Commission File Number: 0-25074

PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST

Issuer’s telephone number: 216-430-2700 Fax number: 216-430-2702

Securities registered under Section 12(b) of the Act: None

Securities registered under to Section 12(g) of the Act: Common Shares, $0.01 par value

Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes þ No o

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB[ ].

Registrant’s revenues for its most recent fiscal year: $660,028.

At February 17, 2005, the Registrant had 33,240,615 common shares of beneficial interest (including 2,859,765 shares held in treasury), $0.01 par value, and 278,455 Class A Cumulative Convertible Preferred Shares. The aggregate market value of the voting common and preferred shares held by non-affiliates of the Registrant was approximately $1,603,829 based on the closing price of $0.13 per common share on the American Stock Exchange on February 17, 2005. The aggregate market value of the voting preferred shares was valued as if each of the remaining 117,045 preferred shares held by non-affiliates were converted into 3.448 common shares on February 17, 2005.

DOCUMENTS INCORPORATED BY REFERENCE

None

Transitional Small Business Disclosure Format (Check one): Yes o No þ

PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST
2004 ANNUAL REPORT ON FORM 10-KSB
TABLE OF CONTENTS

EXHIBITS
     Exhibit 31.1 Section 302 CEO Certificate
     Exhibit 31.2 Section 302 CFO Certificate
     Exhibit 32.1 Section 906 CEO & CFO Certificate

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PART I

Item 1. Description of Business

Company Overview

Paragon Real Estate Equity and Investment Trust (the “Company,” “Paragon,” “we,” “our,” or “us”) is a real estate company with its primary focus on acquiring, owning and operating multi-family residential real estate. As of December 31, 2004, we owned a 1.0% interest in Paragon Real Estate, LP, the operating partnership that owns Richton Trail Apartments (“Richton Trail”), an apartment complex containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we consolidate Richton Trail in our financial statements and show separately amounts for minority interest for Hampton Court Associates, which is the only limited partner. Hampton Court Associates’ ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares.

Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West Apartments Limited Partnership (“River West”). River West is a single asset entity owning an apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragon’s financial statements because we have neither financial nor voting control over the entity. Our exposure is limited to Paragon Housing LLC’s $100 capital contribution in River West, and we and Paragon Housing LLC are not obligated on any of the liabilities of River West.

The Company was formed on March 15, 1994 as a Maryland real estate investment trust (“REIT”). We operated as a traditional real estate investment trust by buying, selling, owning and operating commercial and residential properties through December 31, 1999.

In February 2000, former management of the Company purchased a software technology company. As a result of the operations of the technology company commencing in 2000, the Company did not meet the Internal Revenue Code qualifications to be a REIT for federal tax purposes. In July 2001, former management sold the software technology company, but continued marketing the software product. In 2002, the Company discontinued the operations of the technology segment. Although Paragon is no longer a REIT for federal tax purposes, we can elect REIT status effective for 2005. We are continuing to evaluate our tax status to take advantage of our tax loss carryforwards before electing to be a REIT again.

During the first half of 2003, we put into place a new management team and shareholders elected five new Trustees. Paragon has developed a value-added business plan that is primarily focused on acquiring well located, under-performing multi-family residential properties, including affordable housing complexes, and repositioning them through renovation, leasing, improved management, and branding. This strategy, while unique to public companies, is common among private companies on both a local and limited regional basis. Paragon’s investments will be in properties, portfolios and companies with value-added programs. Paragon intends to raise equity through public and private offerings. We will also use joint venture structures for property and portfolio acquisitions, and tax-deferred operating partnership units for acquisitions of companies. Failure to obtain external sources of capital or to find sellers willing to exchange their properties for tax-deferred partnership units will materially and adversely affect our strategy and our operations, liquidity and financial results.

Because the cash flow from our properties is not expected to fully fund our future liquidity requirements, we have reduced our material future obligations, which include a mortgage on the apartment complex and the employment contracts for our three executive officers. The debt service payment is being funded from the cash flow of the property secured by the mortgage, and the current salary requirements of the employment contracts is only $5,000 per month for each executive officer. We historically have financed our long-term capital needs, including acquisitions, as follows:

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There can be no assurance any of the alternatives will be adopted, or if adopted, will be successful.

Real Estate

Paragon Real Estate, LP, an operating partnership of which we are sole general partner and own a 1.0% interest, owns one residential apartment complex containing 72 units.

Effective July 1, 2003, we closed the acquisition of our residential apartment complex, Richton Trail, located near Chicago, Illinois. Our operating partnership, Paragon Real Estate, LP, acquired the residential complex along with the associated mortgage from Hampton Court Associates, a partnership controlled by James C. Mastandrea, its general partner and our Chairman, Chief Executive Officer and President. In consideration for transferring Richton Trail, Hampton Court Associates received 813,938 restricted limited partnership units of Paragon Real Estate, LP. Each unit is redeemable after four years for cash, or at our option, 22.881 of our common shares.

Paragon Housing LLC is a limited liability company in which we are the sole member and have a $100 investment. It is the general partner of another unrelated limited partnership owning a residential apartment complex of 30 units, which is not consolidated with our financial statements.

Real Estate Tenants

Our tenants have leases that are generally for terms of one year or less.

Competition

The real estate market is highly competitive. Competing properties may be newer or have more desirable locations than the Company’s current property holdings. If the market does not absorb newly constructed units, market vacancies will increase and market rents may decline. As a result, we may have difficulty leasing units within our properties and may be forced to lower rents on leases to compete effectively.

We compete for the acquisition of properties with many entities, including, among others, publicly traded REITs, life insurance companies, pension funds, partnerships and individual investors. Many competitors may have substantially greater financial resources than us. In addition, certain competitors may be willing to accept lower returns on their investments. If competitors prevent us from buying properties that may be targeted for acquisition, our capital appreciation and valuation may be impacted.

Discontinued Operations

We sold our 92.9% general partnership interest in four commercial properties on October 1, 2003. The results of operations for these properties are presented in the accompanying Consolidated Statement of Operations as “Income/Loss from discontinued operations.”

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The following is a summary of the income from discontinued operations of our commercial properties for the years ended December 31, 2004 and 2003.

Employees

The Company has four full-time employees as of February 17, 2005.

Risk Factors

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information included in this Annual Report on Form 10-KSB and other materials filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) contain statements that are forward-looking, such as statements relating to business development and real estate development activities, acquisitions, dispositions, future capital expenditures, financing sources and availability, and the effects of regulation (including environmental regulation) and competition. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be achieved. As forward-looking statements, these statements involve risks, uncertainties and other factors that could cause actual results to differ materially from the expected results and, accordingly, such results may differ from those expressed in any forward-looking statements made by, or on behalf of, the Company. These risks, uncertainties and other factors include uncertainties affecting real estate businesses generally (such as entry into new leases, renewal of leases and dependence on tenants’ ability to pay rent), risks relating to our ability to maintain and increase property occupancy and rental rates, risks relating to construction or development activities, acquisitions, dispositions, possible environmental liabilities, risks relating to leverage and debt service (including availability of financing on terms acceptable to us and sensitivity of our operations and financing arrangements to fluctuations in interest rates), dependence on the primary markets in which our properties are located, the existence of complex regulations relating to our tax status and the potential adverse impact of market interest rates on the market price for our securities. We assume no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

Our cash resources are limited.

As of December 31, 2004, our unrestricted cash resources were approximately $1,799,000 and our marketable securities available for sale were approximately $90,000. Our marketable securities represented 10,000 common shares of Stellent, Inc. and 100 shares of Century Realty Trust. The NASDAQ closing quote on February 17, 2005 was $8.30 per common share of Stellent, Inc. and $16.34 per common share of Century Realty Trust. We are dependent on our existing cash resources and our marketable securities to meet our liquidity needs because cash from operations is not sufficient to meet our operating requirements.

We have a history of losses.

We have reported net losses for each year since our inception. We have an accumulated deficit of

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approximately $23.7 million as of December 31, 2004. There can be no assurance that we will become profitable in the future.

We have approximately $2.8 million in debt secured by Richton Trail.

Our declaration of trust and bylaws have no limitation on the amount of debt that we may incur in the purchase, sale, development or expansion of any property. Richton Trail secures approximately $2.8 million of outstanding mortgage debt. In the future, we may incur additional indebtedness to finance other acquisitions and development projects. Our debt service requirements may reduce funds available for operations and future business opportunities, and may increase our vulnerability to adverse general economic and industry conditions and competition.

We need additional capital to execute our business plan and may not be able to obtain it.

We need additional equity and debt financing to execute our value-added business plan to grow. Additional financing may have unacceptable terms or may not be available at all for reasons relating to:

If adequate financing is not available, we may not be able to acquire additional properties or develop new properties. Failure to obtain this financing will materially and adversely affect our strategy. Any additional capital offerings could dilute our existing shareholders, and we expect that as we grow, our existing shareholders will be diluted significantly.

We will be subject to risks with debt financing.

Our business plan relies on debt financing. There are numerous risks associated with debt financing including:

Our focus on multi-family residential property may not be beneficial.

In the past several years, our real estate focus was to acquire and develop office and industrial properties. Richton Trail is a multi-family residential property, a segment of real estate on which we intend to focus. Since the latter part of 2003, we have been actively seeking and reviewing multi-family residential companies, portfolios and properties, including affordable housing complexes, for potential acquisition. We are currently engaged in discussions with potential sellers, but have not entered into any definitive purchase agreements for any of these properties. There can be no assurance that we will be able to enter into a definitive purchase agreement or that we will be able to close a transaction once a definitive purchase agreement is signed. Even if our management is successful in closing a transaction, investors may not value the transaction in the same manner as we did, and

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investors may not value a portfolio of the same type of properties as highly as they would value portfolios consisting of diverse properties.

We may not be able to manage our growth effectively.

Our business plan envisions significant growth. This growth will require increased investment in management and professionals, personnel, financial and management systems and controls and facilities, which could cause operating results to vary significantly from quarter to quarter and could negatively impact our financial results. Any difficulty or significant delay in the implementation or operation of existing or new systems or integration of new personnel could adversely affect our ability to manage growth and our cash flow.

James C. Mastandrea controls a significant percentage of our shares.

Mr. Mastandrea, our Chairman of the Board, Chief Executive Officer and President, is a member and the manager of Paragon Real Estate Development, LLC and John J. Dee, our Chief Financial Officer and a trustee, is also a member of that entity. Of the 696,078 preferred shares issued to Mr. Mastandrea and Mr. Dee under their restricted share agreements, 534,668 preferred shares were converted during 2003, into 12,233,738 common shares and the balance of 161,410 preferred shares remain outstanding. Mr. Mastandrea and Mr. Dee assigned their common and preferred shares to Paragon Real Estate Development, LLC. Mr. Mastandrea also purchased 25,000 common shares on the open market in 2004. In addition, Hampton Court Associates owns 813,938 units in Paragon Real Estate, LP, which may be converted into cash, or at our option, 18,623,715 common shares at any time after July 1, 2007. Mr. Mastandrea is the general partner of Hampton Court Associates and owns directly or indirectly 325,575 of these units, which may be converted into 7,449,481 common shares or cash, at our discretion. If Mr. Mastandrea caused Hampton Court Associates to redeem all of the limited partnership units in Paragon Real Estate, LP, and we elected to convert such units into common shares, and if the preferred shares held by Paragon Real Estate Development, LLC were converted into common shares, then including the other common shares held by Paragon Real Estate Development, LLC, and if all exercisable options were exercised, Mr. Mastandrea would own or have the right to vote approximately 74.8% of our common shares. Consequently, he would have the ability to approve some matters requiring the vote of shareholders which may result in corporate action with which you do not agree.

