Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2011 Annual Report on Form 10-K. Unless otherwise indicated, information is presented as of second quarter-end 2012, and references to acreage owned includes all acres owned by ventures regardless of our ownership interest in a venture.

Forward-Looking Statements

This Quarterly Report on Form 10-Q and other materials we have filed or may file with the Securities and Exchange Commission contain "forward-looking statements" within the meaning of the federal securities laws. These forward-looking statements are identified by their use of terms and phrases such as "believe," "anticipate," "could," "estimate," "likely," "intend," "may," "plan," "expect," and similar expressions, including references to assumptions. These statements reflect our current views with respect to future events and are subject to risks and uncertainties. We note that a variety of factors and uncertainties could cause our actual results to differ significantly from the results discussed in the forward-looking statements. Factors and uncertainties that might cause such differences include, but are not limited to:

• general economic, market or business conditions in Texas or Georgia, where our real estate activities are concentrated;

• our ability to achieve some or all of our strategic initiatives;

• the opportunities (or lack thereof) that may be presented to us and that we may pursue;

• significant customer concentration;

• future residential, multifamily or commercial entitlements, development approvals and the ability to obtain such approvals;

• obtaining approvals of reimbursements and other payments from special improvement districts and the timing of such payments

• accuracy of estimates and other assumptions related to investment in real estate, the expected timing and pricing of land and lot sales and related cost of real estate sales, impairment of long-lived assets, income taxes, share-based compensation and oil and natural gas reserves;

• the levels of resale housing inventory and potential impact of foreclosures in our mixed-use development projects and the regions in which they are located;

• fluctuations in costs and expenses;

• demand for new housing, which can be affected by a number of factors including the availability of mortgage credit;

• competitive actions by other companies;

• changes in governmental policies, laws or regulations and actions or restrictions of regulatory agencies;

• government regulation of exploration and production technology, including hydraulic fracturing;

• the results of financing efforts, including our ability to obtain financing with favorable terms;

• our partners' ability to fund their capital commitments and otherwise fulfill their operating and financial obligations;

• the effect of limitations, restrictions and natural events on our ability to harvest and deliver timber;

• inability to obtain permits for, or changes in laws, governmental policies or regulations effecting, water withdrawal or usage and

• the final resolutions or outcomes with respect to our contingent and other liabilities related to our business.

Other factors, including the risk factors described in Item 1A of our 2011 Annual Report on Form 10-K, may also cause actual results to differ materially from those projected by our forward-looking statements. New factors emerge from time to time and it is not possible for us to predict all such factors, nor can we assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement.

Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

Strategy

Our strategy is:

• Recognizing and responsibly delivering the greatest value from every acre; and

• Growing through strategic and disciplined investments.

2012 Strategic Initiatives

In 2012, we announced Triple in FOR, new strategic initiatives designed to further enhance shareholder value by:

• Accelerating value realization of our real estate and natural resources by increasing total residential lots sales, oil and gas production, and total segment earnings.

• Optimizing transparency and disclosure by expanding reported oil and natural gas resources, providing additional information related to groundwater interests, and establishing a progress report on corporate responsibility efforts.

• Raising our net asset value through strategic and disciplined investments by pursuing growth opportunities which help prove up our asset value and meet return expectations, developing a low-capital, high-return multifamily business, and accelerating investment in lower-risk oil and natural gas opportunities.

Strategic Acquisition

On June 3, 2012, we entered into a definitive agreement to acquire CREDO Petroleum Corporation (Credo) in an all cash transaction for $14.50 per share, representing an equity purchase price of approximately $146,000,000. Closing is subject to customary conditions, including approval by Credo's stockholders and, if approved, is expected to close in second half of 2012. We obtained a commitment for bridge financing that, combined with available liquidity, is sufficient to fund the acquisition. However, we intend to pursue amendments to our existing senior secured credit facility to fund a significant portion of the purchase price.

