The following discussion should be read in conjunction with our unaudited consolidated financial statements and notes thereto included in this report. References to "N-Star," "we," "us" or "our" refer to NorthStar Realty Finance Corp. and its subsidiaries unless the context specifically requires otherwise.

Introduction

NorthStar Realty Finance Corp. is a real estate finance company that originates, acquires and manages portfolios of commercial real estate, or CRE, debt, CRE securities and net lease properties. In addition, we engage in asset management and other activities related to real estate and real estate finance. We are organized as a real estate investment trust, or REIT, for federal income tax purposes and were formed in October 2003 to continue and expand the CRE debt, CRE securities and net lease business of our predecessor. We conduct substantially all of our operations and make our investments through our operating partnership, NorthStar Realty Finance Limited Partnership, or our Operating Partnership, including its subsidiaries. Our primary business lines are as follows:

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º Commercial Real Estate Debt-Our CRE debt business is focused on originating, structuring, acquiring and managing senior and subordinate debt investments secured primarily by commercial and multifamily properties and includes first mortgage loans, subordinate mortgage interests, mezzanine loans, credit tenant loans and other loans, including preferred equity interests. We directly underwrote and originated approximately 72% of the debt investments in our current portfolio (excluding debt originally owned in the CSE RE 2006-A CDO, or CSE CDO, and CapLease 2005-1 CDO, or CapLease CDO, that we consolidate as a result of acquiring the equity interests in 2010 and 2011, respectively, see also "-Sources of Operating Revenues and Cash Flows"). Our CRE debt portfolio represents approximately 38.5% of our assets under management as of June 30, 2012.

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º Commercial Real Estate Securities-Our CRE securities business is focused on investing in and managing a wide range of CRE securities, including commercial mortgage backed securities, or CMBS, unsecured REIT debt and collateralized debt obligation, or CDO, notes backed primarily by CRE securities and CRE debt. Our CRE securities portfolio represents approximately 41.7% of our assets under management as of June 30, 2012.

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º Net Lease Properties-Our net lease properties business is focused on acquiring CRE located throughout the United States that are typically leased under net leases to corporate tenants and healthcare operators. Our core net lease business invests primarily in office, industrial and retail properties. We also own, manage and invest in a portfolio of healthcare properties focused on mid-acuity facilities (i.e., skilled and assisted), with the highest concentration in assisted living facilities. Our net lease properties portfolio represents approximately 13.6% of our assets under management as of June 30, 2012.

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º Asset Management and Other-Our asset management and other activities relate to real estate and real estate finance, including managing our CDO financing transactions on a fee basis and sponsoring and advising on a fee basis, non-traded REITs, or Sponsored REITs (i.e., NorthStar Real Estate Income Trust, Inc., or NorthStar Income, and NorthStar Healthcare Income, Inc., or NorthStar Healthcare).

We believe that these businesses are complementary to each other due to their overlapping sources of investment opportunities, common reliance on real estate fundamentals and ability to utilize secured borrowings to finance assets and enhance returns. We seek to match-fund our CRE debt and security investments primarily by issuing term financing and other forms of secured term financing.

Our financing strategy focuses on match-funding our assets and liabilities by having similar maturities and like-kind interest rate benchmarks (fixed or floating) to manage refinancing and interest

rate risk. Our legacy CRE debt and security portfolios are predominantly financed through long-term, non-recourse CDOs. Our net lease properties are predominantly financed with non-recourse mortgage notes. Given the nature of our current financing arrangements, we expect to maintain our borrowing at or near our current levels for our existing investments. Borrowing levels may change for new investments depending upon the nature of the assets and the related financing.

Liquidity and access to capital returned to the commercial real estate finance markets in the first quarter of 2012. During the first half of 2012, we raised net proceeds of $199 million from the issuance of common equity, $39 million from the issuance of preferred stock (including pursuant to our at-the-market equity offering program) and $72 million from the issuance of exchangeable senior notes. Subsequent to quarter end, we raised an additional $70 million from the issuance of preferred stock, $7 million from the issuance of exchangeable senior notes and $8 million from the issuance of common stock in a private offering. Total capital raised year to date is $395 million.

