INCOME OPPORTUNITY REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)operations.

NOTE 2 REAL ESTATE ACTIVITY

On January 25, 2008 we sold six apartment complexes which were all located in Midland, Texas in a single transaction. We sold the properties for an aggregate sales price of $50.0 million, receiving $20.7 million in cash after paying off $25.1 million in existing debt. We recorded a $29.4 million gain on sale as follows:

NOTE 3. DISCONTINUED OPERATIONS

The Company applies the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lesser of (1) book value or (2) fair value less cost to sell. In addition, it requires that one accounting model be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions.

During the three months ended March 31, 2008, the Company sold the following properties which were all located in Midland, Texas:

The following table summarizes income from discontinued operations and the related realized gains on sales of real estate from discontinued operations for the three months ended March 31, 2008.

The Company’s application of SFAS No. 144 results in the presentation of the net operating results of these qualifying properties sold or held for sale during 2008 as income from discontinued operations. The application of SFAS No. 144 does not have an impact on net income available to common shareholders. SFAS No. 144 only impacts the presentation of these properties within the Consolidated Statements of Operations.

NOTE 4. NOTES AND INTEREST RECEIVABLE – RELATED PARTIES

The following is a listnotes receivables consists of eight notes andaggregating $26.0 million. The notes accrue interest receivable due IORI on September 30, 2007:at 10.0% to 12.0% with maturity dates ranging from December 2008 to December 2013. The notes are primarily excess cash flow notes.

NOTE 4.5. NOTES AND INTEREST PAYABLE

The following is a listtable lists the mortgage notes payable as of notes and interest payable owed by IORI on September 30, 2007:March 31, 2008;

INCOME OPPORTUNITY REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

NOTE 5.6 ADVISORY AGREEMENT

The Company is a party tohas an Advisory Agreement with Syntek West, Inc. (“SWI”), wherein SWI is responsible for the Company’s day-to-day operations. SWI owns 57.17% of the Company’s common stock. In accordance with the Advisory Agreement, SWI must formulate and submit to IORI’s Board of Directors for approval an annual budget and business plan containing a twelve-monthtwelve month forecast of operations and cash flow with a general plan for asset sales and purchases, borrowing activity and other investments. SWI reports to the Board quarterly on IORI’s performance against the business plan. The Advisory Agreement further places SWI in a fiduciary relationship to IORI’s stockholders and contains a broad standard governing SWI’s liability for any losses incurred by IORI.

SWI receives, as compensation for its management and advice, monthly advisory fees based on .75%6 ¹/2% of IORI’s assets annually as well as specific fees for assisting IORI in obtaining financing and completing acquisitions. If IORI’s operating expenses exceed limits specified in the Advisory Agreement SWI is obligated to refund a portion of the advisory fees.

Effective July 1, 2005, the Company and SWI entered into a Cash Management Agreement to further define the administration of the Company’s day-to-day investment operations, relationship contacts, flow of funds and deposit and borrowing of funds. Under the Cash Management Agreement, all funds of the Company are delivered to SWI which has a deposit liability to the Company and is responsible for investment of all excess funds, which earn interest at theWall Street Journal Prime Rate plus one percent per annum, set quarterly on the first day of each calendar quarter. Borrowings for the benefit of the Company bear the same interest rate. The term of the Cash Management Agreement is coterminous withand the Advisory Agreement and isare automatically renewed each year unless terminated by SWI and IORI.

SWI also receives a Net Income Fee calculated as 7.5% of IORI’s net income for the year.income.

NOTE 6. RECEIVABLES7. RECEIVABLE FROM AND PAYABLE TO AFFILIATES

From time to time, IORI and its affiliates and related parties have made unsecured advances to each other. In addition, IORI and its affiliates have entered into transactions involving the purchase, sale, and financing of property. The table below reflects the various transactions between IORI, SWI, and Transcontinental Realty Investors (“TCI”).TCI.

INCOME OPPORTUNITY REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

NOTE 7.8. OPERATING SEGMENTS

Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their operating income and cash flow. There are no intersegment revenues and expenses and IORI conducted all of its business within the United States.

Presented below is the operating income of each operating segment information for the three and nine months ended September 30,March 31, 2008 and 2007 and 2006 and each segment’s assets at September 30, of each year (amounts(dollars in thousands).:

INCOME OPPORTUNITY REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table reconcilestables below reconcile the segment information to the corresponding amounts in the consolidated statementsConsolidated Statements of operations:Operations:

SEGMENT ASSET RECONCILIATION TO TOTAL ASSETS

NOTE 8.9. COMMITMENTS AND CONTINGENCIES

Liquidity. Management anticipates that IORI may not generate sufficient excess funds from operations in 2007 to be sufficient to discharge all of IORI’s debt obligations as they mature. Management may selectively sell income producing assets, refinance real estate, and/or incur additional borrowings against real estate to meet its cash requirements.