Mr. Mastandrea has the right to appoint a majority of our board of trustees.

Under restricted share agreements, Mr. Mastandrea will have the right to appoint five trustees to our board as long as Paragon Real Estate Development, LLC owns either:

Even if these conditions are not met, Mr. Mastandrea’s appointment right will continue until March 4, 2013; provided that if Mr. Mastandrea remains as our Chairman or Chief Executive Officer on that date, the right to appoint five trustees will continue until the time Mr. Mastandrea is no longer our Chairman or Chief Executive Officer. Although Mr. Mastandrea has not exercised this right in the election of trustees, he may exercise it any time in the future.

Mr. Mastandrea and Mr. Dee have conflicts of interest.

James C. Mastandrea is our Chairman of the Board, Chief Executive Officer and President. We are the general partner of Paragon Real Estate, LP, our operating partnership, and Mr. Mastandrea, as our Chief Executive Officer, therefore, oversees the day to day operations of the operating partnership. Mr. Mastandrea owns directly or indirectly limited partnership units totaling 40% of the operating partnership. Because of his different positions, Mr. Mastandrea faces conflicts of interest in making

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determinations regarding the Paragon operating partnership. Mr. Mastandrea’s interests may differ from the interests of our shareholders and the other limited partners, including different and more adverse tax consequences than holders of our common or preferred shares upon the sale of Richton Trail, the refinancing of Richton Trail’s debt, or in connection with any proposed tender offer or merger involving us. Therefore, we and Mr. Mastandrea, as partners in the Paragon operating partnership, may have different objectives regarding the appropriate terms of any such transaction. John J. Dee is our Senior Vice President, Chief Financial Officer and a trustee. Mr. Mastandrea and Mr. Dee may have a conflict of interest with respect to their obligations as officers and trustees to the extent we attempt or the Paragon operating partnership attempts to enforce the terms of the Paragon operating partnership agreement or any other agreement to which we and either or both Mr. Mastandrea and Mr. Dee are parties. The failure to enforce the material terms of any such agreement, particularly indemnification provisions and the remedy provisions for breaches of representations and warranties or failures to perform covenants, could result in a substantial monetary loss to or otherwise could have a material adverse effect on us and our shareholders.

Mr. Mastandrea has additional conflicts of interest because he owns the management company that manages Richton Trail and his spouse, who is President and CEO of the management company, supervises the on-site property management employees.

Mid Illinois Realty Corp., an Illinois corporation, is owned by Mr. Mastandrea and is the management company that manages Richton Trail. Mr. Mastandrea’s spouse is President and CEO of Mid Illinois Realty and supervises the on-site property employees who manage the daily operations of Richton Trail. The existing management fee is 4.5% of gross revenues collected, excluding expense reimbursements and forfeited security deposits. While the contract to manage Richton Trail, including the management fee, is at a competitive market rate for similar services with an unrelated company, it was not negotiated at arm’s-length. We cannot provide any assurance that a contract with an independent third party could not be negotiated upon terms more favorable to us. In addition, Mr. Mastandrea owns another company, MDC Realty Corporation, an Illinois corporation, which is reimbursed, at cost, for the payroll costs of the employees at Richton Trail that are processed by MDC Realty through an unaffiliated payroll services provider. MDC Realty does not charge Richton for these services. As our Chairman of the Board, Chief Executive Officer and President, and because we are the general partner of the Paragon operating partnership that contracts with Mid Illinois Realty and MDC Realty, Mr. Mastandrea faces conflicts of interest in making determinations regarding the management of Richton Trail and the enforcement of the terms of the Richton Trail management agreement. As the Company acquires more properties, it intends to use local third party management companies until we are able to provide management services ourselves. There can be no assurances that we will be able to provide management services for our properties, or after management services are handled internally that we will operate our properties more efficiently or effectively than third party management companies.

We may face competition from other business interests of Mr. Mastandrea.

Mr. Mastandrea owns a combined mixed-use shopping plaza and office facility in suburban Chicago, Illinois. We do not believe that this property will compete with our apartment complex; however, it is possible that this mixed-use facility may compete with us in the future in the event we invest in a similar property in close proximity to it.

We are dependent on a small number of key senior professionals and the loss of any of these professionals could adversely affect our results and may, in turn, negatively affect the market price of our common shares.

The loss of professionals, particularly a senior professional with a broad range of contacts in an industry, could materially and adversely affect our operating results. Among the key professionals on whom we depend, and whose loss could have a material adverse effect on our business, are Mr. Mastandrea, Mr. Dee and Mr. Jack Kuhn our Sr. Vice President — Chief Property Management & Development Officer. We believe that personal relationships with potential investors, lenders and sellers of real estate properties and projects are an important component of our business plan. These

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relationships depend in part upon the individual employees who represent us. We will face competition for experienced real estate professionals. We cannot assure you that losses of key personnel due to competition or otherwise will not occur.

The board of trustees has the ability to effect changes to our major policies, including our investment policy, without the vote of shareholders.

Our major policies, including policies with respect to acquisitions, mergers, financing, growth, debt capitalization, recapitalization of the equity structure and distributions will be determined by our board of trustees. The board of trustees may amend or revise these and other policies from time to time without the vote of the shareholders. Accordingly, the shareholders will have no direct control over changes in our policies which may not fully serve the interests of all of our shareholders.

We cannot sell Richton Trail for ten years without Mr. Mastandrea’s consent.

We are precluded by the Paragon partnership agreement from selling the Richton Trail apartment buildings for ten years without the consent of Mr. Mastandrea. Mr. Mastandrea’s right to consent may present him with a conflict of interest.

Shareholders could experience possible future dilution through the issuance of additional shares or partnership interests.

As a result of growth relating to acquisitions financed with the issuance of additional preferred or common shares or interests in the Paragon operating partnership or any similar entity of ours, you could experience significant future dilution. We cannot estimate how much dilution will occur, but anticipate that it would be significant.

We currently do not plan to distribute dividends to the holders of our shares.

Unless we again become a real estate investment trust, we intend to retain earnings in order to fund the operation and expand our business. Accordingly, we do not intend to pay cash dividends on our common or preferred shares. Payment of future cash dividends, if any, and the amounts thereof will be dependent upon our earnings, financial requirements and other factors deemed relevant by our board of trustees.

Our real estate assets are located in only one market.

All of our existing properties are located in Illinois. Assuming no other property acquisitions under our business plan, our financial performance is dependent upon economic conditions in this state and the specific local market where the property is located. Like other real estate markets, this market has experienced economic downturns in the past. Such slowdowns can lead companies to lay off employees, which might cause individuals to move or miss rent payments. Declines in the economy of the Illinois real estate market could adversely affect our operations or cash flow and ability to meet ongoing obligations, pay distributions to our shareholders, if in the future we elect to pay cash dividends on our common shares, and adversely impact the value of our shares.

Real Estate Risks

We face competition from numerous real estate entities with greater resources than ours.

We compete for the acquisition of properties with many entities, including, among others, publicly-traded REITs, life insurance companies, pension funds, partnerships and individual investors. Many competitors have substantially greater financial and personnel resources than we do. Competition may reduce the number of suitable acquisition opportunities offered to us and increase the bargaining power of property owners seeking to sell. In addition, certain competitors may be willing to accept lower returns on their investments. If competitors prevent us from buying properties that may be targeted for acquisition, our business plan may be adversely impacted, as will our capital appreciation and value.

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Because real estate is illiquid, we may not be able to sell properties when appropriate.

Real estate investments generally cannot be sold quickly. As we grow in accordance with our business plan, this illiquidity will limit our ability to alter our portfolio, whether necessary to sell our properties, to raise capital, or in response to changes in economic or other conditions. In addition, the sale price of any disposition may not recoup or exceed the amount of our investment.

Our operating costs may rise, which could reduce our cash flow.

As we expand, our operating costs may increase as a percentage of our revenue as a result of rising costs and the heightened awareness of possible terrorist attacks. As a direct result of the September 11, 2001 terrorist attacks, costs have increased for building security, property/casualty and liability insurance, and property maintenance. We may not be able to pass along the increased costs associated with such increased building security to our tenants, which could reduce our cash flow.

The possibility of future terrorist attacks has caused increases in the cost of premiums for insurance coverage. Furthermore, in light of recently-adopted securities laws and regulations and the additional responsibility given to audit committees as a result, we may experience increased costs in our directors and officers liability insurance premiums and fees for auditors and other independent third parties hired by the audit committee to fulfill its expanded responsibilities.

Because of rising costs in general, we might experience increases in our property maintenance costs, such as for cleaning, electricity, real estate taxes and heating, ventilation and air conditioning. If operating expenses increase, the availability of other comparable apartment complexes in our specific geographic market may limit our ability to increase rents, which could reduce our cash flows and limit our ability to make distributions to shareholders, if in the future we elect to pay cash dividends on our common shares.

New development and acquisitions may not produce results in accordance with our expectations and may require development and renovation costs exceeding our estimates.

Our real estate investment strategy is to grow by acquiring well located, under-performing multi-family residential properties and repositioning them through renovation, leasing, improved management and branding. Once made, our investments may not produce results in accordance with our expectations. Our actual renovation and improvement costs to bring an acquired property up to market standards or to bring units of an existing property up to standards for a tenant may exceed our estimates. Risks associated with these activities include:

In addition, acquisitions and development projects require a significant amount of management’s time which could divert management’s attention away from the daily operation of our business.

Financially distressed tenants may limit our ability to realize the value of our investments.

Following a tenant’s lease default, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment and recovering lease and other payments owed to us. In addition, a tenant may seek bankruptcy law protection, which could relieve the tenant from its obligation to make lease payments.

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We may be unable to renew leases or relet units as leases expire.

If tenants fail to renew their leases upon expiration, we may be unable to relet the subject unit. Even if the tenants do renew their leases or we can relet the units, the terms of renewal or reletting (including the cost of any upgrades) may be less favorable than current lease terms.

Some potential losses are not fully covered by insurance or may not be covered by insurance at all.

We carry comprehensive liability, fire, extended coverage and rental loss insurance on our property. We believe the policy specification and insured limits of these policies are adequate and appropriate. However, there are types of losses, such as losses from casualties associated with civil unrest, acts of God, including natural disasters, and acts of war that generally are not insured.

As a consequence of the possibility of terrorist attacks in the future, we may be unable to renew or duplicate our current insurance coverage in adequate amounts. In addition, insurance companies may no longer offer coverage against certain types of losses, such as losses due to terrorist acts and toxic mold, or if offered, these types of insurance may be prohibitively expensive. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. Inflation, changes in building codes and ordinances, environmental considerations, and other factors also might make it unfeasible to use insurance proceeds to replace a property after it has been damaged or destroyed. Under these circumstances, the insurance proceeds received by us might not be adequate to restore our economic position with respect to that property. In such an event, we may nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. We cannot provide assurance that material losses in excess of insurance proceeds will not occur in the future. If any of our properties experience a catastrophic loss, the loss could seriously disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property, if we are able to make the repairs or rebuild the property at all. These events could adversely affect our cash flow and ability to make distributions to shareholders.