In terms of new investment-level financing, we continue to pursue a variety of financing arrangements such as credit facilities, securitized arrangements and other term borrowings. The amount of our borrowings will depend upon the nature and credit quality of our assets, the structure of our financings and where possible, we will seek to limit our reliance on recourse borrowings. In the fourth quarter of 2011, we, through two wholly-owned subsidiaries, entered into two new $100 million term credit facilities to finance loan originations and make investments in CMBS, respectively.

We are also focused on raising capital in alternate channels. Beginning in the second half of 2011, we started to see capital raising velocity increase in NorthStar Income. Total capital raised for the six months ended June 30, 2012 was $169 million, with $325 million raised from inception through June 30, 2012. NorthStar Realty Securities, LLC, or NorthStar Realty Securities, our wholly-owned broker-dealer subsidiary, has executed selling agreements with broker-dealers covering more than 45,000 registered representatives as of June 30, 2012.

Our Investments

The following describes the major CRE asset classes in which we invest and continue to actively manage to maximize stockholder value and to preserve our capital. The following table represents our

assets under management as of June 30, 2012 based on principal amount of CRE debt and security investments and the cost basis of net lease properties (amounts in thousands):

                                                Amount       Percentage
             CRE Debt
             First mortgage loans             $ 1,640,343           23.2 %
             Mezzanine loans                      447,559            6.3 %
             Credit tenant and term loans         191,021            2.7 %
             Subordinate mortgage interests       130,737            1.8 %
             Other(1)                             324,012            4.5 %

             Total CRE debt                     2,733,672           38.5 %
             CRE Securities
             CMBS                               2,527,232           35.7 %
             Third-party CDO notes                261,131            3.7 %
             Other securities                     161,338            2.3 %

             Total CRE securities               2,949,701           41.7 %
             Net Lease
             Core net lease                       404,459            5.7 %
             Healthcare net lease                 561,641            7.9 %

             Total net lease                      966,100           13.6 %

             Subtotal NorthStar                 6,649,473           93.8 %

             Sponsored REITs
             NorthStar Income(2)                  435,826            6.2 %

             Grand total                      $ 7,085,299          100.0 %

º (2)
º Based on consolidated total assets.

Commercial Real Estate Debt

Our Portfolio

As of June 30, 2012, $2.7 billion, or 38.5%, of our assets under management were invested in CRE debt, which includes $0.3 million principal amount of loans related to certain investments accounted for as joint ventures and real estate owned. As of June 30, 2012, our $2.4 billion CRE debt portfolio consisted of 159 investments with an average investment size of $15 million.

The portfolio's diversity across property type and geographic location is summarized as follows, based on outstanding principal amount:

     Loan Portfolio by Property Type   Loan Portfolio by Geographic Location
       [[Image Removed: GRAPHIC]]           [[Image Removed: GRAPHIC]]


Commercial Real Estate Securities

Our Portfolio

    As of June 30, 2012, $2.9 billion, or 41.7%, of our assets under management
were invested in a portfolio of CRE securities. Our CRE securities portfolio
consisted of 622 investments with an average investment size of $5 million. CMBS
represents $2.5 billion, or 85.7%, of our CRE securities portfolio. The CMBS
portfolio had an average credit rating of CCC+/Caa1. The following summarizes
our CRE securities by type and CMBS by vintage, based on outstanding principal
amount:

                 Securities by Type           CMBS by Vintage(1)
             [[Image Removed: GRAPHIC]]   [[Image Removed: GRAPHIC]]


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   º (1)

Net Lease Properties

Core Net Lease Properties

As of June 30, 2012, $404 million, or 5.7%, of our total assets under management were invested in our 24 core net lease properties, consisting of a portfolio of office, retail and industrial facilities totaling 3.2 million square feet. As of June 30, 2012, our core net lease properties had a weighted average remaining lease term of 6.2 years and were 96% leased.

The following summarizes our core net lease portfolio's diversity across property type and geographic location as of June 30, 2012, based on purchase price, or cost.

