The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2011. Historical results and percentage relationships set forth in the consolidated financial statements, including trends which might appear, should not be taken as necessarily indicative of future operations. The following discussion and other parts of this Quarterly Report on Form 10-Q may also contain forward-looking statements based on current judgments and current knowledge of management, which are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those indicated in such forward-looking statements. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements. Investors are cautioned that our forward-looking statements involve risks and uncertainty, including without limitation, economic conditions in the United States and in the market where we own the Property, disruptions in the debt markets, risks of a lessening of demand for the type of real estate owned by us, our ability to lease our vacant space, changes in government regulations and regulatory uncertainty, geopolitical events, and expenditures that cannot be anticipated such as utility rate and usage increases, unanticipated repairs, uncertainty about governmental fiscal policy, additional staffing, insurance increases and real estate tax valuation reassessments. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We may not update any of the forward-looking statements after the date this Quarterly Report on Form 10-Q is filed to conform them to actual results or to changes in our expectations that occur after such date, other than as required by law.

Overview

Our company, FSP Phoenix Tower Corp., which we refer to as the Company, is a Delaware corporation formed to purchase, own, operate, improve and reposition in the marketplace a 34-story multi-tenant office building containing approximately 629,054 rentable square feet of space located on approximately 2.1 acres of land in Houston, Texas, which we refer to as the Property. The Property was completed in 1984 and includes approximately 1,649 parking spaces located inside a glass-enclosed fully-integrated attached eight-level parking garage and approximately 17 on-site surface parking spaces. The Property also has the right to use approximately 190 additional uncovered off-site parking spaces at an adjacent property pursuant to a lease that expires on February 28, 2019.

Franklin Street Properties Corp., which we refer to as Franklin Street, is the sole holder of our one share of common stock, $.01 par value per share, which we refer to as the Common Stock, that is issued and outstanding. Between March 2006 and September 2006, FSP Investments LLC (member, FINRA and SIPC), a wholly-owned subsidiary of Franklin Street, completed the sale on a best efforts basis of 1,050 shares of our preferred stock, $.01 par value per share, which we refer to as the Preferred Stock. FSP Investments LLC sold the Preferred Stock in a private placement offering to "accredited investors" within the meaning of Regulation D under the Securities Act of 1933. Since the completion of the placement of the Preferred Stock in September 2006, Franklin Street has not been entitled to share in any earnings or dividends related to the Common Stock.

We operate in one business segment, which is real estate operations, and own a single property. Our real estate operations involve real estate rental operations, leasing services and property management services. The main factor that affects our real estate operations is the broad economic market conditions in the United States and, more specifically, the economic conditions in Houston, Texas, the relevant submarket. These market conditions affect the occupancy levels and the rent levels on both a national and local level. We have no influence on national or local market conditions.

Trends and Uncertainties



Economic Conditions

The economy in the United States is continuing to experience a period of limited economic growth, including high levels of unemployment, the failure and near failure of a number of financial institutions and increased credit risk premiums for a number of market participants. The broad economic market conditions in the United States are affected by numerous factors, including but not limited to, inflation and employment levels, energy prices, slow growth and/or recessionary concerns, uncertainty about governmental fiscal policy, changes in currency exchange rates, geopolitical events, the regulatory environment and the availability of debt and interest rate fluctuations. Current and future economic factors may negatively affect real estate values, occupancy levels and property income. At this time, we cannot predict the extent or duration of any negative impact that current or future economic factors will have on our business.

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Potential Sale of the Property

On February 22, 2012, we sent a special communication to the holders of our Preferred Stock to inform them that our board of directors had made the decision to try to sell the Property. More specifically, we have retained CB Richard Ellis to facilitate a potential sale of the Property.

Following an aggressive marketing effort and competitive bidding process, the Property went under contract to be sold for a total price of $123,250,000. A majority of the holders of the Company's Preferred Stock voted in favor of selling the Property at that price. Unfortunately, the prospective buyer was unable to consummate the purchase transaction and elected to terminate the purchase contract. Investor interest in Houston remains strong for well-located Class A office properties. We are continuing our strategy to simultaneously keep up current leasing efforts while aggressively marketing the Property for sale.