The ownership of real estate is subject to numerous risks generally.

The underlying value of our real estate investments and our income and our ability to make future distributions to our shareholders are dependent upon our ability to operate rental properties in a manner sufficient to maintain or increase cash available for future distribution, if any. Income from the properties may be adversely affected by:

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Liability for environmental matters could adversely affect our financial position.

Under various federal, state, and local environmental laws, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under or in the property. These laws often impose liability whether or not the owner or operator caused or knew of the presence of the hazardous or toxic substances and whether or not the storage of such substances was in violation of a tenant’s lease. The owner or operator is not always in a position to know what a tenant stores in its apartment. In addition, the presence of hazardous or toxic substances, or the failure to remediate such property, may adversely affect our ability to lease any or all of a property and our ability to borrow using the contaminated property as collateral. In connection with the ownership of any property, we are potentially liable for any cleanup costs and these costs may be substantial.

Our assessments of our existing properties have not revealed any environmental liability that we believe would have a material adverse effect on our business, assets or results of operations, nor are we aware of any such environmental liability. We also intend to condition future acquisitions on successful environmental assessments. Nevertheless, it is possible that our past and future assessments will not reveal all environmental liabilities or that there are existing or future material environmental liabilities of which we will be unaware.

Compliance with applicable laws, rules and regulations, including the Americans with Disabilities Act, can be costly.

All places of public accommodation are required to meet certain federal requirements, including but not limited to those associated with the Americans with Disabilities Act. A number of additional federal, state and local laws exist that also may require modifications to our present and future properties or restrict certain further renovations thereof, with respect to access thereto by disabled persons.

Although we believe that our existing property is substantially in compliance with present requirements, future legislation may impose additional burdens or restrictions on owners with respect to access by disabled persons. Although the costs of compliance with any additional legislation are not currently ascertainable, the costs could be substantial. Limitations or restrictions on the completion of certain renovations may also limit application of our investment strategy in certain instances or reduce overall returns on our investments.

We may not be able to meet the American Stock Exchange’s continued listing qualifications.

While our common shares are currently listed on the American Stock Exchange, we may not be able to meet the American Stock Exchange’s continued listing qualifications in the future and we received a letter on December 1, 2004 from the American Stock Exchange notifying the Company that we are not in compliance with continued listing requirements of the exchange. Specifically, we are not in compliance due to shareholders’ equity of less than $2.0 million and losses from continuing operations and net losses in the three most recent years, as well as shareholders’ equity of less than $4.0 million and losses from continuing operations and net losses in the four most recent years.

We submitted a plan to the exchange proposing actions we will take within 12 months to bring the Company into compliance with the exchange’s listing standards. In February 2005, the exchange determined that Paragon’s plan makes a reasonable demonstration for the Company to regain compliance with the exchange’s listing standards by December 2, 2005, the end of the plan period. If the Company is not in compliance with the listing standards at the end of the plan period, or does not make progress consistent with the plan, Paragon’s common shares would be subject to delisting proceedings. Even though the Company has fallen below the listing standards of the exchange, the exchange is continuing Paragon’s listing on an extension.

In addition, our common shares are thinly traded and trading volumes fluctuate significantly.

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The average trading volume for the year ended December 31, 2004 was approximately 40,000 common shares per day. As a result, investors may have difficulty selling our common shares at generally prevailing prices.

Advantageous transactions may be prevented.

Certain provisions contained in our declaration of trust and bylaws and under federal and Maryland laws may have the effect of discouraging a third party from making any acquisition proposal for us. For example, such provisions may

Possible issuances of future series of preferred shares.

Pursuant to our declaration of trust, our board of trustees has the authority to fix the rights, preferences, privileges and restrictions, including voting rights, of unissued shares and to issue those shares without any further vote or action by the shareholders. The rights of the holders of our common shares will be subject to, and may be adversely affected by, the rights of the holders of any series of preferred shares that may be issued in the future.

Item 2. Description of Property

As of December 31, 2004, we owned one residential apartment complex, Richton Trail, consisting of 12 three-story apartment buildings containing a total 72 units, which we acquired on July 1, 2003. The apartment buildings were built in 1978, 1979 and 1982, were refurbished in the late 1980’s and again in the 1990’s. They are situated in a suburb of Chicago on 3.21 acres, or 139,884 square feet, of land. Each building has its own parking lot and contains six apartment units, with a combined total of 60 two-bedroom apartments and 12 one-bedroom apartments.

Richton Trail contains 56,040 square feet of net rentable area and 74,196 square feet of above grade gross building area. The property has generated rental revenue of approximately $609,000 in 2004, and for the year ended December 31, 2004, 99.0% of the property, or in excess of 71 units, were rented. Tenants’ lease obligations are generally on a year-to-year basis. Richton Trail must maintain approximately 81% of the apartments rented in order to achieve the necessary cash flow to operate the property with its current expenses and liabilities. We currently have no plans for any significant improvements at Richton Trail because the property has been maintained in the past and it is at or near full occupancy.

Paragon Real Estate, LP, an operating partnership of which we are sole general partner and own a 1.0% interest, owns Richton Trail. Hampton Court Associates owns the remaining 99.0% interest of Paragon Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we consolidate Richton Trail in our financial statements and show separately amounts for minority interest for Hampton Court Associates, which is the only limited partner. Hampton Court Associates’ ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares.

Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West Apartments Limited Partnership (“River West”). River West is a single asset entity owning an apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragon’s financial statements because we do not have sufficient equity at risk for Paragon Housing LLC to finance its activities without additional subordinated financial support. Our exposure is limited to

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Paragon Housing LLC’s $100 capital contribution in River West, and we and Paragon Housing LLC are not obligated on any of the liabilities of River West.

On October 1, 2003, we closed on the sale of our 92.9% general partnership interest in four commercial properties. Proceeds from the sale of these properties, net of closing costs and the mortgage balances assumed by the purchaser, were approximately $1,601,000. The proceeds from the sale were paid in a combination of approximately $801,000 in cash and 2,859,765 of our common shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $0.28. Also as a result of the sale, approximately $318,000 representing cash from the commercial real estate properties was released from mortgage related restrictions and made available for operations.

Investments in Real Estate Depreciation and Insurance Coverages

Depreciation expense on our apartment buildings is computed using the straight line method based on a useful life of 40 years.

We believe we have adequate insurance coverage for our real estate property.

Mortgage Loan

Richton Trail has a mortgage loan with an independent lender. The mortgage loan had an original balance of $2.8 million with a fixed interest rate of 5.87% for a term of 10 years. The monthly principal and interest payments are approximately $18,000, based on a 25-year amortization schedule. The balance due at maturity in 2013 will be approximately $2.1 million. The mortgage loan payable was approximately $2,763,000 as of December 31, 2004.

Item 3. Legal Proceedings

In the normal course of business, we may be involved in legal actions arising from the ownership and administration of our properties. In our opinion, the liabilities, if any, that may ultimately result from such legal actions are not expected to have a materially adverse effect on our consolidated financial position, operations or liquidity. We are not currently involved in any legal actions.

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

No matters were submitted to a vote of security holders during the fourth quarter of 2004.

PART II

Item 5. Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.

Our common shares began trading on the American Stock Exchange on October 28, 1999 under the symbol “RPP.” On June 30, 2003 we changed our name to “Paragon Real Estate Equity and Investment Trust.” As a result of our name change our common shares now trade under the new symbol “PRG” on the American Stock Exchange. As discussed above under “Risk Factors,” we received a letter from the American Stock Exchange notifying the Company that it is not in compliance with continued listing requirements of the exchange. In February 2005, we received another letter from the exchange in which it determined that Paragon’s plan submitted to the exchange in December 2004, makes a reasonable demonstration for the Company to be in compliance by December 2, 2005, the end of the plan period. Even though the Company has fallen below the exchange’s listing standards, the exchange is presently continuing Paragon’s listing on an extension.

Our Class A Preferred Shares began trading on the American Stock Exchange on October 28, 1999

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under the symbol “RPP.A.” In May 2003, we offered preferred shareholders a one-time incentive to exchange preferred shares into common shares, which expired June 30, 2003. Through that exchange offer, preferred shareholders exchanged 1,174,120 of the preferred shares, or nearly 81%, for 26,865,042 common shares. After the exchange offer was completed, the remaining preferred shares held by investors not affiliated with Paragon had an aggregate market value below $1 million and therefore no longer met the minimum requirement for listing on the American Stock Exchange, as set forth in the American Stock Exchange’s Company Guide. This requirement was disclosed in the proxy statement as well as our intent not to seek another trading market for the preferred shares. The exchange suspended trading of the preferred shares and the Securities and Exchange Commission removed the preferred shares from listing and registration in accordance with Section 12 of the Securities and Exchange Act of 1934. Preferred shareholders retain the right to convert each of their shares for 3.448 common shares. The preferred shares are now on the Over the Counter Market with the symbol “PRGYP.”

The table below shows the range of the high and low sale prices for our common shares as reported on the American Stock Exchange. The quotations shown represent interdealer prices without adjustment for retail markups, markdowns or commissions, and may not reflect actual transactions.

On February 17, 2005, the last reported sales price of our common shares on the American Stock Exchange was $0.13. The number of holders of record of our common shares was approximately 300 as of February 17, 2005 and we estimate we have approximately 1,200 beneficial holders of common interests as of that same date.

Dividend Policy

We have not declared or paid dividends on our common shares since the fourth quarter of 1999, and we do not anticipate paying dividends on our common shares in the foreseeable future. Declaration or payment of dividends, if any, in the future, will be at the discretion of the board of trustees and will depend on our then current financial condition, results of operations, capital requirements and other factors deemed relevant by the board of trustees.

On June 30, 2003, the holders of our preferred shares consented to waive the dividend that would otherwise have been payable in May 2003 and to eliminate any future dividends that would have been payable under the terms of our preferred shares. The waiver was sought in connection with a one-time incentive exchange offer under which we offered to exchange each of our preferred shares for 22.881 common shares. The exchange offer was completed on June 30, 2003.

Preferred Share Conversions

No preferred shares were converted during the fourth quarter of 2004.

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Item 6. Management’s Discussion and Analysis or Plan of Operation

Overview

Paragon Real Estate Equity and Investment Trust, (the “Company,” “Paragon,” “we,” “our,” or “us”) is a real estate company that primarily acquires, owns and operates multi-family residential properties. As of December 31, 2004, we owned a 1.0% interest in Paragon Real Estate, LP, the operating partnership that owns Richton Trail Apartments (“Richton Trail”), an apartment complex containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon Real Estate, LP. We are the sole general partner of Paragon Real Estate, LP and Hampton Court Associates is the limited partner. Hampton Court Associates’ ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each unit redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares.

Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West Apartments Limited Partnership (“River West”). River West is a single asset entity owning an apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragon’s financial statements because we do not have sufficient equity at risk for Paragon Housing LLC to finance its activities without additional subordinated financial support. Our exposure is limited to Paragon Housing LLC’s $100 capital contribution in River West, and we and Paragon Housing LLC are not obligated on any of the liabilities of River West.

Brief History

The Company was formed on March 15, 1994 as a Maryland real estate investment trust (“REIT”). We operated as a traditional real estate investment trust by buying, selling, owning and operating commercial and residential properties through December 31, 1999.