Core Net Lease by Property Type Core Net Lease by Geographic Location
[[Image Removed: GRAPHIC]] [[Image Removed: GRAPHIC]]

Healthcare Net Lease Properties

As of June 30, 2012, $562 million, or 7.9%, of our assets under management were invested in our healthcare net lease properties, with a focus on the senior housing sector which includes assisted living, skilled nursing and independent living facilities. Our portfolio was comprised of 42 assisted living facilities (ALF), 31 skilled nursing facilities (SNF), three life science buildings (LSB), six independent living facilities (ILF) and one medical office building (MOB). As of June 30, 2012, 100% of our net lease healthcare portfolio was leased to third-party operators with weighted average lease coverage of 1.4x and a 7.4 year weighted average remaining lease term.

The following summarizes our healthcare portfolio by property type and geographic location as of June 30, 2012, based on purchase price.

Healthcare Net Lease by Property Type Healthcare Net Lease by Geographic Location
[[Image Removed: GRAPHIC]] [[Image Removed: GRAPHIC]]

Asset Management and Other

Our asset management and other activities are focused on:

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º Managing CDO financing transactions on a fee basis.

We manage eleven CDOs representing $5.7 billion of assets based on principal amount, nine of which were sponsored by us, or the N-Star CDOs. In addition, we have acquired the equity interests of two CDOs that have been integrated into our platform, the CSE CDO and the CapLease CDO, which we herein collectively refer to as our acquired CDOs. In the case of the CSE CDO, we were delegated the collateral management and special servicing rights and for the CapLease CDO, we acquired the collateral management rights. Five of the CDOs are primarily collateralized by CRE debt and six are primarily collateralized by CRE securities.

We consolidate these CDO financing transactions under accounting principles generally accepted in the United States, or U.S. GAAP. As a result, the collateral management fees we earn and receive in cash are eliminated in consolidation in the statements of operations.

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º Sponsoring and advising on a fee basis, our Sponsored REITs.

In connection with our current public Sponsored REIT, NorthStar Income, we manage the day-to-day affairs including identifying, originating, acquiring and managing investments on its behalf, and we earn advisory and other fees for these services, which vary based on the amount of assets under management, investment activity and investment performance.

In addition, NorthStar Realty Securities distributes equity for our Sponsored REITs. NorthStar Realty Securities is currently raising equity capital for NorthStar Income and we expect that NorthStar Realty Securities will assist us in the future in accessing diverse sources of capital for other companies that may be sponsored and managed by us, such as NorthStar Healthcare.

Other Opportunistic Investments

We also pursue other opportunistic investments that we expect will generate attractive risk-adjusted returns, such as repurchasing our CDO bonds at a significant discount to principal amount as well as other real estate-related investments. These CDO bonds typically have significant credit support and, when we repurchase a CDO bond, we generally expect the CDO bonds will be repaid at par.

As of August 2, 2012, the principal proceeds we could receive from CDO bonds we owned was $800 million, of which $650 million was repurchased at an average price of 36% in the secondary market and had a weighted average original credit rating of A+/A1. Because our CDO financing transactions are consolidated under U.S. GAAP, these CDO bonds are generally not presented as an investment but rather are eliminated in our consolidated financial statements. We will generate cash flows in future periods through the interest payable on these bonds, as well as realizing (in cash) the discount as the bonds repay. If realized, this $417 million discount will generally not be reported as a gain and the interest will not be recorded as income under U.S. GAAP.

Sources of Operating Revenues and Cash Flows

We primarily generate revenues from interest income on our CRE debt and security portfolios, rental income from the net lease properties and fee income from the asset management and other related activities. Our income is primarily derived through the difference between revenues and the cost at which we are able to finance our assets. We may also acquire investments which generate attractive returns without any leverage.

Our legacy CRE debt and security investments are predominantly financed in CDOs. We consolidate the CDO financing transactions under U.S. GAAP regardless of whether we retain the equity interests for our sponsored CDOs or acquire the equity interests of other CDOs. However, we generate cash flows based on the equity interests that we retain/acquire. As a result, the cash flows may be different from the income (loss) generated for U.S. GAAP purposes.