Real Estate Operations

The Property is occupied by a diverse group of tenants, including financial institutions, energy firms, law firms and other professional service organizations. As of June 30, 2012, the Property was approximately 91.8% leased, a 1.0% increase from the prior quarter. Management is aggressively working to lease all vacant space. Management believes that any tenant that leases 10% or more of the Property's rentable space is material. As of June 30, 2012, Permian Mud Service, Inc., an energy-related firm d/b/a Champion Technologies, leased approximately 105,441 square feet (17%) of the Property's rentable space through February 2018. Other prominent additional tenants include Allen Boone Humphries Robinson LLP, a law firm, which leases approximately 51,153 square feet (8%) through July 2018, WorleyParsons Group Inc. (engineering services), which leases approximately 50,716 square feet (8%) through April 2015, and New York Life Insurance Company (insurance), which leases approximately 33,394 square feet (5%) through September 2022. Permian Mud Service, Inc., Allen Boone Humphries Robinson LLP, WorleyParsons Group Inc., and New York Life Insurance account for approximately 240,704 square feet (38%) of the rentable area of the Property. Other well-known tenants include Sprint Communications, Lincoln National Life Insurance Company, Thompson and Horton LLP and NetApp, Inc. There are currently approximately 46 tenants leasing office space at the Property.

Since its completion in 1984, the Property has competed within the office market in Houston, Texas. Management believes that the Property is still competitive with other office buildings, but given its age, determined at the time of acquisition that it needed improvements in several important areas in order to maintain or enhance its prominent position in the marketplace. Management believes that such a repositioning could increase the value of the Property and lead to higher future rent and occupancy levels. The improvements included, among others, remediation of the glass façade and upgrades to the garage, ground floor lobby, ninth floor sky lobby and terrace, streetscape and landscape. The improvements were substantially completed in June 2009 at a cost of approximately $12 million and have received favorable responses from our existing tenants, potential future tenants and the local leasing community.

Conditions, including new leasing activity, at the Property have caused management to make additional improvements at additional cost in order to further enhance the Property. Through June 30, 2012, the Company had incurred additional costs of approximately $4 million to make additional improvements to the Property, including an elevator modernization project (described further below), common corridor upgrades, multi-tenant corridor conversions and the establishment of a fitness center. If future conditions warrant, management may elect to make additional improvements at additional cost in order to further enhance the Property.

On September 15, 2010, we entered into a $2.8 million dollar contract with Thyssen Krupp Elevator Corporation to modernize 21 elevators serving the Property. Over the years, the increasing costs to maintain and operate the system's mechanical relay controls, as well as the declining level of performance of the vertical transportation, have warranted the modernization project. The work commenced during the fourth quarter of 2010 and was completed on time and on budget at the end of 2011. Management believes that the elevator modernization project could reduce operating costs, improve the overall performance of elevator service, and provideanother positive attribute to entice prospective tenants.

It is difficult for management to predict what will happen to occupancy and rents at the Property because the need for space and the price tenants are willing to pay are tied to both the local economy and to the larger trends in the national economy, such as job growth, interest rates, the availability of credit and corporate earnings, which in turn are tied to even larger macroeconomic and political factors, such as recessionary concerns, volatility in energy pricing and the risk of terrorism. In addition to the difficulty of predicting macroeconomic factors, it is difficult to predict how our local market or tenants (existing and potential) will suffer or benefit from changes in the larger economy. In addition, because the Property is in a single geographical market, these macroeconomic trends may have a different effect on the Property and on its tenants (existing and potential), some of which may operate on a national level. Although we cannot predict how long it will take to lease vacant space at the Property or what the terms and conditions of any new leases will be, we expect to sign new leases at then current market rates which may be below the expiring rates. Recent leasing activity at the Property could support higher dividend yields as the build-out of newly-leased premises is completed and periods of free rent expire.