In February 2000, former management of the Company purchased a software technology company. As a result of the operations of the technology company commencing in 2000, the Company did not meet the Internal Revenue Code qualifications to be a REIT for federal tax purposes. In July 2001, former management sold the software technology company, but continued marketing the software product. In 2002, the Company discontinued the operations of the technology segment. Although Paragon is no longer a REIT for federal tax purposes, we can elect REIT status effective for 2005. We are continuing to evaluate our tax status to take advantage of our tax loss carryforwards before electing to be a REIT again.

Recent Developments in 2004 and Executive Overview

On March 4, 2003, James C. Mastandrea and John J. Dee signed exclusive employment agreements with the Company, and were joined by Jack R. Kuhn in July 2004. Mr. Mastandrea is our Chairman, Chief Executive Officer and President and Mr. Dee is our Chief Financial Officer, Senior Vice President and a trustee. Mr. Kuhn is our Sr. Vice President — Chief Property Management and Development Officer, responsible for overseeing, managing and directing all property management and development activities. At the June 30, 2003 annual meeting, shareholders approved several proxy proposals to reposition the Company, of which the most significant were the following:

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Due to the sale of our four commercial properties, the revenues and expenses of those properties were reclassified as discontinued operations for 2003.

Our management team and board of trustees have formulated a value-added business strategy focused on acquiring well located, underperforming multi-family residential properties and repositioning them through renovation, leasing, improved management and branding. During 2004 and the latter part of 2003, management has been pursuing this strategy by actively seeking and reviewing of multi-family residential companies, portfolios and properties, including affordable housing complexes. While we made offers to some of the sellers, low interest rates for debt financing have had the effect of increasing sale prices for these types of properties and we did not enter into any definitive purchase agreements in 2004. Additionally in December 2004, we formed Paragon Housing LLC, a limited liability company in which we are the sole member and have a $100 investment. Paragon Housing LLC is the general partner of another unrelated limited partnership owning a residential apartment complex of 30 units, which is qualified under Section 42 of the Internal Revenue Code to receive low income housing tax credits. We are currently engaged in discussions with potential sellers, but have not entered into any definitive purchase agreements for any of these properties. There can be no assurance that we will be able to enter into a definitive purchase agreement or that we will be able to close a transaction once a definitive purchase agreement is signed. Even if our management is successful in closing a transaction, investors may not value the transaction in the same manner as we did, and investors may not value a portfolio of the same type of properties as highly as they would value portfolios consisting of diverse properties.

Forward-Looking Information

The following is a discussion of our results of operations for the years ended December 31, 2004 and 2003 and financial condition, including

This section contains “forward-looking” statements, as defined in the Private Securities Litigation Reform Act of 1995, that are based on our current expectations, estimates and projections about future events and financial trends affecting the financial condition and operations of our business. Forward-looking statements can be identified by the use of words such as “may,” “will,” “should,” “expect,” “estimate” or comparable terminology. Forward-looking statements are inherently subject to risks and uncertainties, many of which we cannot predict with accuracy and some of which we might not even anticipate. Although we believe that the expectations, estimates and projections reflected in these forward-looking statements are based on reasonable assumptions when they are made, we can give no assurance that these expectations, estimates and projections can be achieved. Future events and actual results may differ materially from those discussed in the forward-looking statements. The Company assumes no obligation to update or supplement forward-looking statements that become untrue

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because of subsequent events. Factors that could cause actual results to differ materially from management’s current expectations include, but are not limited to, changes in general economic conditions, changes in local real estate conditions (including rental rates and competing properties), changes in the economic conditions affecting industries which employ tenants residing in our property, our failure to lease unoccupied units or to re-lease occupied units upon expiration of leases in accordance with the our projections, changes in prevailing interest rates, the cost or general availability of equity and debt financing, unanticipated costs associated with the acquisition and integration of our acquisitions, our ability to obtain adequate insurance for terrorist acts, demand for tenant services beyond those traditionally provided by landlords, and potential liability under environmental or other laws. Please see the section “Risk Factors” on previous pages for other factors which could affect our Company.

Comparison of the years ended December 31, 2004 and 2003

Revenues from Continuing Operations

As a result of the October 1, 2003 sale of our 92.9% general partnership interest in the operating partnership that held our four commercial real estate properties, rental revenues and interest income and other income related to these properties were reclassified to discontinued operations for the year ended December 31, 2003. Richton Trail, which we acquired on July 1, 2003, is included in continuing operations.

Rental revenue of approximately $609,000 for the year ended December 31, 2004 represents twelve months revenue for Richton Trail and the rental revenue of approximately $288,000 for the year ended December 31, 2003 represents only six months revenue for Richton Trail, which was acquired on July 1, 2003.

Interest income and other income increased by approximately $32,000 or 166.7% to approximately $51,000 for the year ended December 31, 2004 compared to the year ended December 31, 2003. The increase is primarily due to the increase in cash and cash equivalents, as a result of the disposition of the commercial properties and the refinancing of Richton Trail in the fourth quarter of 2003.

Expenses from Continuing Operations

Total expenses increased from approximately $1,223,000 for the year ended December 31, 2003 to approximately $1,558,000 for the year ended December 31, 2004, a net increase of $335,000 as described below.

As a result of the October 1, 2003 sale of our 92.9% general partnership interest in the four commercial Minnesota properties, property taxes and insurance, depreciation and amortization, interest and management fees related to these properties were reclassified to discontinued operations. Richton Trail, which we acquired on July 1, 2003, is included in continuing operations, as follows:

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The increases in expenses shown above, except for general and administrative explained in the following paragraph, are mainly due to twelve months of Richton Trail operations in 2004 compared to only six months in 2003. Other differences between the full year 2004 and annualized 2003 include an increase of approximately $34,000 in interest expense due to the refinancing of Richton Trail, an increase of approximately $11,000 in legal costs related to collections and evictions, and an increase in utilities due to the seasonal nature of heating costs of approximately $10,000.

General and administrative expenses increased from approximately $951,000 for the year ended December 31, 2003 to approximately $958,000 for the year ended December 31, 2004. The increase of approximately $7,000 was the result of an increase of approximately $81,000 in legal costs related to litigation with former management and legal costs related to the pursuit of new deals. In addition we had increased travel costs related to the pursuit of new deals of approximately $32,000 and increased rent costs of approximately $14,000. The rent is a non-cash cost paid through the issuance of restricted shares. The increased costs were partially offset by decreased compensation and related costs of approximately $89,000 representing non-cash severance costs incurred in 2003, net of increased costs in 2004 including approximately $118,000 of non-cash costs paid through the issuance of restricted shares. Other lower costs include reduced director and officer liability insurance and other insurance costs of approximately $13,000, and reduced public company mailing and related costs of approximately $18,000.

General and administrative costs represent approximately 61% of total costs. General and administrative costs are a large percent of total costs because we have only one property and continue to actively seek and review potential acquisitions to build our portfolio.

Loss from operations before minority interests

As a result of the above, loss from operations before minority interests decreased from approximately $917,000 for the year ended December 31, 2003 to approximately $898,000 for the year ended December 31, 2004.

Loss allocated to minority interests

Loss allocated to minority interests decreased from approximately $149,000 for the year ended December 31, 2003 to approximately $82,000 for the year ended December 31, 2004, primarily as a result of the October 2003 sale of our partnership interest in our commercial properties offset, and in part, by the July 2003 acquisition of our partnership interest in Richton Trail.

Loss from operations

As a result of the above, loss from operations increased from approximately $768,000 for the year ended December 31, 2003 to approximately $816,000 for the year ended December 31, 2004.

Gain on sale of marketable securities

The gain on sale of marketable securities of approximately $136,000 for the year ended December 31, 2003 was a result of our sale of 30,000 common shares of Stellent, Inc. at an average price of $8.30 per share.

Loss from continuing operations

Loss from continuing operations increased from approximately $632,000 for the year ended December 31, 2003 to approximately $816,000 for the year ended December 31, 2004.

Discontinued operations

Loss from discontinued operations of our commercial properties, net of tax, was approximately $0 and

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$458,000 for the years ended December 31, 2004 and 2003, respectively. The loss in 2003 included $350,000 representing tenant improvements, leasing commission and professional fees spent on the commercial properties prior to their sale without an increase in proceeds. The discontinued operations were a result of the sale of our 92.9% general partnership interest in the four commercial properties on October 1, 2003. Current management did not consider these properties, comprised of small office/industrial facilities, to be core assets for the new value-added business plan. Therefore, the commercial properties were sold to raise cash for short term operations and for future acquisitions.

As a result of the sale of our commercial properties on October 1, 2003, we received cash of approximately $801,000, and approximately $318,000 of additional cash was released from mortgage related restrictions and made available for operations.

Net loss attributable to Common Shareholders

Based on the above, the net loss attributable to common shareholders decreased from approximately $1,090,000 for the year ended December 31, 2003 to approximately $816,000 for the year ended December 31, 2004.

Critical Accounting Policies and Estimates

Our Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles, which require us to make certain estimates and assumptions. A summary of our significant accounting policies is provided in Note 3 to our Consolidated Financial Statements. The following section is a summary of certain aspects of those accounting policies that both require our most subjective judgment and are most important to the presentation of our financial condition and results of operations. It is possible that the use of different estimates or assumptions in making these judgments could result in materially different amounts being reported in our Consolidated Financial Statements.

Impairment of Long-Lived Assets

We recognize an impairment loss on a real estate asset if the asset’s carrying amount exceeds its fair value and is non-recoverable. First, to determine if impairment may exist, we review our properties and identify those, if any, which have had either an event of change or event of circumstances warranting further assessment of recoverability. Next, we estimate the fair value of those properties on an individual basis through either independent appraisals or by capitalizing the expected net operating income. These amounts are then compared to the property’s depreciated cost to determine whether an impairment exists. We compute the expected net operating income using certain estimates and assumptions for revenues and expenses. As a result, these estimates and assumptions impact the amount of impairment loss that we recognize. In 2003, we recognized a provision for loss on the four commercial properties of $350,000 for tenant improvements, leasing commissions and professional fees spent on the properties prior to their sale without an increase in proceeds.

Real Estate Investments

When we acquire real estate properties, we allocate the components of these acquisitions using relative fair values computed using our estimates and assumptions. These estimates and assumptions affect the amount of costs allocated between land and different categories of building improvements. The allocations impact depreciation expense and gain or loss recorded on sale of real estate. When we acquired Richton Trail, we allocated 80% of the acquisition price to building and 20% to land, based on our judgment of the relative values of the two components and as supported by standard industry practice. The acquisition price was from a market appraisal.

Valuation Allowance of Deferred Tax Asset

We account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities

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using enacted tax rates in effect for the period in which the differences are expected to affect taxable income. At December 31, 2004, we have net operating losses totaling approximately $11.0 million and capital losses of approximately $0.6 million. While these losses created a deferred tax asset of approximately $4.9 million, a valuation allowance of $4.9 million was applied against this asset because of the uncertainty of whether we will be able to use these loss carryforwards, which will expire in varying amounts through the year 2024.

Liquidity and Capital Resources

Cash provided by operations, equity transactions, and borrowings from affiliates and lending institutions have generally provided the primary sources of liquidity to the Company. Historically, the Company has used these sources to fund operating expenses, satisfy its debt service obligations and fund distributions to shareholders. In 2003, as part of the one-time incentive exchange offer for holders of preferred shares to convert to common shares, our shareholders approved eliminating the preferred dividend, which allows us to use that cash for current operations and future growth of the Company.