Results of Operations

A summary of our consolidated results by business segment follows:




                                                              Second Quarter                 First Six Months
                                                           2012            2011            2012            2011
                                                                              (In thousands)
Revenues:
Real estate                                              $  26,647       $  19,615       $  44,569       $  40,754
Mineral resources                                            7,148           4,580          16,574          11,913
Fiber resources                                              1,517           1,290           2,261           2,658

Total revenues                                           $  35,312       $  25,485       $  63,404       $  55,325

Segment earnings:
Real estate                                              $   7,666       $   1,007       $  19,243       $   3,582
Mineral resources                                            3,953           3,102           9,828           8,700
Fiber resources                                                594             704             984           1,344

Total segment earnings                                      12,213           4,813          30,055          13,626
Items not allocated to segments:
General and administrative expense                          (7,120 )        (7,081 )       (11,482 )       (10,997 )
Share-based compensation expense                                67             148          (5,164 )        (3,952 )
Interest expense                                            (3,664 )        (4,653 )        (7,555 )        (8,662 )
Other corporate non-operating income and expense                47              24             111              51

Income (loss) before taxes                                   1,543          (6,749 )         5,965          (9,934 )
Income tax benefit (expense)                                  (732 )         2,828          (2,352 )         3,540

Net income (loss) attributable to Forestar Group Inc.    $     811       $  (3,921 )     $   3,613       $  (6,394 )

Significant aspects of our results of operations follow:

Second Quarter and First Six months 2012

• Second quarter 2012 real estate segment earnings benefited principally from $3,401,000 gain from a consolidated venture's sale of 800 acres near Dallas and increased residential lot and commercial sales. In first six months 2012, segment earnings benefited principally from $11,675,000 gain from the sale of our 25 percent interest in Palisades West LLC for $32,095,000 and increased residential lot and commercial sales. These items are partially offset by decreased retail land sales volume.

• Mineral resources segment earnings benefited from increased oil production volumes which was partially offset by decreased lease bonus activity and increased costs from additional oil and natural gas personnel and professional services associated with our water initiatives.

• Second quarter and first six months 2012 general and administrative expense includes $2,461,000 in transaction costs to outside advisors related to entering into a definitive agreement to acquire CREDO Petroleum Corporation.

• Second quarter 2012 share-based compensation expense related to cash-settled awards decreased as result of a decline in our stock price and the impact on vested awards. In first six months 2012, the decline in our stock price and the impact on cash-settled awards was offset by expenses related to equity-settled awards granted in first quarter 2012.

Second Quarter and First Six months 2011

• Second quarter 2011 real estate segment earnings was negatively impacted by lower undeveloped land sales and prices as a result of current market conditions. Second quarter and first six months 2011 real estate earnings benefited from increased residential lot sales and prices and reallocation from us to noncontrolling financial interests of a previously recognized $1,342,000 loss related to foreclosure of a lien on a property owned by a consolidated venture, which partially offset lower levels of undeveloped land sales.

• Second quarter and first six months 2011 general and administrative expense includes $2,730,000 associated with proposed private debt offerings that we withdrew as a result of deterioration of terms available to us in the credit markets.

• Second quarter and first six months 2011 share-based compensation decreased primarily due to the effect of our lower stock price associated with vested cash-settled awards.

Current Market Conditions

Current U.S. single-family residential market conditions are showing signs of stability; however, high unemployment rates, depressed sales volumes and prices, difficult financing environment for purchasers and competition from foreclosure inventory continue to negatively influence housing markets. It is difficult to predict when and at what rate these broader negative conditions will improve. We have seen signs of stability in certain markets, where declining finished lot inventories and lack of real estate development is increasing demand for our developed lots, principally in the Texas markets. Multifamily market conditions continue to be strong, with many markets experiencing healthy occupancy levels and positive rent growth. This improvement has been driven primarily by limited new construction activity, reduced single-family mortgage credit availability, and the increased propensity to rent among the 18 to 34 year old demographic of the U.S. population.

Oil prices have weakened recently reflecting market concerns about world economic and oil demand growth. Natural gas prices have remained at low historical levels due to abundant supplies and high inventories due to a warm winter. Shale resource drilling and production remains strong and working natural gas inventories are expected to remain relatively high. In the East Texas Basin, exploration and production companies continue to focus drilling on high liquid rich gas prospects due to relatively high condensate and natural gas liquids prices. In the Gulf Coast Basin, in Louisiana, activity has increased as operators have shifted exploration efforts to oil and high liquid natural gas plays. These conditions may impact the demand for new mineral leases, new exploration activity and the amount of royalty revenues we receive.

Pine sawtimber prices continue to be depressed due to weak demand driven by the overall slowdown in residential construction activity, while pine pulpwood demand remains steady and pricing is relatively flat.

Business Segments

We manage our operations through three business segments:

• Real estate,

• Mineral resources, and

• Fiber resources.