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On December 4, 2008, we entered into a three-year secured promissory note for a revolving line of credit, which we refer to as the Phoenix Revolver, with Franklin Street for up to $15,000,000. On March 31, 2011, the Phoenix Revolver was amended to extend its maturity date from November 2011 to November 30, 2012 and to increase the interest rate applicable to advances thereunder from the 30-day LIBOR rate plus 300 basis points to the 30-day LIBOR rate plus 440 basis points (4.64% at June 30, 2012). The Phoenix Revolver is secured by a mortgage on the Property and each advance thereunder requires payment of a 50 basis point draw fee. We anticipate that the Phoenix Revolver will be replaced or refinanced on or before its maturity date. However, there can be no assurance that we will be able to replace or refinance the Phoenix Revolver on favorable terms or at all. As of June 30, 2012, advances drawn and outstanding under the Phoenix Revolver totaled $15,000,000. For the six months ended June 30, 2012 and 2011, the draw fees were $20,000 and $14,000, respectively, and interest expense paid to Franklin Street was approximately $274,000 and $166,000, respectively.

For the three months ended June 30, 2012, we believe that vacancy rates decreased and that rental rates increased for buildings in the Houston office market compared to the prior quarter. These trends may continue, worsen or improve in the future. Continuing economic turmoil has slowed the pace of leasing activity in the Houston market and will likely prolong the time it takes to lease the vacant space at the Property. However, management believes that the repositioning of the Property in the marketplace, combined with a dwindling supply of large blocks of available Class A office space in the area, will continue to result in increased inquiries from prospective tenants. Management also believes that the position of the Property within the city's office market is strong, and management is optimistic that the existing vacant space will ultimately be leased to new tenants.

The potential for any of our tenants to default on its lease or to seek the protection of bankruptcy laws exists. If any of our tenants defaults on its lease, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment. In addition, at any time, a tenant may seek the protection of bankruptcy laws, which could result in the rejection and termination of such tenant's lease and thereby cause a reduction in cash available for distribution to our stockholders. Bankruptcy or a material adverse change in the financial condition of a material tenant would likely have a material adverse effect on our results of operations.

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Critical Accounting Policies

We have certain critical accounting policies that are subject to judgments and estimates by our management and uncertainties of outcome that affect the application of these policies. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. On an on-going basis, we evaluate our estimates. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. The accounting policies that we believe are most critical to the understanding of our financial position and results of operations, and that require significant management estimates and judgments, are discussed in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2011.

Critical accounting policies are those that have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates. We believe that our judgments and assessments are consistently applied and produce financial information that fairly presents our results of operations.

No changes to our critical accounting policies have occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

As of June 30, 2012 the Property was approximately 91.8% leased to a diverse group of tenants with staggered lease expirations. The largest tenant is Permian Mud Service Inc., an energy-related firm d/b/a Champion Technologies, which leases approximately 105,441 square feet (17%) of the Property's rentable space through February of 2018.

Comparison of the three months ended June 30, 2012 to the three months ended June 30, 2011.

Revenue

Total revenue increased by $1.1 million to $3.8 million for the three months ended June 30, 2012, as compared to $2.7 million for the three months ended June 30, 2011. The increase was primarily attributable to increases in both base rents of $0.5 million and $0.6 million in recoverable rent revenue due to higher levels of occupancy. The majority of the operating expenses, real estate taxes and insurance expenses represent amounts recoverable by the Company.

Expenses

Total expenses increased by $0.6 million to $3.4 million for the three months ended June 30, 2012, as compared to $2.8 million for the three months ended June 30, 2011. This increase was predominately attributable to a $0.3 million increase in operating expenses, a $0.1 million increase in real estate taxes, a $0.1 million increase in depreciation and amortization, and a $0.1 million increase in interest expense.

Comparison of the six months ended June 30, 2012 to the six months ended June 30, 2011.

Revenue

Total revenue increased by $1.4 million to $6.8 million for the six months ended June 30, 2012, as compared to $5.4 million for the six months ended June 30, 2011. This increase was primarily attributable to increases in both base rents of $0.6 million and $0.8 million in recoverable rent revenue due to increased levels of occupancy. The majority of the operating expenses, real estate taxes and insurance expenses represent amounts recoverable by the Company.

Expenses

Total expenses increased by $0.7 million to $6.3 million for the six months ended June 30, 2012, as compared to $5.6 million for the six months ended June 30, 2011. This increase was predominately attributable to a $0.3 million increase in operating expenses, a $0.2 million increase in real estate taxes, a $0.1 million increase in depreciation and amortization, and a $0.1 million increase in interest expense.

Liquidity and Capital Resources

Cash and cash equivalents were $4.8 million at June 30, 2012 and $2.8 million at December 31, 2011. This $2.0 million increase was primarily attributable to $0.7 million provided by operating activities and $2.4 million provided by financing activities and was offset by $1.1 million used for investing activities.