Cash Flows

As of December 31, 2004, our unrestricted cash resources were approximately $1,799,000 and our marketable securities available for sale were approximately $90,000, comprised of 10,000 common shares of Stellent, Inc. and 100 shares of Century Realty Trust. The NASDAQ closing quote on February 17, 2005 was $8.30 per common share of Stellent, Inc. and $16.34 per common share of Century Realty Trust. We are dependent on our existing cash resources and the Stellent, Inc. shares to meet our liquidity needs because cash from operations are not sufficient to meet our operating requirements.

During the year ended December 31, 2004, the Company’s cash balance decreased by approximately $419,000 from approximately $2,219,000 at December 31, 2003 to approximately $1,799,000 at December 31, 2004. Cash was used primarily for (i) continuing operations of approximately $344,000 which included the receipt of a deposit on a development site of $250,000, (ii) improvements to real estate properties of approximately $26,000, and (iii) payments on mortgage loans of approximately $49,000.

Cash used for continuing operations is negatively impacted by general and administrative costs that represent approximately 61% of total costs. General and administrative costs are a large percent of total costs because we have only one property and continue to actively seek and review potential acquisitions to build our portfolio.

Future Obligations

Because the cash flow from our properties is not expected to fully fund our future liquidity requirements, we have reduced our material future obligations. At December 31, 2004, future obligations include the mortgage on the apartment complex and the employment contracts for our executive officers.

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Long Term Liquidity and Operating Strategies

We historically have financed our long term capital needs, including acquisitions, as follows:

During the first half of 2003, we put into place a new management team and shareholders elected five new Trustees. Paragon has developed a value-added business plan that is primarily focused on acquiring well located, under-performing multi-family residential properties, including affordable housing complexes, and repositioning them through renovation, leasing, improved management, and branding. This strategy, while unique to public companies, is common among private companies on both a local and limited regional basis. Paragon’s investments will be in properties, portfolios and companies with value-added programs. Paragon intends to raise equity through public and private offerings. We will also use joint venture structures for property and portfolio acquisitions, and tax-deferred operating partnership units, convertible into a separate class of common shares, for acquisitions of companies. Failure to obtain external sources of capital or to find sellers willing to exchange their properties for tax-deferred partnership units will materially and adversely affect our strategy and will materially and adversely affect our operations, liquidity and financial results. Paragon’s investment advantages, compared to private companies, include our potential ability to access capital and to offer sellers a tax-deferred exit alternative to exchange their properties for partnership units with opportunities for both liquidity and share appreciation. Our cash resources are sufficient to meet our current overhead for approximately two years while we identify and pursue potential acquisitions.

Current Tax Status

At December 31, 2004, we have net operating losses of approximately $11.0 million. While these losses created a deferred tax asset, a valuation allowance was applied against the asset because of the uncertainty of whether we will be able to use these loss carry forwards, which will expire in varying amounts through the year 2024.

We, and certain of our subsidiaries, are also subject to certain state and local income, excise and franchise taxes. The provision for state and local taxes has been reflected in general and administrative expense in the consolidated statements of operations and has not been separately stated due to its insignificance.

Interest Rates and Inflation

For the past several years, interest rates have declined, and many financial experts and economists have predicted that interest rates reached bottom in 2003. Lower interest rates have led to higher selling prices for established real estate properties, the type that we intend to buy. Purchasers of properties have been able to place a larger amount of debt on their acquisitions because the lower interest rates have lowered the monthly mortgage payments. Interest rates started to increase during 2004, which should lead to slightly lower prices for real estate properties and to higher borrowing rates. The interactions between an increase in interest rates and a decrease in selling prices of properties cannot be measured with any certainty. Paragon will continue to pursue its value-added

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business plan during 2005. The economics of transactions, including price, current cash flow, existing debt, cost of new funds for acquiring the properties, and potential for increased value, will be reviewed closely prior to making any acquisitions.

We were not significantly affected by inflation during the periods presented in this report due primarily to the relative low nationwide inflation rates.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have, or are likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 7. Financial Statements

The required audited consolidated financial statements of the Company are included herein commencing on page F-1.

Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None

Item 8a. Disclosure Controls and Procedures

As of December 31, 2004, the date of this report, James M. Mastandrea, our Chief Executive Officer and President, and John J. Dee, our Chief Financial Officer and Senior Vice President, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based upon this evaluation, Messrs. Mastandrea and Dee concluded that, as of December 31, 2004, our disclosure controls and procedures are effective to ensure that material information relating to the Company and our consolidated subsidiaries is recorded, processed, summarized and reported in a timely manner.

Further, there were no significant changes in the internal controls or, to our knowledge, in other factors that could significantly affect such controls subsequent to December 31, 2004.

Item 8b. Other Information

None.

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PART III

Item 9. Trustees and Executive Officers of the Registrant

The names, ages and positions of our trustees and executive officers are as follows:

Board of Trustees and Executive Officers

The business experience, principal occupations and employment, as well as the periods of service, of each of our trustees and executive officers during at least the last five years are set forth below.

James C. Mastandrea has served as President and Chairman of the Board of Trustees since March 4, 2003 and as Chief Executive Officer since April 7, 2003. In May 1998, Mr. Mastandrea returned as Chairman and Chief Executive Officer to MDC Realty Corporation, Chicago, Illinois, which he founded in 1978 and had used for the development of over $500 million of real estate projects until 1993. From July 1993 to December 1993, Mr. Mastandrea was President of First Union Real Estate Investments, a NYSE listed real estate investment trust headquartered in Cleveland, Ohio. From January 1994 until his departure in May 1998, he was Chairman of the Board of Trustees and Chief Executive Officer of First Union. During his tenure at First Union, Mr. Mastandrea and his management team substantially grew the assets of the company from $495 million at the beginning of 1994 to $934 million at the end of 1997, along with commensurate growth in net operating income and funds from operations. In 1999, Mr. Mastandrea formed Eagle’s Wings Aviation Corporation, where he served as Chief Executive Officer, to purchase a troubled aviation services business. At the time of the purchase, the business was in default on its debt obligations. Following the September 11, 2001 terrorist attacks, the business was further adversely affected. In March 2002, Eagle’s Wings filed for protection under Chapter 11 of the federal bankruptcy laws. Mr. Mastandrea has been the general partner of Hampton Court Associates, L.P. since its formation in 1983. Mr. Mastandrea is a director of Cleveland State University Foundation Board and Chairman of the nominating committee, and a director and a member of the real estate committee of University Circle Inc., Cleveland, Ohio. He is a member of National Association of Real Estate Investment Trusts (NAREIT), Pension Real Estate Association (PREA), and National Multifamily Housing Association (NMHA).

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John J. Dee has served as a trustee and Senior Vice President since March 4, 2003, and as Chief Financial Officer since April 7, 2003. Prior to Mr. Dee’s joining Paragon, from 2002 to 2003, he was Senior Vice President and Chief Financial Officer of MDC Realty Corporation, Cleveland, Ohio, an affiliate of MDC Realty Corporation, Chicago, Illinois. From 2000 to 2002, Mr. Dee was Director of Finance and Administration for Frantz Ward, LLP, Cleveland, Ohio, a Cleveland-based law firm with approximately 100 employees. From 1978 to 2000, Mr. Dee held various management positions with First Union Real Estate Investments (NYSE), most recently as Senior Vice President and Chief Accounting Officer from 1996 to 2000. Mr. Dee is licensed as a CPA (non-practicing) in the State of Ohio.

Jack R. Kuhn joined Paragon as Senior Vice President and Chief Property Management and Development Officer on July 19, 2004. Mr. Kuhn’s responsibilities include overseeing all of Paragon’s property management and development activities. Prior to joining Paragon, from 1985 to June 2004, Mr. Kuhn was an Executive Vice President of Forest City Enterprises (NYSE), and President of Forest City Management. Forest City is a $5 billion diversified real estate development and Management Company located in Cleveland, Ohio, with commercial and residential properties throughout the country. At Forest City, Mr. Kuhn was directly responsible for all of the property management and development properties in 13 states, particularly during Forest City’s substantial growth. Mr. Kuhn is a member of the Urban Land Institute (ULI), Builders Owners and Managers Association (BOMA), International Council of Shopping Centers (ICSC); and a board member of United Way, Shoes for Kids, and Salvation Army.

Daryl J. Carter has served as a trustee since June 30, 2003. Mr. Carter is Co-Chairman and Chief Investment Officer of Capri Capital, Irvine, California, an affiliated company of Charter Mac Mortgage Capital. Capri Capital is a diversified real estate financial services firm that Mr. Carter co-founded in 1992. Capri Capital has $7 billion in assets under management, including investments in commercial mortgages, mezzanine capital, and equity investments in Fannie Mae, Freddie Mac and HUD/FHA programs, along with equity and mezzanine capital investments on behalf of various public, private and labor funds. Mr. Carter serves as a Director of Catellus Development Corporation (NYSE), San Francisco, California, a publicly held real estate investment trust. Mr. Carter is a member of the Pension Real Estate Association (PREA), a Trustee and Vice Chairman of the Urban Land Institute (ULI), a Board Member and Chair of the Finance Committee of the National Multifamily Housing Association (NMHA), and a member of the Commercial Board of Governors of the Mortgage Bankers Association.

Daniel G. DeVos has served as a trustee since March 4, 2003. Mr. DeVos is Chairman of the Board and Chief Executive Officer of DP Fox Ventures, LLC, a diversified management enterprise with investments in real estate, transportation, and sports teams. In addition, Mr. DeVos is the majority owner of the Grand Rapids Rampage (AFL), Grand Rapids Griffins (AHL) and has ownership interests in the Orlando Magic (NBA). Mr. DeVos is a director of Alticor, Inc., the parent of Amway Corporation, located in Ada, Michigan, and the Orlando Magic (NBA). From 1994 to 1998, Mr. DeVos served as a trustee of First Union Real Estate Investments (NYSE).

Paul T. Lambert has served as a trustee since November 1998. Mr. Lambert serves as the Chief Executive Officer of Lambert Capital Corporation. He served on the Board of Directors and was the Chief Operating Officer of First Industrial Realty Trust, Inc. (NYSE) from its initial public offering in October 1994 to the end of 1995. Mr. Lambert was one of the largest contributors to the formation of First Industrial and one of its founding shareholders. Prior to forming First Industrial, Mr. Lambert was managing partner for The Shidler Group, a national private real estate investment company. Prior to joining Shidler, Mr. Lambert was a commercial real estate developer with Dillingham Corporation and, prior to that, was a consultant with The Boston Consulting Group.

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Michael T. Oliver has served as a trustee since March 4, 2003. Mr. Oliver is the State Investment Officer of Real Estate and Private Equity Investments of the Alaska State Pension Board of the Alaska State Pension Fund, Juneau, Alaska, a position he has held since August 2000. Prior to joining the Alaska State Pension Board, Mr. Oliver was a consultant from March 1998 to July 2000 to MPAC Capital Markets, Seattle, Washington, and a consultant to several Asian governments concerning laws governing REITs. From April 1996 to March 1998, Mr. Oliver was Chairman of RERC Capital Markets, LLC, Chicago, Illinois. From March 1987 to February 1996, he was Chairman of Heitman/PRA Securities Advisors, Inc. and President of its Real Estate Fund. Prior to March 1987 and since 1967, Mr. Oliver held positions at real estate companies raising capital and making direct investments in real estate, and at investment banking firms analyzing real estate companies and raising capital.