We evaluate performance based on earnings (loss) before unallocated items and income taxes. Segment earnings (loss) consist of operating income, equity in earnings (loss) of unconsolidated ventures', gain on sale of assets, yield accretion on loans secured by real estate and net (income) loss attributable to noncontrolling interests. Items not allocated to our business segments consist of general and administrative expenses, share-based compensation, gain on sale of strategic timberland, interest expense and other corporate non-operating income and expense. The accounting policies of the segments are the same as those described in the accounting policy note to the consolidated financial statements.

We operate in cyclical industries. Our operations are affected to varying degrees by supply and demand factors and economic conditions including changes in interest rates, availability of mortgage credit, consumer and home builder sentiment, new housing starts, real estate values, employment levels, changes in the market prices for oil, natural gas, and timber, and the overall strength or weakness of the U.S. economy.

Real Estate

We own directly or through ventures about 145,000 acres of real estate located in eight states and 12 markets. Our real estate segment secures entitlements and develops infrastructure on our lands, primarily for single-family residential and mixed-use communities. We own approximately 104,000 acres in a broad area around Atlanta, Georgia, with the balance located primarily in Texas. We target investments principally in regions across the southern half of the United States that possess key demographic and growth

characteristics that we believe make them attractive for long-term real estate investment. We own and manage our projects either directly or through ventures. Our real estate segment revenues are principally derived from the sales of residential single-family lots and tracts, undeveloped land and commercial real estate and from the operation of commercial and income producing properties, primarily a hotel and our multifamily investments.

A summary of our real estate results follows:

                                                 Second Quarter                 First Six Months
                                              2012            2011            2012            2011
                                                                 (In thousands)
Revenues                                    $  26,647       $  19,615       $  44,569       $  40,754
Cost of sales                                 (15,216 )       (10,357 )       (25,547 )       (20,527 )
Operating expenses                             (8,243 )        (8,633 )       (15,787 )       (16,347 )

                                                3,188             625           3,235           3,880
Yield accretion on loan secured by real
estate                                          1,093              -            1,093              -
Gain on sale of assets                          3,401              -           15,076              -
Equity in earnings (loss) of
unconsolidated ventures                           644             (23 )         1,194              66
Less: Net (income) loss attributable to
noncontrolling interests                         (660 )           405          (1,355 )          (364 )

Segment earnings                            $   7,666       $   1,007       $  19,243       $   3,582

Second quarter and first six months 2012 segment earnings include $1,093,000 related to yield accretion on a loan secured by real estate.

In second quarter and first six months 2012, gain on sale of assets includes $3,401,000 from a consolidated venture's sale of 800 acres in Dallas. In addition, in first six months 2012, gain on sale of assets includes $11,675,000 from the sale of our 25 percent interest in Palisades West LLC for $32,095,000.

Revenues in our owned and consolidated ventures consist of:

                                                 Second Quarter           First Six Months
                                                2012         2011         2012         2011
                                                              (In thousands)
 Residential real estate                      $ 14,830     $  9,360     $ 23,328     $ 17,227
 Commercial real estate                          1,765          736        1,765          736
 Undeveloped land                                2,581        2,480        3,314        8,570
 Commercial and income producing properties      7,298        6,812       14,576       13,747
 Other                                             173          227        1,586          474

 Total revenues                               $ 26,647     $ 19,615     $ 44,569     $ 40,754

Residential real estate revenues principally consist of the sale of single-family lots to national, regional and local homebuilders. In second quarter and first six months 2012, residential real estate revenues increased principally as a result of increased lot sales volume due to demand for finished lot inventory by homebuilders in markets where supply has diminished. In second quarter 2012, we sold the remaining 109 fully developed lots from our River Plantation project located in Tampa for $2,145,000 or about $19,675 per lot, resulting in about $533,000 in segment earnings.

In second quarter and first six months 2012, commercial real estate revenues increased primarily as result of selling 35 acres from our Summer Creek Ranch project located in Fort Worth for $1,295,000 which generated about $822,000 in segment earnings.

In first six months 2012, undeveloped land sales decreased due to lower volume from our retail land sales program as a result of challenging market conditions including limited credit availability and alternate investment options to buyers in the marketplace.

In second quarter and first six months 2012, commercial and income producing properties revenue increased as a result of higher occupancy levels and revenue per available room from our 413 guest room hotel in Austin and rent growth from our 401 unit multifamily property located in Houston.

In first six months 2012, other revenues include $1,047,000 as result of selling seven acres of impervious cover entitlement credits to a national homebuilder. This sale generated segment earnings of approximately $920,000.