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Management believes that the existing cash and cash equivalents as of June 30, 2012 of $4.8 million and cash anticipated to be generated internally by operations and borrowings will be sufficient to meet working capital requirements, distributions and anticipated capital expenditures for at least the next 12 months.

Operating Activities

Cash provided by operating activities of $0.7 million for the six months ended June 30, 2012 was primarily attributable to net income of $0.5 million plus non-cash items of $2.0 million consisting primarily of depreciation and amortization and was offset by uses arising from other current accounts of $1.1 million and payments of deferred leasing costs of $0.7 million.

Investing Activities

The cash used for investing activities of $1.1 million for the six months ended June 30, 2012 was for capital expenditures.

Financing Activities

The cash provided by financing activities of $2.4 million for the six months ended June 30, 2012 was primarily attributable to the $4.0 million proceeds from the loan payable and was offset by the $1.6 million for the distributions to stockholders.

Sources and Uses of Funds

Our principal demands on liquidity are cash for operations, interest on debt payments and dividends paid to equity holders. As of June 30, 2012, we had approximately $2.4 million in accrued liabilities and $15.0 million in long-term debt. In the near term, liquidity is generated by cash from operations.

Contingencies

We may be subject to various legal proceedings and claims that arise in the ordinary course of our business. Although occasional adverse decisions (or settlements) may occur, we believe that the final disposition of such matters will not have a material adverse effect on our financial position or results of operations.

Related Party Transactions

We have in the past engaged in and currently engage in transactions with a related party, Franklin Street, and its subsidiaries FSP Investments LLC and FSP Property Management LLC, which we collectively refer to as FSP. We expect to continue to have related party transactions with FSP in the form of management fees paid to FSP to manage the Company on behalf of our stockholders. FSP Property Management LLC currently provides the Company with asset management and financial reporting services. The asset management agreement between the Company and FSP Property Management LLC requires the Company to pay FSP Property Management LLC a monthly fee equal to one percent (1%) of the gross revenues of the Property. The asset management agreement between the Company and FSP Property Management LLC may be terminated by either party without cause at any time, upon at least thirty (30) days' written notice. For the six months ended June 30, 2012 and 2011, management fees paid were $62,000 and $51,000, respectively.

On December 4, 2008, we entered into a three-year secured promissory note for a revolving line of credit, which we refer to as the Phoenix Revolver, with Franklin Street for up to $15,000,000. On March 31, 2011, the Phoenix Revolver was amended to extend its maturity date from November 30, 2011 to November 30, 2012 and to increase the interest rate applicable to advances thereunder from the 30-day LIBOR rate plus 300 basis points to the 30-day LIBOR rate plus 440 basis points (4.64% at June 30, 2012). The Phoenix Revolver is secured by a mortgage on the Property and each advance thereunder requires payment of a 50 basis point draw fee. We anticipate that the Phoenix Revolver will be replaced or refinanced on or before its maturity date. However, there can be no assurance that we will be able to replace or refinance the Phoenix Revolver on favorable terms or at all. As of June 30, 2012, advances drawn and outstanding under the Phoenix Revolver totaled $15,000,000. For the six months ended June 30, 2012 and 2011, the draw fees were $20,000 and $14,000, respectively, and interest expense paid to Franklin Street was approximately $274,000 and $166,000, respectively.

On September 22, 2006, Franklin Street purchased 48 shares of Preferred Stock for $4,116,000. Prior to purchasing any shares of Preferred Stock, Franklin Street agreed to vote any shares held by it on any matter presented to the holders of Preferred Stock in a manner that approximates as closely as possible the votes cast in favor of and opposed to such matter by the holders of the Preferred Stock other than Franklin Street and its affiliates. For purposes of determining how Franklin Street votes its shares of Preferred Stock, abstentions and non-votes by stockholders other than Franklin Street are not considered. Franklin Street is entitled to distributions that are declared on the Preferred Stock.

Franklin Street is the sole holder of our one share of Common Stock that is issued and outstanding. Subsequent to the completion of the placement of our Preferred Stock in September 2006, Franklin Street has not been entitled to share in our earnings or any dividend related to our Common Stock.

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