In this Quarterly Report on Form 10-Q, we refer to certain CDOs that we consolidate on our balance sheet as "our CDOs." Our CDOs are financing transactions that we consolidate on our balance sheet in accordance with U.S. GAAP, as we own the equity interests in such CDOs. We do not, however, own undivided interests in any of the assets within our CDOs and all senior and junior bondholders of the CDOs have economic interests that are senior to our equity interests. A more detailed discussion of our CDO financing transactions is provided in this section under "-Liquidity and Capital Resources."

Profitability and Performance Metrics

We calculate several metrics to evaluate the profitability and performance of our business.

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º Adjusted funds from operations, or AFFO (see "-Non-GAAP Financial Measures-Funds from Operations and Adjusted Funds from Operations" for a description of this metric).

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º Credit losses are a measure of performance and can be used to compare the credit performance of our assets to our competitors and other finance companies.

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º Assets under management growth is a driver of our ability to grow our income especially related to our Sponsored REITs, but we believe it is of lesser importance than other metrics such as AFFO.

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º Cash from our investments is a driver of our ability to maintain and/or grow our distributions to our stockholders.

Outlook and Recent Trends

In the first half of 2011, liquidity began to return to the commercial real estate finance markets and capital started to become available to the stronger sponsors. Wall Street and commercial banks began to more actively provide credit to real estate borrowers. A proxy of the easing of credit and restarting of the capital markets for CRE debt is the approximately $30 billion in non-agency CMBS issuance that were completed during 2011. Credit started to contract in mid-2011 as the European debt woes began to unfold resulting in severe market volatility.

Global financial markets continue to be strained in 2012 and we expect that the commercial real estate finance markets will continue to be volatile in the near term due to anemic U.S. economic growth, continued high levels of unemployment and global market instability, along with the risk of maturing CRE debt that will have difficulties being refinanced. It is currently estimated that $1.3 trillion of CRE debt will mature in the next three years and $2.1 trillion will mature through 2017. Many of these loans will not be able to be refinanced, exacerbating growth and potentially leading to contracting credit. With that, capital markets continue to make slow gains toward recovery. Through June 30, 2012, there has been $18 billion in non-agency CMBS issuance and many industry experts are predicting approximately $35 billion of total non-agency CMBS issuance for 2012.

Virtually all commercial real estate property types were adversely impacted by the credit crisis, including core property types such as hotel, retail, office, industrial and multifamily properties. Land, condominium and other commercial property types were more severely impacted. As a result, cash flows and values associated with properties serving as collateral for our loans are generally weaker than expected when we originated the loans. Despite the difficult U.S. and global economic conditions, investor interest has been returning to commercial real estate especially in urban areas having high concentrations of institutional quality real estate and especially in certain asset types such as apartments. The degree to which commercial real estate values improve or erode in 2012 in the markets in which our real estate collateral is located, will impact the performance of our asset base and the related level of loan losses.

Our CRE debt and securities investments are negatively impacted by weaker real estate market and economic conditions. Slow economic conditions reduce a tenant's ability to make rent payments in accordance with the terms of their leases and for companies to lease new space. To the extent that market rental and occupancy rates are reduced, property-level cash flows are negatively affected as existing leases renew at lower rates and over longer periods of time impact the value of underlying properties and the borrowers' ability to service their outstanding loans.

Many of our legacy CRE debt investments bear interest based on a spread to one-month LIBOR, a floating-rate index based on rates that banks charge each other to borrow. One-month LIBOR as of

June 30, 2012 was 0.25%, well below its 1.26% average over the past five years. Lower LIBOR means lower debt service costs for our borrowers. This dynamic has partially offset decreasing cash flows caused by the challenging economic conditions and may also result in extending the life of interest reserves for those debt investments that require interest reserves to service debt. However, many of our new CRE loan originations have a LIBOR floor that is in excess of current LIBOR. The degree in which rates will remain low is driven in a significant part by the actions of the Federal Reserve to enter into programs to support the U.S. economy and keep rates low. Our current expectation is that rates will remain low into 2014.