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

ITEM 2.

ITEM 2:

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

WARNING CONCERNING FORWARD-LOOKING STATEMENTS

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this Report.report.

This Report on Form 10-Q may contain forward-looking statements within the meaning of the federal securities laws, principally, but not only, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.Operations.” We caution investors that any forward-looking statements in this Report,report, or which management may make orally or in writing from time to time, are based on management’s beliefs and on assumptions made by, and information currently available to, management. When used, the words “anticipate”, “believe”, “expect”, “intend”, “may”, “might”, “plan”, “estimate”, “project”, “should”, “will”,“anticipate,” “believe,” “expect,” “intend,” “may,” “might,” “plan,” “estimate,” “project,” “should,” “will,” “result” and similar expressions which do not relate solely to historical matters are intended to identify forward-looking statements. These statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. We caution you that, while forward-looking statements reflect our good faith beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after we make such statements. We expressly disclaim any responsibility to update our forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the factors listed and described at Item 1A. Risk Factors in the Company’s Annual Report on Form 10-K, which investors should review. There have been no changes from the risk factors previously described in the Company’s Form 10-K for the fiscal year ended December 31, 2006.2007.

Other sections of this Reportreport may also include suggested factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for management to predict all such matters; nor can we assess the impact of all such matters on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to our quarterly reports on Form 10-Q for future periods and current reports on Form 8-K as we file them with the Securities and Exchange Commission (“SEC”) and to other materials we may furnish to the public from time to time through Forms 8-K or otherwise.

Overview

IORI invests in equity interests in real estate through acquisitions, leases, partnerships and in mortgage loans. IORI is the successor to a California business trust organized on December 14, 1984, which commenced operations on April 10, 1985.

At September 30, 2007, IORI owned seven residential apartment communities totaling 1,319 units, one office building, one shopping center, one industrial property and 211 acres of land held for development. Except for a single apartment property located in Indiana, all of the Company’s real estate assets are located in Texas.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires management to use judgment in the application of accounting policies,

including making estimates and assumptions. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of our financial statements. From time –to time,time-to-time, we evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. Below is a discussion of accounting policies that we consider critical in that they may require complex judgment in their application or require estimates about matters that are inherently uncertain.

Real Estate Held for Investment

Real estate held for investment is carried at cost. Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), requires that a property be considered impaired if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property. If impairment exists, an impairment loss is recognized, by a charge against earnings, equal to the amount by which the carrying amount of the property exceeds the fair value less cost to sell the property. If impairment of a property is recognized, the carrying amount of the property is reduced by the amount of the impairment, and a new cost for the property is established. Such new cost is depreciated over the property’s remaining useful life. Depreciation is provided by the straight-line method over estimated useful lives, which range from 5five to 40 years.

Real Estate Held-for-Sale

Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. SFAS No. 144 also requires that properties held-for-sale be reported at the lower of carrying amount or fair value less costs of sale. If a reduction in a held–for-saleheld-for-sale property’s carrying amount to fair value less costs of sale is required, a provision for loss is recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held–for-saleheld-for-sale property’s estimated fair value less costs of sale are recorded as an adjustment to the property’s carrying amount, but not in excess of the property’s carrying amount when originally classified as held-for-sale. A corresponding charge against or credit to earnings is recognized. Properties held-for-saleheld for sale are not depreciated.

Investments in Equity Investees

IORI may be considered to have the ability to exercise significant influence over the operating and investment policies of certain of its investees. Those investees are accounted for using the equity method. Under the equity method, an initial investment, recorded at cost, is increased by a proportionate share of the investee’s operating income and any additional investment and decreased by a proportionate share of the investee’s operating losses and distributions received.

Recognition of Rental Income

Rental income for commercial property leases is recognized on a straight-line basis over the respective lease terms. Rental income for residential property leases is recorded when due from residents and is recognized monthly as earned, which is not materially different than on a straight-line basis as lease terms are generally for periods of one year or less.

Revenue Recognition on the Sale of Real Estate

Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”), as amended by SFAS No. 144. Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using the deposit, installment, cost recovery or financing method, whichever is appropriate. When IORI provides seller financing, gain is not recognized at the time of sale unless the buyer’s initial investment and continuing investment are deemed to be adequate as determined by SFAS No. 66 guidelines.

Non-performingNon-Performing Notes Receivable

IORI considers a note receivable to be non-performing when the maturity date has passed without principal repayment and the borrower is not making interest payments. Any new note receivable that results from a modification or extension of a note considered non-performing will also be considered non-performing, without regard to the borrower’s adherence to payment terms.