Units sold in our owned and consolidated ventures consist of:

                                        Second Quarter            First Six Months
                                      2012         2011          2012         2011
         Residential real estate:
         Lots sold                       345           158          482           303
         Revenue per lot sold       $ 42,725     $  59,235     $ 48,210     $  56,853
         Commercial real estate:
         Acres sold                       38             4           38             4
         Revenue per acre sold      $ 47,040     $ 185,344     $ 47,040     $ 185,344
         Undeveloped land:
         Acres sold                      933           762        1,253         3,390
         Revenue per acre sold      $  2,765     $   3,258     $  2,645     $   2,528

Operating expenses consist of:

                                             Second Quarter          First Six Months
                                            2012        2011         2012         2011
                                                          (In thousands)
      Employee compensation and benefits   $ 1,929     $ 1,896     $  4,054     $  3,837
      Property taxes                         2,398       2,277        4,341        4,461
      Professional services                    821       1,265        2,078        2,231
      Depreciation and amortization          1,103       1,314        2,150        2,594
      Other                                  1,992       1,881        3,164        3,224

      Total operating expenses             $ 8,243     $ 8,633     $ 15,787     $ 16,347

Information about our real estate projects and our real estate ventures follows:

                                                                    Second Quarter-End
                                                                    2012          2011
Owned and consolidated ventures:
Entitled, developed and under development projects
Number of projects                                                       65            53
Residential lots remaining                                           19,979        18,763
Commercial acres remaining                                            2,085         1,811
Undeveloped land and land in the entitlement process
Number of projects                                                       16            17
Acres in entitlement process                                         27,590        28,650
Acres undeveloped                                                    95,901       166,626
Ventures accounted for using the equity method:
Ventures' lot sales (for first six months)
Lots sold                                                               230           194
Average price per lot sold                                        $  47,568     $  40,882
Ventures' entitled, developed and under development projects
Number of projects                                                        7            21
Residential lots remaining                                            3,954         9,440
Commercial acres sold (for first six months)                             -             20
Average price per acre sold                                       $      -      $ 152,460
Commercial acres remaining                                              333           538
Ventures' undeveloped land and land in the entitlement process
Acres sold (for first six months)                                       135            19
Average price per acre sold                                       $   2,600     $   3,000
Acres undeveloped                                                     5,655         5,712

In first quarter 2012, we acquired from CL Realty and Temco, 14 entitled, developed and under development projects and interests in three ventures accounted for using the equity method. The acquired assets represented approximately 1,130 fully developed lots, 4,900 planned lots, and over 460 commercial acres at time of acquisition, principally in the major markets of Texas.

We underwrite development projects based on a variety of assumptions incorporated into our development plans, including the timing and pricing of sales and leasing and costs to complete development. Our development plans are periodically reviewed in comparison to our return projections and expectations, and we may revise our plans as business conditions warrant. If as a result of changes to our development plans the anticipated future net cash flows are reduced such that our basis in a project is not fully recoverable, we may be required to recognize a non-cash impairment charge for such project.

At second quarter-end 2012, Broadstone Memorial, a 401unit multifamily property in Houston with a carrying value of $46,001,000, is being marketed for sale with a targeted close in the second half of 2012. Las Brisas, a 414 unit (unconsolidated venture) multifamily property located near Austin with a carrying value of $31,739,000, also is being marketed for sale with a targeted close in the second half of 2012. We hold a 59 percent interest in the venture that owns Las Brisas.

Our net investment in owned and consolidated real estate by geographic location follows:

                   Entitled,
                Developed, and                            Commercial
                     Under                                and Income
                  Development         Undeveloped          Producing
   State           Projects              Land             Properties             Total
                                              (In thousands)
   Texas        $       299,122     $         9,626     $        99,436     $       408,184
   Georgia               21,916              58,433                  -               80,349
   Colorado              21,937                  -                   -               21,937
   California             8,915              14,771                  -               23,686
   Other                  6,509                 573                  -                7,082

   Total        $       358,399     $        83,403     $        99,436     $       541,238

Mineral Resources

We own directly or through ventures about 594,000 net acres of mineral interests. Our mineral resources segment revenues are principally derived from oil and natural gas royalties, non-operating working interests and other lease revenues from our mineral interests located principally in Texas, Louisiana, Georgia and Alabama. At second quarter-end 2012, we have about 45,000 net acres under lease and about 35,000 net acres held by production.

A summary of our mineral resources results follows:

                                                     Second Quarter               First Six Months
                                                   2012           2011           2012           2011
                                                                    (In thousands)
Revenues                                         $  7,148       $  4,580       $ 16,574       $ 11,913
. . .