-99		Various
		$	7,348,063	$	44,632,553	$	249,036	$	1,967,785	$	7,597,099	$	46,600,338	$	54,197,437	$	10,653,504

⁽¹⁾ All properties are located in New York, NY.

⁽²⁾ Represents a leasehold interest amortized over the life of the underlying lease.

F-66

The changes in real estate for the two years ended December 31, 2004 are as follows:

	2004		2003
Balance at beginning of year	$	52,646,282	$	54,136,887
Improvements		21,230		334,790
Basis step up		1,529,925		—
Retirements/disposals		—		(,825,395	)
Balance at end of year	$	54,197,437	$	52,646,282

The changes in accumulated depreciation, exclusive of amounts relating to equipment and furniture and fixtures, for the two years ended December 31, 2004, are as follows:

	2004		2003
Balance at beginning of year	$	8,794,965	$	8,552,419
Depreciation for the year		1,858,539		2,067,941
Retirements/disposals		—		(1,825,395	)
Balance at end of year	$	10,653,504	$	8,794,965

F-67

NorthStar Funding LLC

Financial Statements

Contents

	Page
Report of Independent Registered Public Accounting Firm	F-69
Balance Sheet as of December 31, 2004	F-70
Statements of Income for the years ended December 31, 2004 and 2003	F-71
Statements of Members' Equity for the years ended December 31, 2004 and 2003	F-72
Statements of Cash Flows for the years ended December 31, 2004 and 2003	F-73
Notes to Financial Statements	F-74
Schedule IV — Loans and other Lending Investments as of December 31, 2004	F-79

F-68

Report of Independent Registered Public Accounting Firm

To the Members of

NorthStar Funding LLC

We have audited the accompanying balance sheet of NorthStar Funding LLC (“the Company”) as of December 31, 2004, and the related statements of income, members’ equity, and cash flows for each of the two years in the period ended December 31, 2004. Our audits also included the financial statement Schedule IV. These financial statements and schedule are the responsibility of the Company’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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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 NorthStar Funding LLC at December 31, 2004, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG LLP

New York, New York

March 30, 2005

F-69

NorthStar Funding LLC

Balance Sheet

	December 31, 2004
Assets
Cash and cash equivalents	$	147,289
Subordinate real estate debt investments		107,823,661
Accrued interest receivable		745,075
Total assets	$	108,716,025
Liabilities
Accrued expenses	$	15,715
Deferred loan origination fees, net		854,159
Unearned revenue		—
Due to loan participant		—
Due to affiliates		232,509
Total liabilities		1,102,383
Members' equity		107,613,642
Total liabilities and members' equity	$	108,716,025

See accompanying notes to financial statements.

F-70

NorthStar Funding LLC

Statements of Income

	Years ended December 31,
	2004		2003
Revenue:
Interest income	$	13,580,769	$	6,827,156
Other income		186,546		10,939
Total revenue		13,767,315		6,838,095
Expenses:
Advisory fees — affiliate		1,080,863		556,661
Legal fees		67,562		61,768
General and administrative		15,148		22,626
Other expenses		34,480		20,248
Total expenses		1,198,053		661,303
Net income	$	12,569,262	$	6,176,792

See accompanying notes to financial statements.

F-71

NorthStar Funding LLC

Statements of Members' Equity

Years ended December 31, 2004 and 2003

	Managing Member			NSF Venture Investor			NorthStar			Total
Balance at December 31, 2002	$	—		$	18,195,917		$	2,021,701		$	20,217,618
Contributed capital		—			90,202,826			3,672,895			93,875,721
Distributions		—			(5,432,944	)		(365,103	)		(5,798,047	)
Net income		—			5,790,244			386,548			6,176,792
Balance at December 31, 2003		—			108,756,043			5,716,041			114,472,084
Contributed capital		—			19,913,624			1,048,085			20,961,709
Distributions		(453,442	)		(37,938,916	)		(1,997,055	)		(40,389,413	)
Net income		453,442			11,510,029			605,791			12,569,262
Balance at December 31, 2004	$	—		$	102,240,780		$	5,372,862		$	107,613,642

See accompanying notes to financial statements.