The board of trustees has determined that each of Messrs. Carter, DeVos, Lambert and Oliver do not have a material relationship with Paragon that would interfere with the exercise of independent judgment and are independent as defined by the applicable rules of the American Stock Exchange. Mr. Oliver is the chairman of Paragon’s audit committee and serves as the committee’s financial expert. Mr. Carter is the chairman of the management, organization and compensation committee. All four independent trustees are on the audit committee and the management, organization and compensation committee.

Code of Ethics

On January 14, 2004, our Board of Trustees adopted a code of conduct and ethics that applies to all officers, trustees and employees of Paragon, including our principal executive officer, principal financial officer and principal accounting officer. Upon written request to the Company, we will provide a copy of our Code of Conduct and Ethics without charge.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s officers, trustees and persons who own more that 10% of our common shares to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, Trustees and greater than 10% shareholders are required by regulation to furnish us with copies of all Section 16(a) forms they file.

Separate Form 4s filed by Messrs. Mastandrea and Dee, each reporting an award of restricted shares and share options, were not filed on a timely basis. Based solely on review of the copies of the forms furnished to us, or written representations that no Annual Statements of Beneficial Ownership of Securities on Form 5 were required to be filed, we believe that for the fiscal year ended December 31, 2004, all other Section 16(a) filing requirements applicable to its officers, trustees and greater than 10% shareholders were complied with in 2004.

Item 10. Executive Compensation

The following table sets forth the compensation paid to our CEO for the years ended December 31, 2004, 2003, and 2002.

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Options/SAR Grants In Last Fiscal Year

Options for 150,000 common shares were granted on January 2, 2004 to James C. Mastandrea, our Chief Executive Officer and President. One third of the options vest on each January 2nd of 2005, 2006, and 2007. The following table summarizes the terms of the grant.

OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
Individual Grants

Option/SAR value at Fiscal Year End

The following table summarizes the value of options held by Mr. Mastandrea at December 31, 2004, none of which were “in-the-money.”

Aggregated Option/SAR Exercises in Last Fiscal Year
And FY-End Option/SAR Values

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Employment Agreements

The employment agreement with the former chief executive officer provided for an annual salary of $150,000. The severance provision of this agreement provided for him to receive 95,541 preferred shares in lieu of a $300,000 severance payment for his resignation. The number of shares issued was based on two times his annual salary with the price of the preferred shares based on the average closing price for the 30 calendar days prior to March 1, 2003. For his services from April 7, 2003 until June 15, 2003, he received compensation based on an annual salary of $60,000.

The employment agreement with James C. Mastandrea provides for an annual salary of $60,000 effective as of March 4, 2003 and in connection therewith, Mr. Mastandrea was appointed as Chief Executive Officer on April 7, 2003. The initial term of Mr. Mastandrea’s employment is for two years and may be extended for terms of one year through his 70^th birthday. Mr. Mastandrea’s base annual salary may be adjusted from time to time, except that the adjustment may not be lower than the preceding year’s base salary. The employment agreement provides that Mr. Mastandrea will be entitled to base salary and bonus at the rate in effect before any termination for a period of three years in the event that his employment is terminated without cause by us or for good reason by Mr. Mastandrea.

Effective June 30, 2003, we issued 696,078 preferred shares valued at approximately $2.4 million to Messrs. Mastandrea and Dee pursuant to separate restricted share agreements. On June 30, 2003, 534,668 preferred shares were converted at a factor 22.881 into 12,233,739 common shares. Under the restricted share agreement for each of Mr. Mastandrea and Mr. Dee, the restricted shares vest upon the later of the following dates:

Compensation of Trustees

Effective October 28, 2003, each trustee who is not an officer of the Company receives a retainer of $5,000 per annum, $500 per meeting for each meeting attended in person, $100 per meeting for each meeting attended via teleconference, 25,000 options as to common shares which are to vest one year after issuance and to expire 90 days after the term of the trustee ends and 50,000 restricted common shares that will vest one year after their issuance. Effective June 15, 2004, 100,000 options at an exercise price of $0.18 per common share and 200,000 restricted common shares were issued.

During the year ended December 31, 2004, trustees were paid approximately $27,000 for retainers and meetings for 2004, and, as of December 31, 2003, the Company had accrued $19,000 for retainers and meetings for 2003, which was subsequently paid in 2004.

Item 11. Security Ownership of Management and Certain Beneficial Owners

The following table includes certain information with respect to the beneficial ownership of our shares by: (i) each person known by us to own more than 5% in interest of the outstanding shares; (ii) each of the trustees and each nominee for trustee; (iii) each of our executive officers; and (iv) all of the trustees and executive officers as a group. Except as otherwise noted, the person or entity named has sole voting and investment power over the shares indicated.

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     The table shows ownership as of February 17, 2005.

28

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Equity Compensation Plan Information

In addition to the above plans, we entered into an agreement dated March 4, 2003 and approved by the shareholders on June 30, 2003 with Mr. Mastandrea, Mr. Dee and Paragon Real Estate Development, LLC of which Mr. Mastandrea is the managing member, and Mr. Dee is a member. Pursuant to this agreement, we may issue up to $26.0 million in our common shares to Paragon Real Estate Development, LLC in exchange for it and its members procuring future acquisition, development and re-development real estate transactions for Paragon’s benefit. This agreement is intended to serve as incentive for Mr. Mastandrea and Mr. Dee to increase our assets and net operating income in the future. The exact number of common shares that would be issued to Paragon Real Estate Development, LLC will be calculated in accordance with a formula based on the type of project that they present to us. The formula for a particular real estate transaction would be calculated by dividing (i) estimated net operating income to be generated from the real estate transaction for the first year following its consummation by (ii) the capitalization rate used in the real estate transaction, less the “applicable basis point factor.” The “applicable basis point factor” is defined as: 75 basis points for the acquisition of an existing operating property, 87.5 basis points for the acquisition of a re-development property, and 100 basis points for the acquisition of a development property. We would issue our common shares to Paragon Real Estate Development, LLC only upon the closing of the real estate transaction. For each transaction, Mr. Mastandrea would be allocated half of the common shares and Mr. Dee would be allocated the other half. All of the common shares would be held by Paragon Real Estate Development, LLC for the benefit of its owners.

Item 12. Certain Relationships and Related Transactions

Management Fees

During 2003, we had a property management agreement with Hoyt Properties, Inc. (“Hoyt Properties”), an entity controlled by our former chairman of the board, which served as property manager of the

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commercial properties owned by us. In connection with the agreement, Hoyt Properties managed the day-to-day operations of properties owned by us and received a management fee for this service. Management fees paid to Hoyt Properties were $0 and approximately $49,000 for the years ended December 31, 2004 and 2003, respectively. On October 1, 2003, we sold our four commercial properties managed by Hoyt Properties. As a result, these management fees are included in discontinued operations.

James C. Mastandrea, our Chairman, Chief Executive Officer and President, is the general partner of Hampton Court Associates and owns two companies which provide services to Richton Trail. Mid Illinois Realty Corp. manages Richton Trail and MDC Realty Corp. is reimbursed, at cost, for Richton Trial’s payroll related costs. The related management fees included in years ended December 31, 2004 and December 31, 2003 were approximately $28,000 and $13,000, respectively. Reimbursement, at cost, for the payroll related costs paid and accrued for the years ended December 31, 2004 and December 31, 2003 were approximately $59,300 and $30,700, respectively. As the Company acquires more properties, it intends to use local third party management companies until we are able to provide management services ourselves.

Leasing Commissions

During the year ended December 31, 2003, we paid a leasing commission of approximately $18,000 to Hoyt Properties in connection with two new leases for a total of approximately 21,000 square feet. On October 1, 2003 we sold our four commercial properties managed by Hoyt Properties. As a result, these leasing commissions, net of accumulated amortization are included in discontinued operations.

Rental Expense

During the years ended December 31, 2004 and 2003, we recognized rental expense of $0 and approximately $8,000, respectively, related to office space leased from Hoyt Properties.

Item 13. Exhibits, List and Reports on Form 8-K

(a) Exhibits

31

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(b) Reports On Form 8-K

On December 4, 2004 we filed with the Securities and Exchange Commission a Current Report on Form 8-K dated December 1, 2004 reporting our receipt of a letter from the American Stock Exchange notifying the Company that it is not in compliance with continued listing requirements of the exchange.

Item 14. Principal Accountant Fees and Services

The aggregate fees billed by the principal independent registered public accountants (Boulay, Heutmaker, Zibell & Co., P.L.L.P.) to the Company for the fiscal years ended December 31, 2004 and 2003 are as follows:

Policy for pre-approval of Audit and Permissible Non-Audit Services of Independent Auditors

Before the independent auditors are engaged by the Company to render audit or non-audit services, the Audit Committee approves the engagement.

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SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

KNOW ALL PERSON BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints John J. Dee, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-KSB and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.

In accordance with Section 13 or 15(d) of the Securities Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST

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PARAGON REAL ESTATE EQUITY AND INVESTMENT TRUST AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Trustees and Shareholders of
Paragon Real Estate Equity and Investment Trust and Subsidiaries:

We have audited the accompanying consolidated balance sheet of Paragon Real Estate Equity and Investment Trust and Subsidiaries as of December 31, 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years ending December 31, 2004 and 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Paragon Real Estate Equity and Investment Trust and Subsidiaries as of December 31, 2004, and the results of their operations and their cash flows for the years ending December 31, 2004 and 2003 in conformity with U.S. generally accepted accounting principles.

/s/ Boulay, Heutmaker, Zibell & Co. P.L.L.P.

Minneapolis, Minnesota
February 9, 2005

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Paragon Real Estate Equity and Investment Trust and Subsidiaries

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

F-3

Paragon Real Estate Equity and Investment Trust and Subsidiaries

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

F-4

Paragon Real Estate Equity and Investment Trust

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

F-5

Paragon Real Estate Equity and Investment Trust and Subsidiaries

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

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Paragon Real Estate Equity and Investment Trust and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 – Organization

Paragon Real Estate Equity and Investment Trust (the “Company,” “Paragon,” “we,” “our,” or “us”) is a real estate company, which primarily acquires, owns and operates multi-family residential real estate properties. As of December 31, 2004, we owned a 1.0% interest in Paragon Real Estate, LP, the operating partnership that owns Richton Trail Apartments (“Richton Trail”), an apartment complex containing 72 units. Hampton Court Associates owns the remaining 99.0% interest in Paragon Real Estate, LP. Because we are the sole general partner of Paragon Real Estate, LP, we consolidate Richton Trail in our financial statements and show separately amounts for minority interest for Hampton Court Associates, which is the only limited partner. Hampton Court Associates’ ownership interest in Paragon Real Estate, LP is 813,938 restricted limited partnership units, each redeemable after July 1, 2007 for cash, or at our option, 22.881 of our common shares.

Paragon is also the sole member of Paragon Housing LLC, which is the general partner of River West Apartments Limited Partnership (“River West”). River West is a single asset entity owning an apartment complex of 30 units. We do not consolidate Paragon Housing LLC with Paragon’s financial statements because we do not have sufficient equity at risk for Paragon Housing LLC to finance its activities without additional subordinated financial support. Our exposure is limited to Paragon Housing LLC’s $100 capital contribution in River West, and we and Paragon Housing LLC are not obligated on any of the liabilities of River West.