CRE security values are also influenced by credit ratings assigned by the rating agencies. Beginning in 2009 and continuing into late 2011, the rating agencies dramatically changed their ratings methodologies for all securitized asset classes, including commercial real estate. Combined with challenging economic conditions, their reviews have resulted in large amounts of rating downgrade actions for CMBS, negatively impacting market values of CMBS and in many cases negatively impacting the CDO financing structures used by us and others to finance these assets. To some extent, we took advantage of the rating agency downgrades by purchasing $1.2 billion of CMBS in our CDOs in 2009 and 2010 at a weighted average discount to par of approximately 60%.

Our net lease properties are also adversely impacted by a weaker economy. Corporate space needs contracted resulting in lower lease renewal rates and longer releasing periods when leases are not renewed. Poor economic conditions may negatively impact the creditworthiness of our tenants, which could result in their inability to meet the terms of their leases. Further, our healthcare net lease portfolio is also subject to impact from regulatory changes which are also impacted by a weak economy, such as changes to the Medicaid and Medicare programs that could negatively affect property values. Although we cannot make assurances that our cash flow will not be impacted by changes to these programs, a majority of our assets do not derive revenues from these government programs and we believe assets dependent on these programs have adequate lease coverage to support the rent of our operators.

Our Strategy

Our primary business objectives are to make commercial real estate-related investments in order to produce attractive risk-adjusted returns, generate stable cash flows for distribution to our stockholders and build long-term franchise value. When we observed deteriorating market conditions, we responded by decreasing investment activity and preserving capital. At the same time, we focused on raising capital in alternative channels, such as the non-traded REIT market.

We currently anticipate that most of our investment activity and uses of available unrestricted cash liquidity will be focused on our businesses of originating new loans and investing in securities, as well as opportunistic investments, including discounted repurchases of our previously-issued CDO bonds and other real estate-related investments. Availability and cost of capital will impact our profitability and earnings since we must raise new capital to fund a majority of this growth. As a result, we also remain focused on the growth of our asset management business and in particular, our Sponsored REITs.

As liquidity was becoming more available and commercial real estate fundamentals were beginning to stabilize in 2011 and 2012, we took advantage of this dynamic in terms of both capital raising and investment activity. We raised $232 million of capital in the first half of 2011 and $387 million of capital through July 2012. In addition, we entered into two $100 million term credit facilities in the fourth quarter 2011 with Wells Fargo Bank, N.A, or Wells Fargo to finance the origination of CRE first mortgage loans and the purchase of AAA-rated CMBS investments. In July 2012, we entered into a credit facility with Doral Bank that provides up to $40 million on a non-recourse basis, subject to certain exceptions, to finance first mortgage loans and senior loan participations secured by commercial real estate.

Throughout 2012, we have been actively investing across our businesses. Through July 2012, we originated six loans and acquired two loans with an aggregate principal amount of $186 million (including an interest owned through a joint venture) with a weighted average expected return on invested equity of approximately 17%. Also, as the advisor of NorthStar Income, we originated ten loans with a principal amount of $265 million during the same period. The principal proceeds we could receive from CDO bonds acquired during the first half of 2012 is $285 million, which were purchased for $132 million and have an expected yield-to-maturity of over 20%. We invested $77 million of equity in other real estate-related investments with an expected return on equity of over 16%. There is no assurance we will realize this expected return on equity over the term of these investments. Our actual return on equity could vary significantly from our expectations.

We believe the supply/demand imbalance driven by the large amount of maturing CRE loans creates an opportunity for us. The relative lack of supply and high demand for capital is allowing investors with capital, such as us, to make investments with attractive risk/return profiles compared to historical levels.

Financing Strategy

We seek to access a wide range of secured and unsecured debt and public and private equity capital sources to fund our investment activities and asset growth. Since our IPO in 2004, we have completed preferred and common equity offerings raising approximately $1.2 billion of aggregate net proceeds including raising $199 million from the issuance of common equity and $39 million from the issuance of preferred equity in the first half of 2012. We have also raised $286 million of long-term, subordinated debt capital that is equity-like in nature due to its 30-year term (at the time of issuance) and relatively few covenants. In addition, we have raised $500 million of unsecured exchangeable senior notes, of which $296 million was outstanding as of June 30, 2012.

We use asset-level financing as part of our strategy and we seek to . . .