Interest Recognition on Notes Receivable

Interest income is not recognized on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.

Allowance for Estimated Losses

A valuation allowance is provided for estimated losses on notes receivable considered to be impaired. Impairment is considered to exist when it is probable that all amounts due under the terms of the note will not be collected. Valuation allowances are provided for estimated losses on notes receivable to the extent that the investment in the note exceeds management’s estimate of the fair value of the collateral securing such note.

Fair Value of Financial Instruments

The following assumptions were used in estimating the fair value of its notes receivable, marketable equity securities, and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For non-performing notes receivable, the estimated fair value of IORI’s interest in the collateral property was used. For marketable equity securities, fair value was based on the year-end closing market price of each security. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities.

Liquidity and Capital Resources

General

Our principal liquidity needs are:

Cash and cash equivalents totaled $101,000 and $267,000 at September 30, 2007 were $104,000 compared to $80,000 atMarch 31, 2008 and December 31, 2006. IORI’s principal sources2007, respectively. Our primary source of cash have beenis from the refinancing of existing mortgages, rents, receivables, and sale of assets. In 2008, we will continue to be property operations, proceeds from asset sales, interest earned on notes receivable, proceeds from financingsrefinance debt obligations as

they become due and refinancings and partnership distributions. Management anticipates that IORI will generate excess cash from operations in 2007 due to increased rental receipts at itsand sale of properties. However, suchif refinancing and excess maycash from operations does not prove to be sufficient to dischargesatisfy all of IORI’s debtour obligations as they mature. Managementmature, we may selectively sell income-producing assets,real estate, refinance real estate, and/orand incur additional borrowings againstsecured by real estate to meet itsour cash requirements. We anticipate that our cash from the sale of properties in the first quarter will be sufficient to meet our liquidity needs.

Cash flow summary

The Company reported a net lossfollowing summary discussion of ($705,000)our cash flows is based on the consolidated statement of cash flows from “ITEM 1—Financial Statements” and is not meant to be an all inclusive discussion of the changes in our cash flows for the nineperiods presented.

Cash and cash equivalents were $101,000 as of the three months ended September 30, 2007, which includedMarch 31, 2008 as compared to $65,000 as of the following non-cash items: depreciation and amortization of $1 million, loss of investees of $24,000 and minority interest of $62,000.

Forsame period ended 2007. During the nine monthsthree month period ended September 30, 2007, netMarch 31, 2008 our cash used in operating activities was ($5.8 million), cash provided by operatinginvesting activities totaled $1 million; netwas $30.3 million and our cash used in investing activities was $8.7 million, consisting almost entirely of advances to the Company’s Advisor under the terms of the Cash Management Agreement (see Note 5. Advisory Agreements) and net cash provided by financing activities was $7.8($24.6 million).

Cash used in operating activities of $5.8 million was primarily due to the payment $5.0 million in sales incentive fees which represents net proceedswas in addition to our normal operating cash requirements. This fee relates to the sale of the six apartment complexes sold in January.

Cash provided by investing activities of $30.3 million was due to receiving $46.4 million on the sale of six apartment complexes in January 2008. We sold the Brighton, Enclave, Delmar, Sinclair, Meridian, and Signature apartments. The excess cash of $16.1, after paying down our existing notes on those properties, closing cost and other operating expenses, was transferred to our advisor per the cash management agreement. Effective June 2005 the advisory agreement was amended to provide that we would receive or pay interest to or from refinancingthe advisor for funds loaned to or borrowed from the advisor. The interest rate on the transfers is 1% plus prime.

Cash used in financing activities was $24.6 million. The majority of properties. In June 2007, the Company refinanced $6.4this was used to pay down $25.1 million of existing debtmortgages on two apartment communities locatedthe six properties that were sold in Midland, Texas. The new loans total $15.4 million and bear interest at rates currently averaging 7.8 percent per annum. The loans matureJanuary.

We did not pay quarterly dividends in June 2008 ($4.6 million) and July 2037 ($10.8 million).or 2007.

Management reviews the carrying values of IORI’s properties at least annually or whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. If impairment is found to exist, a provision for loss is recorded by a charge against earnings. The property review generally includes selective property inspections, discussions with the manager of the property, visits to selected properties in the area and a review of the following: (1) the property’s current rents compared to market rents, (2) the property’s expenses, (3) the property’s maintenance requirements and (4) the property’s cash flows.

Results of Operations

IORI had a net income (loss) of $180,000 and ($705,000)The following discussion is based on our consolidated financial statements for the three and nine months ended September 30, 2007March 31, 2008 and 2007. The following summary discussion is based on the consolidated statements of operations from “ITEM 1” and is not meant to be an all inclusive discussion of the changes in our net income applicable to common shareholders.