We owned four commercial real estate investments through an operating partnership, Wellington Properties Investments, LP, of which we were the sole general partner and owned an approximate 92.9% interest. On October 1, 2003, we completed the sale of our 92.9% general partnership interest, resulting in the sale of the commercial properties.

Note 2 – Basis of Presentation

Minority interest at December 31, 2004 represents approximately a 99.0% aggregate partnership interest in Paragon Real Estate, LP held by Hampton Court Associates for its partners. The Company is the sole general partner of Paragon Real Estate, LP and owns the remaining 1.0% interest. After July 1, 2007, the limited partners may redeem, in whole or in part, their Paragon Real Estate, LP units for cash. When these units are offered for redemption in cash, we may, at our option, elect to convert the limited partnership units into our common shares. The conversion ratio would be 22.881 common shares for each limited partnership unit, or 18,623,715 common shares. The cash redemption price would be the cash value of the common shares into which the limited partnership units could have been converted.

We report our investments using the consolidated method of accounting as we own the outstanding voting interests and can control operations for Paragon Real Estate, LP. In the consolidation method, the accounts of these entities are combined with our accounts. All significant intercompany transactions are eliminated in consolidation.

Note 3 – Summary of Significant Accounting Policies

Use of Estimates in the Preparation of Financial Statements

In order to conform with generally accepted accounting principles, management, in preparation of our consolidated financial statements, is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of December 31, 2004, and the reported amounts of revenues and expenses for the years ended December 31, 2004 and 2003. Actual results could differ from those estimates. Significant estimates include the valuation of investments in real estate, marketable securities, deferred

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taxes and a related valuation allowance, and these significant estimates, as well as other estimates and assumptions, may change in the near term.

Investments in Real Estate

Our investments in real estate assets are reported at the lower of cost or estimated net realizable value.

We periodically review our properties for impairment and provide for a provision if impairments are determined. First, to determine if impairment may exist, we review our properties and identify those, if any, which have had either an event of change or event of circumstances warranting further assessment of recoverability. Then, we estimate the fair value of those properties on an individual basis based on an independent appraisal, capitalizing the expected net operating income, or applying various other valuation factors. Such amounts are then compared to the property’s depreciated cost to determine whether an impairment exists.

In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), impairment of investments in real estate exists when the carrying amount of the investments exceeds its fair value and is non-recoverable. Fair value of these assets is the amount an asset could be bought or sold in a current transaction between willing parties. Further, SFAS 144 defines a component of a company to be the operations that can be clearly distinguished from the rest of the company, and then requires elimination from our continuing operations for those assets held for sale or disposed of. Accordingly, one of the impacts of our adoption of SFAS 144 is that revenues and expenses associated with our commercial properties sold on October 1, 2003 are classified as discontinued operations on our Consolidated Statements of Operations for all periods reported.

During the quarter ended June 30, 2003, we recorded non-recurring real estate expense in the amount of $350,000. This expense represented $280,000 of tenant improvements, $31,000 of leasing commissions and $39,000 of professional expense incurred on our commercial properties located in Minnesota. The sale of our 92.9% general partnership interest in these commercial properties closed on October 1, 2003 and the amount of proceeds received was not increased as a result of these expenditures. As a result of the sale on October 1, 2003, we have included these costs in discontinued operations of commercial properties.

Depreciation expense is computed using the straight-line method based on the following useful lives:

Expenditures for ordinary maintenance and repairs are expensed to operations as incurred and significant renovations and improvements that improve or extend the useful life of the asset are capitalized and depreciated over their estimated useful life.

When a property is sold or retired, the costs and related accumulated depreciation are removed from the accounts and the resulting gain or loss, together with the related historical operating results, are included in discontinued operations.

Cash and cash equivalents

Cash and cash equivalents include all cash and liquid investments that mature three months or less from when they are purchased. Cash equivalents are reported at cost, which approximates fair value. We maintain our cash in bank accounts in amounts that may exceed federally insured limits at times. We also maintained cash of approximately $18,000 at December 31, 2004 in a money market account that was not federally insured. Cash of approximately $49,000 is classified as restricted at December 31, 2004 because it is held in an escrow account of the mortgage lender for the payment of property taxes and insurance, and cash of approximately

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$57,000 is classified as restricted at December 31, 2004 because it is held as security deposits for the tenants at Richton Trail.

Accounts Receivable

Our accounts receivable of approximately $8,000 are reported net of a reserve for bad debts of approximately $2,000.

Other Assets

As of December 31, 2004 other assets of approximately $116,000 include approximately $60,000 of prepaid insurance, deferred financing costs of approximately $48,000 (net of accumulated amortization) incurred to obtain and secure mortgage debt financing, approximately $5,000 prepaid natural gas for Richton Trail, and approximately $3,000 prepaid legal fees. Other assets are carried at cost, less accumulated amortization.

The deferred financing costs of approximately $54,000 are being amortized over the life of the respective loans on a straight-line basis. Accumulated amortization related to deferred financing costs as of December 31, 2004 was approximately $6,000.

Revenue Recognition

Revenues from rental property are recognized when due from tenants. Leases are generally for terms of one year or less.

Stock Based Compensation

At December 31, 2004, we had one stock-based employee and trustee compensation plan, which is described more fully in Note 8. During the year ended December 31, 2004, we issued options as to 575,000 common shares under this plan and further issued 1,700,000 restricted common share grants under this plan. In 2004 we cancelled 350,000 restricted share grants. During the year ended December 31, 2003, we issued options as to 100,000 common shares and restricted share grants as to 250,000 common shares under this plan. The Company accounted for the grants of options and restricted shares using the intrinsic value method of Accounting Principles Board (“APB”) Opinions No. 25, “Accounting for Stock Issued to Employees” and related interpretations. No stock-based employee compensation cost is reflected in net loss for options granted, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Stock-based employee compensation cost of approximately $118,000 is reflected in net loss for the year ended December 31, 2004. The Company has adopted the disclosure only provisions of both SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Pursuant to the requirements of SFAS No. 148, the following are the pro forma net loss amounts for 2004 and 2003, as if the compensation cost for the options granted to the trustees had been determined based on the fair value at the grant date:

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The assumptions made in estimating the fair value of the options on the grant date based upon the Black-Scholes option-pricing model are as follows:

Income Taxes

Because we are no longer a REIT for federal income tax purposes, we now account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the period in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We are eligible to re-elect REIT status as of January 1, 2005. We are continuing to evaluate our tax status to take advantage of our tax loss carryforwards before electing to be a REIT again.

At December 31, 2004, we have net operating losses totaling approximately $11.0 million and capital losses of approximately $0.6 million. While these losses created a deferred tax asset, a valuation allowance was applied against the asset because of the uncertainty of whether we will be able to use these loss carry forwards, which will expire in varying amounts through the year 2024.

We are also subject to certain state and local income, excise and franchise taxes. The provision for state and local taxes has been reflected in general and administrative expense in the consolidated statements of operations and has not been separately stated due to its insignificance.

Fair Value of Financial Instruments

Our financial instruments include cash and cash equivalents, marketable securities and a mortgage loan. The fair values of the financial instruments were not materially different from their carrying or contract values at December 31, 2004.

F-10

Segment Disclosure

In June 1997, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” This Statement requires that a public company report financial and descriptive information about its reportable operating segments. Generally, financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments. Management views the Company as a single segment, which acquires, owns and operates rental real estate. During 2003 we sold our commercial real estate resulting in the revenues and expenses of these properties being classified as discontinued operations for the year ended December 31, 2003.

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(R), “Share-based Payment.” This Statement requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees. The Statement is effective for the first reporting period, interim or annual, beginning after December 15, 2005.

The Company is currently evaluating the effects of this Statement, and does expect it to have a material impact on the financial condition or operating results of the Company.

In December 2003, the FASB issued Interpretation No. 46(R), “Consolidation of Variable Interest Entities” (“FIN 46(R)). FIN 46(R) provides guidance on possible consolidation of entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.

We have reviewed our consolidation of Paragon Real Estate, LP under FIN 46(R) and believe that it does not apply. Accordingly, consolidation will be continued under previously issued accounting standards.

Paragon Housing LLC, an Ohio limited liability company, was created on December 13, 2004 with Paragon Real Estate Equity and Investment Trust as the sole member. We have reviewed Paragon Housing LLC’s agreements with River West Apartments Limited Partnership (“River West”) and determined that the agreements do not give us the characteristics of a controlling financial interest and we do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. Therefore we will not consolidate Paragon Housing LLC into our financial statements. The following describes our involvement with River West:

Note 4 – Commercial and Residential Real Estate Properties

2003 Disposition of Investments in Real Estate

On October 1, 2003, we closed on the sale of our 92.9% general partnership interest in four commercial properties. Proceeds from the sale of these properties, net of closing costs and the mortgage balances assumed by the purchaser, were approximately $1,601,000. The proceeds from the sale were paid in a combination of approximately $801,000 in cash and 2,859,765 of our common shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $0.28. Also as a result of the sale, approximately $318,000 representing cash from the commercial real estate properties was released from mortgage related restrictions and made available for operations.

F-11

2003 Acquisition of Investments in Real Estate

Effective as of July 1, 2003, we closed the acquisition of Richton Trail, a residential apartment complex located near Chicago, Illinois, following approval by our shareholders of the transaction on June 30, 2003. Our operating partnership, Paragon Real Estate, LP, acquired Richton Trail along with the associated mortgage from Hampton Court Associates, a partnership controlled by James C. Mastandrea, its general partner and our Chairman, Chief Executive Officer and President. In consideration for transferring Richton Trail, Hampton Court Associates received 813,938 restricted limited partnership units of Paragon Real Estate, LP. Each unit is redeemable after four years for cash, or at our option, 22.881 of our common shares. We are the general partner of Paragon Real Estate, LP.

Note 5 – Marketable Securities

Our investments in marketable securities are available-for-sale, as of December 31, 2004, and represent 10,000 common shares of Stellent, Inc. and 100 common shares of Century Realty Trust.

As of December 31, 2004, our marketable securities had a fair market value of approximately $90,000 (based upon the NASDAQ closing quote of $8.82 per share for Stellent, Inc. and $17.49 per share for Century Realty Trust on December 31, 2004). We recorded an unrealized loss on marketable securities during 2004 of approximately $10,000, resulting in a balance of approximately $51,000 in shareholders’ equity for unrealized gain on marketable securities.

The NASDAQ closing quote on February 17, 2005 was $8.30 per common share of Stellent, Inc. and $16.34 per common share of Century Realty Trust.

As of December 31, 2003, we owned 10,000 shares of Stellent, Inc., which had a fair market value of approximately $99,000 (based upon the NASDAQ closing quote of $9.92 per share on December 31, 2003). We recorded an unrealized gain on marketable securities during 2003 of $34,500, resulting in a balance of $61,700 in shareholders’ equity for unrealized gain on marketable securities.

During the year ended December 31, 2003, we sold 30,000 shares of Stellent, Inc. at an average price of $8.30 per share and recognized a gain on the sale of these shares totaling approximately $136,000.

We recognize gain or loss on the sale of marketable securities based upon the first-in-first-out method.