F-72

NorthStar Funding LLC

Statements of Cash Flows

	Years ended December 31,
	2004			2003
Cash flows from operating activities:
Net income	$	12,569,262		$	6,176,792
Adjustments to reconcile net income to net cash provided by operating activities:
Changes in assets and liabilities:
Accrued interest receivable		(149,497	)		(494,169	)
Amortization of deferred loan origination costs		(428,895	)		(37,958	)
Unearned revenue		(77,792	)		77,792
Due to affiliate		(47,286	)		247,425
Due to loan participant		(26,179	)		26,179
Accrued expenses		(90,826	)		(144,861	)
Net cash provided by operating activities		11,748,787			5,851,200
Cash flows from investing activities:
Additions to subordinate real estate debt investments		(21,000,000	)		(230,388,229	)
Deferred loan origination costs		543,750			810,682
Principal repayments		28,017,032			78,029
Proceeds from sale of sub-participation interests		—			135,719,507
Net cash provided by (used in) investing activities		7,560,782			(93,780,011	)
Cash flows from financing activities:
Capital contributions by members		20,961,709			93,875,721
Distributions to members		(40,389,413	)		(5,798,047	)
Net cash (used in) provided by financing activities		(19,427,704	)		88,077,674
Net (decrease) increase in cash and cash equivalents		(118,135	)		148,863
Cash and cash equivalents at beginning of period		265,424			116,561
Cash and cash equivalents at end of period	$	147,289		$	265,424

See accompanying notes to financial statements.

F-73

NorthStar Funding LLC

Notes to Financial Statements

1.    Organization

NorthStar Funding LLC (the "Company") is a limited liability company formed under the laws of the State of Delaware on May 16, 2001 for the purpose of making fixed income investments secured by real estate. The Company is authorized to acquire or originate the following types of investments: loans secured by a pledge of equity interest in portfolio companies (whether corporations, partnerships, limited liability companies or other types of entities with interests primarily in real estate assets) that are subordinate to mortgage loans; subordinated debt and preferred equity securities issued by public or private portfolio companies; second mortgage loans secured by junior interests in real estate; shorter term bridge loans secured by mortgages or pledges of equity in portfolio companies; bank loans secured by real estate; distressed debt and equity securities issued by portfolio companies; participation interests in any of the foregoing funds as well as participation interests in first mortgage loans, and securities or other assets received by the Company as distributions on, in exchange for or as a result of foreclosing on any of the foregoing.

The term of the Company's existence shall initially be seven years and may be extended for up to two additional one-year terms. On September 14, 2004, the Company amended its limited liability agreement (the "Member agreement") to extend its term to continue through May 24, 2014.

The managing member of the Company is NorthStar Funding Management LLC (the "Managing Member"). NorthStar Funding Investor Member LLC, a Delaware limited liability company ("NorthStar"), and an institutional pension fund (the "NSF Venture Investor"), are the investor members (the "Investor Members"). The Managing Member owns .01% of the Company. NorthStar and the NSF Venture Investor initially committed to invest $10.0 million and $90.0 million for a 9.995% and 89.995% interest, respectively, in the Company.

On July 10, 2003, the Managing Member negotiated several modifications regarding funding requirements, which included an increase in the NSF Venture Investor's capital commitment to $190 million, and a reduction of NorthStar's ownership interest to 4.995%. Subsequent to July 10, 2003, NorthStar Funding Management LLC continues to own .01% of the Company and NorthStar and the NSF Venture Investor own a 4.995% and 94.995% interest, respectively, in the Company.

Total funded capital to the Company from Investor Members as of December 31, 2004 is $135.2 million.

2.    Summary of Significant Accounting Policies

Basis of Presentation

The financial statements are presented on an accrual basis in conformity with accounting principles generally accepted in the United States.

Cash and Cash Equivalents

The Company classifies highly liquid investments with original maturities of three months or less from the date of purchase as cash equivalents. At December 31, 2004, cash balances of approximately $147,300 were on deposit with a bank in New York and are federally insured up to $100,000.

Revenue Recognition

Interest income for the Company's subordinate real estate debt investments is recognized on an accrual basis over the life of the investment using the effective interest method. Additional interest to be collected at payoff is recognized over the term of the loan as an adjustment to yield.

Allowances for loan investment losses are established based upon a periodic review of the loan investments. Income recognition is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the suspended loan becomes contractually current and performance is demonstrated to be resumed. In performing this review, management considers the estimated net recoverable value of the loan as well as other factors, including the fair market value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic situation of the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized from the loan investments may differ materially from the carrying value at the balance sheet date.

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Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of four subordinate real estate debt investments, the underlying loans for which are collateralized by commercial properties, and cash balances held with financial institutions, which at times exceed federally insurable limits. As of December 31, 2004, approximately 49% and 23% of all loan investments are secured by properties in New York and Chicago, respectively.

Subordinate Real Estate Debt Investments

Investments in subordinate real estate debt investments, either direct or participating interests, are recorded at their purchased cost. Discounts and premiums on purchased assets are amortized over the life of the investment using the effective interest method.

Fair Values of Financial Instruments

The Company has estimated that the carrying amounts of its financial instruments cash and cash equivalents, receivables, accounts payable balances reasonably approximate their fair values due to the short-term nature of these items. Subordinate real estate debt participations had an estimated fair value of approximately $108,936,661 which exceeds the book value by $1,113,000.

Disclosure about fair value of financial instruments is based on pertinent information available to management as of December 31, 2004. Although management is not aware of any factors that would significantly affect the reasonable fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.

Loan Origination Fees and Acquisition Costs

The Company defers costs incurred related to the acquisition or underwriting of loan investments, as well as any origination fees received. The net balance of deferred costs/fees is amortized using the effective interest method over the life of the related loan investment. Such amortization is reflected as a component of interest income. The Company has recorded net loan origination fees and acquisition costs of ($854,159) at December 31, 2004.

Sale of Sub-Participations of Loan Investments

The Company records the transfer of a sub-participation in a loan investment as a sale when the attributes of the transaction meet the criteria for sale of FAS 140, "Accounting for Transfers of Financial Assets and Extinguishments of Liabilities", including transferring the financial interest beyond the reach of the Company's creditors and placing no substantive restrictions on the resale of the sub-participation by the purchaser.

Income Taxes

No provision has been made in the accompanying financial statements for federal, state or local income taxes as each member of the Company is responsible for reporting their respective share of the Company's income or losses.

Use of Estimates

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

F-75

Recent Accounting Pronouncement

In December 2003, the Financial Accounting Standards Board ("FASB") issued interpretation No 46R ("FIN 46R") "Consolidation of Variable Interest Entities" to replace Interpretation No 46 ("FIN 46") which was issued in January 2003. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with proportionate voting rights or (b) has not been capitalized with sufficient financial resources for the entity to support its activities. FIN 46R requires a variable interest entity to be consolidated by primary beneficiary which is the entity subject to a majority of the risk of loss from the variable interest entity's activities or is entitled to receive a majority of the entity's residual returns, or both. The Company has adopted FIN 46R and analyzed the applicability of this interpretation. The adoption of FIN 46R had no material impact on the Company's financial condition or results of operations as of December 31, 2004.

3.    Limited Liability Company Agreement

The Company's Member agreement stipulates the method of allocation and distribution of the Company's income and cash.

Allocations of Net Income and Net Loss

Each item of income, gain, loss deduction or credit included in net income and net loss shall generally be allocated among the members in the manner in which distributable proceeds have been or are distributed to the members pursuant to the Company's Member Agreement.

Cash Distributions of Portfolio Investments

Distributable proceeds are derived from the cash remaining from the disposition or financing proceeds of a portfolio investment, from insurance proceeds received related to a casualty loss or from items of ordinary income such as interest, dividends, or rental income, net of all related costs and expenses.

Generally, each member's percentage interest of distributable proceeds will be paid as follows: First, pro rata based on ownership percentages to each member until 100% of invested capital is recovered and a priority return of 10% per annum on the liquidated portion of the portfolio have been received. Second, 80% of distributable proceeds are allocated to the Managing Member and 20% is allocated to the Investor Members pro rata until the Managing Member has received 20% of the cumulative cash distributed. Thereafter, the Managing Member will receive 20% of the distributable proceeds and the Investor Members will receive 80% of distributable proceeds on a pro rata basis.

The Company made cash distributions of $453,442 to the Managing Member during the year ended December 31, 2004 in connection with loan repayments by borrowers.

4.    Subordinate Real Estate Debt Investments

At December 31, 2004, the Company's investments in subordinate real estate debt are as follows, in thousands:

Investment	Closing Date		Face Amount		Proceeds from Sale of Subparticipations		NS Funding LLC Net Participation		Principal payments (2)		December 31, 2004 Investment Balance
Alhambra Plaza		11/06/2002	$	14,000	$	6,000	$	8,000		—		—
Douglas Entrance		12/19/2002		12,250		—		12,250		—		—
Portland Multifamily Portfolio,		02/06/2003		15,300		7,650		7,650		—		—
BellSouth Tower, (1)		4/15/2003		24,300		14,820		9,480	$	195	$	9,285
IBM Plaza		7/10/2003		64,789		40,000		24,789		—		24,789
Max Capital Portfolio, (1)		8/1/2003		56,000		32,000		24,000		—		24,000
450 West 33rd Street (3)		12/31/2003		70,000		41,250		28,750		—		28,750
Pickwick Plaza		9/14/2004		21,000		—		21,000		—		21,000
Totals			$	277,639	$	141,720	$	135,919	$	195	$	107,824

⁽¹⁾ Loan was extended and paid off in February, 2005. See Note 7.

⁽²⁾ All loans are interest only, except for BellSouth Tower which requires monthly principal payments of $9,753.

⁽³⁾ Loan was paid off in March, 2005. See Note 7.

F-76

Investment	Location	Type	Initial Maturity	Extension Options	Interest Rate at 12/31/04	Base Rate
Alhambra Plaza	Florida	Office	10/09/05	Two 1-year	—	30 Day Libor + 9.30%
Douglas Entrance	Florida	Office	11/10/2004	One 1-year	—	12%
Portland Multifamily Portfolio	Oregon	Multifamily	12/11/2004	6 months, two one year	—	30 Day Libor + 8.75%
BellSouth Tower	Florida	Office	8/11/2004	Two 1-year	12.74%	30 Day Libor + 10.34%
IBM Plaza	Chicago	Office	3/09/2006	Two 1-year	12.46%	30 Day Libor + 10.06%
Max Capital Portfolio	New York	Office	1/09/2005	Three 1-year	12.42%	30 Day Libor( 3% floor) + 9.42%
450 West 33rd Street	New York	Office	1/09/2006	Three 1-year	13.08%	30 Day Libor + 10.68%
Pickwick Plaza	Connecticut	Office	4/11/2014	No extensions	9.84%	Fixed rate of 9.84%

Investment activity

The Douglas Entrance mezzanine loan was prepaid on February 11, 2004. The amount of the prepayment was approximately $12.6 million, which included the principal balance of $12.25 million, interest and prepayment premiums.

In September 2004, the Company originated a $21 million mezzanine loan collateralized by an office building in Connecticut. The interest rate is 9.84% and initial maturity is April, 2014.

The Alhambra mezzanine loan was prepaid on October 12, 2004. The amount of the prepayment was approximately $14.1 million, which included the principal balance of $14.0 million and interest.

The Portland Multifamily mezzanine loan was prepaid on December 17, 2004. The amount of the prepayment was approximately $15.4 million, which included the principal balance of approximately $15.3 million and interest.

5.    Advisory Fees—Affiliates

On May 24, 2001, the Company entered into an advisory agreement (the "Advisory Agreement") with NorthStar Capital Investment Corp., a Maryland corporation, an affiliate of NorthStar. On November 18, 2003 the Advisory Agreement was assigned by NorthStar Capital Investment Corp. to Managing Member. NorthStar Capital Investment Corp. and Managing Member are collectively referred to as the "Advisor."

F-77

The Company pays the Advisor an annual administrative and advisory fee (the "Advisory Fee"), payable quarterly in arrears equal to (i) 1% of the aggregate capital contributions of NorthStar, the NSF Venture Investor and members of the Company with capital commitments of $50.0 million or more and (ii) 1.5% of the capital contributions of members (other than NorthStar) of the Company with capital commitments of less than $50.0 million. In the event that the Advisor does not act as an investment advisor to the Company for the entire quarter, the Advisory Fee will be prorated to reflect the portion of such quarter.

The Advisory Agreement will continue for a seven-year period and shall thereafter automatically renew for up to two one-year periods upon the extension of the term of the existence of the Company. This agreement may be terminated by either the Advisor or the Company upon the resignation or removal of NorthStar Funding Management LLC as Managing Member of the Company.

In 2004 and 2003, the Company incurred advisory fees of $1,080,863 and $556,661, of which $35,043 is included in due to affiliates at December 31, 2004.

6.    Due to Affiliates

Due to affiliates includes cash received on behalf of an affiliate and advisory fees due to the Managing Member.

7.    Subsequent Events

The Bell South Tower mezzanine loan was repaid February 3, 2005. The prepayment was approximately $9.5 million, which included the principal balance of approximately $9.3 million, interest and a prepayment premium of $102,519.

The Max Capital mezzanine loan was repaid February 14, 2005. The prepayment was approximately $24.3 million which included the principal balance of approximately $24.0 million and accrued interest.

The 450 West 33rd Street loan was repaid on March 8, 2005. The amount of the prepayment was approximately $29.6 million which included the principal balance of $28.8 million, exit and prepayment fees totaling approximately $0.5 million and accrued interest.

F-78

NorthStar Funding LLC

Schedule IV—Loans and Other Lending Investments

December 31, 2004

(dollars in thousands)

Type of Loan/Borrowers	Description/ Locations	Interest Accrual Rates	Interest Payment Rates	Final Maturity Date	Periodic Payment Terms(1)		Principal Amounts		Carrying Amount of Loans
BellSouth Tower (2)	Office, Florida	30 Day Libor +10.31%	30 Day Libor +10.31%	8/11/2004		P&I	$	9,285	$	9,285
IBM Plaza	Office, Chicago	30 Day Libor +10.02%	30 Day Libor +10.02%	3/09/2006		I/O		24,789		24,789
Max Capital Portfolio (2)	Office, New York	30 Day Libor +9.42%	30 Day Libor(3% floor) +9.42%	1/09/2005		I/O		24,000		24,000
450 West 33rd Street (3)	Office, New York	30 Day Libor +10.62%	30 Day Libor +10.62%	1/09/2006		I/O		28,750		28,750
Pickwick Plaza	Office, Connecticut	9.84% Fixed	9.84% Fixed	4/11/2014		I/O		21,000		21,000
Subtotal								107,824		107,824
Provision for losses								—		—
Total							$	107,824	$	107,824

⁽¹⁾ Interest only or I/O; principal and Interest or P&I.

⁽²⁾ Loan was extended and paid off in February, 2005.

⁽³⁾ Loan was paid off in March, 2005.

No prior liens exist on the above loans.

F-79

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 on March 16, 2006.

NORTHSTAR REALTY FINANCE CORP.
By:	/s/ David T. Hamamoto
	Name: David T. Hamamoto
	Title: Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mark E. Chertok and Richard J. McCready and each of them severally, his true and lawful attorney-in-fact with power of substitution and resubstitution to sign in his name, place and stead, in any and all capacities, to do any and all things and execute and all instruments that such attorney may deem necessary or advisable under the Securities Exchange Act of 1934 and any rules, regulations and requirements of the U.S. Securities and Exchange Commission in connection with this Annual Report on Form 10-K and any and all amendments hereto, as fully for all intents and purposes as he might or could do in person, and hereby ratifies and confirms all said attorneys-in-fact and agents, each acting alone, and his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below on behalf of the Registrant in the capacities and on the dates indicated.

Signature	Title	Date
/s/ DAVID T. HAMAMOTO	Chief Executive Officer and President	March 16, 2006
David T. Hamamoto	(Principal Executive Officer)
/s/ MARK E. CHERTOK	Chief Financial Officer and Treasurer	March 16, 2006
Mark E. Chertok	(Principal Financial Officer)
/s/ W. EDWARD SCHEETZ	Chairman of the Board of Directors	March 16, 2006
W. Edward Scheetz
/s/ WILLIAM V. ADAMSKI	Director	March 16, 2006
William V. Adamski
/s/ PRESTON BUTCHER	Director	March 16, 2006
Preston Butcher
/s/ JUDITH A. HANNAWAY	Director	March 16, 2006
Judith A. Hannaway
/s/ WESLEY D. MINAMI	Director	March 16, 2006
Wesley D. Minami
/s/ LOUIS J. PAGLIA	Director	March 16, 2006
Louis J. Paglia
/s/ FRANK V. SICA	Director	March 16, 2006
Frank V. Sica