Our net income applicable to common shares was $20.0 million which includes income from discontinued operations of $13.7 million for the three months ended March 31, 2008, as compared to a net income (loss)applicable to common shares of ($229,000) and $430,000$66,000 which includes income from discontinued operations of $127,000 for the corresponding periods in 2006. Fluctuations in components of revenuesame period ended 2007.

Rents and expense between September 30, 2007 and the corresponding periods in 2006 are discussed below.

Rental incomeother property revenues were $556,000 for the three and nine months ended September 30, 2007 was $2.2 million and $6.5 million, respectively,March 31, 2008 as compared to $2.0$579,000 for the same period ended 2007, a decrease of $23,000. This is relatively consistent and comparable to prior year as there have been no significant changes within our same property portfolio.

Property operations expenses were $1.1 million and $5.6 million infor the corresponding periods in 2006. Thethree months ended March 31, 2008 as compared to $496,000 for the same period ended 2007, an increase of $557,000 this is primarily due to revenue from the Falcon Point Apartments, whichwriting off $500,000 in our investment in Nakash Income Associates.

Interest income was acquired on March 31, 2006, as well as an overall increase in rents at the residential properties.

Property operating expense$698,000 for the three and nine months ended September 30, 2007 was $1.2 million and $3.4 millionMarch 31, 2008 as compared to $1.2 million and $3.0$1.1 million for the corresponding periods in 2006.same period ended 2007. In 2008, the Company has approximately $27 million of notes receivable from an affiliated entity, Unified Housing Foundation. The increase interms of the nine month amounts is primarily due to operating expensesnotes provide that interest will only be paid from excess cash flow from the Falcon Point Apartments.properties. Beginning in 2008, the Company discontinued accruing interest on the notes receivable until cash is received.

Interest income

Mortgage and loan interest expenses were $904,000 for the three and nine months ended September 30,March 31, 2008 as compared to $836,000 for the same period ended 2007, an increase of approximately $68,000. This is relatively consistent with the prior period.

Income from discontinued operations was $1.3$13.7 million which includes gain on sale of income producing properties of $29.4 million, offset by mortgage interest expense of $2.5 million, sales incentive fee of $5.0 million and $3.5 million, respectively, compared to $707,000 and $2.9tax expense of $7.4 million for the corresponding periods in 2006. The increase was due almost entirelythree months ended March 31, 2008 as compared to the$127,000 which includes interest earned on monies advanced to the Company’s financial advisor in accordance with the cash management agreement (See Note 5. Advisory Agreement).

Interest expense of $584,000, and tax expense of $69,000 for the three and nine months ended September 30, 2007 was $1.5 million and $5.4 million, respectively, compared to $1.3 million and $3.3 million for the corresponding periods2007. Discontinued operations included 6 apartment complexes that were all sold in 2006. The increase was primarily due to the additional debt incurred by IORI during 2006 and 2007 due to new loans, refinancings and the acquisition of the Falcon Point Apartments. The increase was also due to increased interest rates for IORI’s variable interest rate debt.January 2008.

The overall increase in interest expense was partially offset by the elimination of interest expense on the debt to Transcontinental Realty Investors, Inc. (“TCI”), which was cancelled when One Hickory Center, an office building located in Dallas, Texas, was transferred to TCI in May 12, 2006. TCI owns approximately 25 percent of IDRI’s outstanding common stock.

Advisory fees to affiliate for the three and nine months ended September 30, 2007 were $227,000 and $805,000, respectively, compared to $261,000 and $886,000 for the corresponding periods in 2006. The advisory fee for the three and nine months ended September 30, 2007 increased by $34,000 and $81,000, respectively, due to a net increase in gross assets which is the basis of the advisory fee. This increase was offset by a decrease of fees for refinancing certain mortgage obligations (See Note 5. Advisory Agreement).

There was no net income fee to affiliates for the three and nine months ended September 30, 2007, compared to $17,000 and $38,000 for the corresponding periods in 2006. The net income fee is based on .75% of IORI’s net income (See Note 5. Advisory Agreement).

		For the Three Months Ended March 31,
		2008				2007
Revenue
Rental		$	586			$	1,509
Property operations			427				610
			159				899
Expenses
Interest			(2,517	)			(584	)
G&A			(1,002	)			(8	)
Depreciation			—				(111	)
			(3,519	)			(703	)
Net loss from discontinued operations before gains on sale of real estate			(3,360	)			196
Gain on sale of discontinued operations			29,367				—
Net Sales fee to affiliate			(4,909	)
Income (loss) from discontinued operations			21,098				196
Tax expense			(7,384	)			(69	)
Income (loss) from discontinued operations		$	13,714			$	127