Note 6 – Pro Forma Consolidated Financial Information (Unaudited)

The following pro forma condensed consolidated financial information presented below is as if the disposition of our 92.9% general partnership interest in our commercial properties (closed October 1, 2003) and the acquisition of the Richton Trail (closed July 1, 2003) had occurred on January 1, 2003. The pro forma financial information is not necessarily indicative of the results that actually would have occurred if the disposition and acquisition had been consummated on January 1, 2003, nor does the pro forma information purport to represent the results of operations for future periods. For the year ended December 31, 2003, all revenues and expenses associated with the commercial properties have been recorded as discontinued operations.

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Note 7 – Mortgage Loan

In connection with the acquisition of Richton Trail, we assumed a mortgage loan payable of approximately $1.5 million, which had a maturity date of October 1, 2012. Payments were required monthly in the amount of approximately $13,000, which represented principal and interest at 7.25%.

On October 31, 2003, we completed the refinance of Richton Trail with an independent lender. The mortgage loan payable of $2.8 million has a fixed interest rate of 5.87% for a term of 10 years. The monthly principal and interest payments are approximately $18,000 based on a 25-year amortization schedule. The balance due at maturity in 2013 will be approximately $2.2 million. The net proceeds from the loan were approximately $1.3 million. The mortgage loan payable was approximately $2,763,000 as of December 31, 2004.

The mortgage loan matures as follows:

Note 8 – Shareholders’ Equity

Preferred Shares

During 1999, we issued 785,037 Class A Cumulative Convertible Preferred Shares (“preferred shares”) to the public. Each of the preferred shares is entitled, at all meetings of shareholders, to 3.448 votes, the number of common shares into which they are convertible, subject to adjustment for stock splits and similar events. The preferred shares are entitled to vote as a class on certain matters that affect their respective rights. The preferred shares bear a liquidation value of $10.00 per share and originally accrued a dividend equal to $0.475 per share, payable every six months. The preferred shares are convertible into 3.448 common shares subject to certain formulas. We have the right to redeem the preferred shares. Proceeds from the issuance of the preferred shares, net of underwriters’ discount and total offering expenses, were approximately $6.7 million. Since the original issuance and prior to the exchange offer on June 30, 2003, a total of 121,746 preferred shares were converted into 419,779 common shares.

Effective April 7, 2003, we issued 95,541 preferred shares to the former chief executive officer in connection with his resignation in lieu of a $300,000 payment required by the terms of his employment agreement dated March 4, 2003 and recorded compensation expense of $300,000 as a result of the issuance and employment termination.

In May 2003, we offered preferred shareholders a one-time incentive to exchange preferred shares into common shares, which expired June 30, 2003. Through that exchange offer, preferred shareholders exchanged 1,174,120 of the preferred shares, or nearly 81%, for 26,865,042 common shares. After the exchange offer was completed, the remaining preferred shares held by investors not affiliated with Paragon had an aggregate market value below $1 million and therefore no longer met the minimum requirement for listing on the American Stock Exchange, as set forth in Section 1202(b) of the American Stock Exchange’s Company Guide. This requirement was disclosed in the proxy statement as well as our intent not to seek another trading market for the preferred shares. The Exchange suspended trading of the preferred shares and the Securities and Exchange Commission removed the preferred shares from listing and registration in accordance with Section 12 of the Securities and Exchange Act of 1934. Preferred shareholders retain the right to convert each of their shares for 3.448 common shares. The preferred shares are on the Over the Counter Market with the symbol “PRGYP.”

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On June 30, 2003, the holders of our preferred shares consented to waive the dividend that would otherwise have been payable in May 2003 and to eliminate any future dividends that would have been payable under the terms of our preferred shares. The waiver was sought in connection with a one-time incentive exchange offer under which we offered to exchange each of our preferred shares for 22.881 common shares.

Effective June 30, 2003, we issued 696,078 preferred shares valued at approximately $2.4 million to Messrs. Mastandrea and Dee pursuant to separate restricted share agreements. Under each restricted share agreement, the restricted shares vest upon the later of the following dates:

During the first quarter of 2004, 935 preferred shares were converted to 3,224 common shares and during the fourth quarter of 2003, 1,400 preferred shares were converted to 4,827 common shares, both at a conversion rate of 3.448 common shares for each preferred share.

On October 1, 2003 we completed the sale of our 92.9% general partnership interest in our four commercial properties. A portion of the proceeds from the sale was paid in 2,859,765 of our common shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $0.28 or approximately $801,000. These shares are recorded at cost in the accompanying consolidated balance sheet under treasury shares.

Common Shares

Restricted Common Shares

On June 30, 2003, our shareholders approved the issuance of additional common shares to Paragon Real Estate Development, LLC for James C. Mastandrea, our Chief Executive Officer and President, and John J. Dee, our Chief Financial Officer and Senior Vice President, to encourage them to substantially grow the asset base, net operating income, funds from operations, net value, and share value of Paragon. We will issue restricted common shares if they locate and close on our behalf future acquisition, development or re-development transactions. Any of these transactions would be subject to approval by our board of trustees. The maximum number of common shares they may receive under the additional contribution agreement is limited to a total value of $26 million based on the average closing price of the common shares for 30 calendar days preceding the closing of any acquisition. The common shares will be restricted until we achieve the five-year proforma income target for the acquisition, as approved by the board of trustees, and an increase of 5% in Paragon’s net operating income and funds from operations. The restricted shares would vest immediately upon any “shift in ownership,” as defined in the agreement.

On October 28, 2003, our board of trustees approved the issuance of 50,000 restricted commons shares to each of our four trustees who are not officers of the Company. The restricted shares were issued effective as of October 28, 2003 and vested on October 28, 2004. The market value of the shares on the date of grant was $44,000. Following each annual meeting, trustees serving on our board who are not officers of the company will receive similar grants of restricted shares.

On December 16, 2003, our board of trustees approved the issuance of 50,000 restricted commons shares to an employee hired June 16, 2003. The employee terminated employment in 2004 and the restricted shares have been cancelled.

On December 16, 2003, our board of trustees approved the issuance of 500,000 restricted common shares to Paragon’s landlord for 4,000 square feet of fully furnished office space, including all utilities, phone, high speed internet, equipment usage, copying, presentation packaging and preliminary design planning for our proposed projects for two years. Half of the shares were to be issued in March of 2004 and half are to be issued in March 2005. The shares have restrictions as to voting and transfer. A proxy will be signed when the shares are issued

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granting Mr. Mastandrea the right to vote the shares during the ownership of the landlord or if transferred in a block sale. The shares are restricted from being transferred or sold for four years from the date of issuance, and thereafter have volume limits on the number of shares that may be sold daily in the open market or transferred in a block sale. The market value of the office space and services for two years was estimated at $103,000.

On January 2, 2004 our board of trustees approved the issuance of 300,000 restricted common shares each to James C. Mastandrea, our Chief Executive Officer and President, John J. Dee, our Chief Financial Officer and Senior Vice President and to an employee that terminated employment in 2004. Half of the restricted shares vest in five years or earlier if Paragon’s share price rises to $1.00 per share. The remaining half vests when funds from operations has doubled or when Paragon’s share price is 50% higher compared to the average trading price for the five days preceding the grant date. The market value of the restricted common shares on the date of the grant was $198,000. The 300,000 restricted shares previously issued to the employee who terminated in 2004 were cancelled.

On June 15, 2004 following our annual meeting, 50,000 restricted commons shares were issued to each of our four trustees who are not officers of the Company as part of their compensation for serving on Paragon’s board and committees. The restrictions will be removed from the shares after 12 months from the date of issuance. The market value of the restricted common shares on the date of the grant was $36,000.

Effective July 19, 2004, our board of trustees approved a commitment to issue a total of 1.0 million restricted common shares to a new officer of the Company. The initial grant of 500,000 restricted shares will vest half of the shares in four years and the second half in five years. Additional grants of 125,000 restricted common shares will be made annually for the next four years beginning on the anniversary date of his employment with vesting effective four years after each grant date. The market value of the 500,000 restricted common shares issued on the date of the grant was $65,000.

Effective December 1, 2004, our board of trustees approved the issuance of 100,000 restricted common shares to a new employee of the Company. Half of the shares will vest in four years and the second half will vest in five years. The market value of the 100,000 restricted common shares issued on the date of the grant was $13,000.

The total number of restricted common shares issued in the year ended December 31, 2004 was 1,700,000 shares plus 250,000 shares to be issued, and in the year ended December 31, 2003 was 250,000.

Warrants

On March 5, 1998, we issued a warrant to Credit Suisse First Boston Mortgage LLC in connection with the refinancing of debt. The warrant provides for the right to purchase 47,500 common shares at a price of $5.37 per common share and is exercisable at any time through March 5, 2008. The warrant remains unexercised as of December 31, 2004.

In connection with the issuance of preferred shares on October 28, 1999, we issued to a representative of the underwriters a warrant to purchase 35,500 preferred shares at a price of $10.00 per share. The warrant was exercisable through November 2, 2004 and expired unexercised.

Options

On May 27, 1998, in accordance with our former stock option plan (“Former Plan”) we granted options as to 54,387 Common Shares to then existing employees and trustees. The options remain unexercised and are exercisable on any date through May 26, 2008 at a price of $5.37 per share.

On November 16, 1998, we adopted the 1998 Share Option Plan. In 2004 the board of trustees unanimously recommended and the shareholders approved amendments to our 1998 Share Option Plan to increase the number of shares available for grant from 3,166,666 to 3,500,000 and to conform it with current tax regulations (“2004

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Plan”). The 2004 Plan provides for the granting of share options to officers, trustees and employees at a price determined by a formula in the 2004 Plan agreement. The options are to be exercisable over a period of time determined by the 2004 Plan committee, but no longer than ten years after the grant date. Compensation resulting from the share options is initially measured at the grant date based on fair market value of the shares.

In connection with employment agreements entered into during 1999 and in accordance with the 1998 Share Option Plan, we issued options to purchase 80,000 Common Shares at $2.90 per share to each of our former chief executive officer and former president. The former chief executive officer’s options were returned to the Company in 2003 and the former president’s options expire on December 31, 2005.

Effective May 15, 2002 we issued 50,000 options to each of our five trustees with a price of $0.45 per share. The options can be exercised six months after issuance and expire 90 days after the trustee’s term ends. On September 30, 2003, 200,000 options expired and were returned to the Company.

Effective October 28, 2003 we issued 25,000 options to each of our four independent trustees, who are not executive officers of the Company, at a price of $0.22 per share. The options can be exercised six months after issuance and expire 90 days after the trustee’s term ends.

Effective January 2, 2004 we issued 150,000 options each to James C. Mastandrea, our Chief Executive Officer and President, John J. Dee, our Chief Financial Officer and Senior Vice President, and an employee that terminated employment in 2004. The options have an exercise price of $0.27 per share and vest one-third on each of January 2, 2005, 2006, and 2007. The options expire on the earlier of January 2, 2009 or 90 days after leaving the employ of the Company.

Effective January 2, 2004 we issued 25,000 options to an employee at an exercise price of $0.22 per share. The employee terminated employment in 2004 and the options were cancelled.

Effective June 15, 2004, we issued 25,000 options to each of our four independent trustees, who are not executive officers of the Company, with a price of $0.18 per share. The options can be exercised six months after issuance and expire 90 days after the trustee’s term ends.

The following table summarizes the Company’s option activity for the years ended December 31, 2004 and 2003:

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The following tables summarize exercisable options outstanding as of December 31, 2004 and December 31, 2003: