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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

 X   

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.  

For the quarterly period ended March 31, 2005.

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from ________________ to _______________.

Commission File Number 1-12222

BEDFORD PROPERTY INVESTORS, INC.

(Exact name of registrant as specified in its charter)

           MARYLAND

68-0306514

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

270 Lafayette Circle, Lafayette, CA

94549    

(Address of principal executive offices)

(Zip Code)

(925) 283-8910

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  X   No___

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  X   No___

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

           Class                                                                

Outstanding as of May 9, 2005

Common Stock, $0.02 par value              

16,419,685

BEDFORD PROPERTY INVESTORS, INC.

INDEX

PART I.  FINANCIAL INFORMATION

Page

Item 1.  Financial Statements (Unaudited)

Consolidated Balance Sheets as of March 31, 2005

and December 31, 2004

1

Consolidated Statements of Income for the three months ended

March 31, 2005 and 2004

2

Consolidated Statement of Stockholders' Equity for the

three months ended March 31, 2005

3

Consolidated Statements of Cash Flows for the three months ended

March 31, 2005 and 2004

4

Notes to Consolidated Financial Statements

5-17

Item 2.  Management's Discussion and Analysis of

Financial Condition and Results of Operations

18-43

Item 3.  Quantitative and Qualitative Disclosures

about Market Risk

44

Item 4.  Controls and Procedures

44

PART II.  OTHER INFORMATION

Items 1 - 6

45-46

SIGNATURES

47

EXHIBIT INDEX

48

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

 1

BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2005 AND DECEMBER 31, 2004

 (in thousands, except share and per share amounts)

See accompanying notes to consolidated  financial statements.

 1

BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004

(Unaudited)

(in thousands, except share and per share amounts)

See accompanying notes to consolidated financial statements.

 2

BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(Unaudited)

(in thousands, except per share amounts)

See accompanying notes to consolidated financial statements.

 3

BEDFORD PROPERTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004

(Unaudited)

(in thousands)

See accompanying notes to consolidated financial statements

 4

BEDFORD PROPERTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2005

Note 1 - Organization and Summary of Significant Accounting Policies and Practices

The Company

Bedford Property Investors, Inc. is a real estate investment trust (REIT) incorporated in 1993 as a Maryland corporation. We are a self-administered and self-managed equity REIT engaged in the business of owning, managing, acquiring and developing multi-tenant industrial and suburban office properties concentrated in the western United States. Our common stock, par value $0.02 per share, trades under the symbol "BED" on both the New York Stock Exchange and the Pacific Exchange.

Basis of Presentation

We have prepared the accompanying unaudited interim financial statements in accordance with the requirements of Form 10-Q as set forth by the United States Securities and Exchange Commission. Therefore, they do not include all information and footnotes necessary for a presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (GAAP). In our opinion, the interim financial statements presented reflect all adjustments, consisting only of normally recurring adjustments, which are necessary for a fair presentation of our financial condition and results of operations. These unaudited financial statements should be read in conjunction with the notes to the 2004 audited financial statements contained in our annual report on Form 10-K for the year ended December 31, 2004.

Basis of Consolidation

Our consolidated financial statements have been prepared in accordance with GAAP. Our consolidated financial statements include the financial information of Bedford Property Investors, Inc., seven wholly-owned corporations, and three wholly-owned limited liability companies. All significant inter-entity balances have been eliminated in consolidation.

Accounting for Development Costs

Costs associated with the development of real estate include acquisition and direct construction costs as well as capitalization of real estate taxes, insurance, incidental revenue and expenses, and a portion of salaries and overhead of personnel responsible for development activity.  In addition, we capitalize interest expense to the development project. The amount of interest capitalized during a period is determined by applying the weighted average rate of our borrowings to the average accumulated costs, excluding interest, of the project. The capitalization of interest, real estate taxes, insurance, and incidental revenue and expenses begins when construction of a project commences and ends when a project or a portion of the project is placed in service, not to exceed twelve months from the cessation of construction activities.  The capitalization of salaries and overhead of development personnel begins upon acquisition of a land parcel or upon commencement of active development for redevelopment and rehabilitation projects and ends with completion of the project.

 5

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required payments, which results in a reduction to income. Management determines the adequacy of this allowance by continually evaluating individual tenant receivables, taking into account the tenant’s financial condition, security deposits, any letters of credit, any lease guarantees, and current economic conditions.  As of March 31, 2005 and December 31, 2004, our allowance for doubtful accounts related to accounts receivable was approximately $55,000 and $20,000, respectively. We did not have an allowance for doubtful accounts related to notes receivable as of March 31, 2005. As of December 31, 2004, our allowance for doubtful accounts related to a note receivable was approximately $127,000.  Accounts and notes receivable amounts are presented net of these allowances for doubtful accounts in the consolidated bala nce sheets.

Per Share Data

Per share data are based on the weighted average number of common shares outstanding during the year. We include stock options issued under our stock option plans and non-vested restricted stock in the calculation of diluted per share data if, upon exercise or vestiture, they would have a dilutive effect. The dilutive shares are calculated using the treasury stock method.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) 123R, “Share-Based Payment,” a revision of SFAS 123, “Accounting for Stock-Based Compensation.” This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123R is now effective for public companies beginning with the first fiscal year commencing after June 15, 2005. Due to our adoption of the fair value based method of accounting for stock-based employee compensation effective January 1, 2003, we do not expect this pronouncement to have a material impact on our financial position or results of operations.

In March 2005, the FASB issued SFAS Interpretation (FIN) 47, “Accounting for Conditional Asset Retirement Obligations – an Interpretation of FASB Statement No. 143.” FIN 47 clarifies the term “conditional asset retirement obligation” as used in SFAS 143, “Accounting for Asset Retirement Obligations.” FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We are currently evaluating the potential impact on our financial position and results of operations as a result of implementing this interpretation.

 6

Note 2 – Real Estate Investments

As of March 31, 2005, our real estate investments were diversified by property type as follows (dollars in

thousands):

* Gross cost for operating properties held for sale is shown net of accumulated depreciation of $2,359 on the Consolidated Balance Sheet at March 31, 2005.

 7

The following table sets forth our real estate investments at March 31, 2005 and December 31, 2004 (in thousands):

 8

Our personnel directly manage all but six of our properties from regional offices in Lafayette, California; Tustin, California; Phoenix, Arizona; Denver, Colorado; and Seattle, Washington. We have retained outside managers to assist in some of the management functions for U.S. Bank Centre in Reno, Nevada; Russell Commerce Center in Las Vegas, Nevada; Northport Business Center in North Las Vegas, Nevada; and SunTech Corporate Park 1, SunTech Corporate Park 2, and Tanasbourne Corporate Park in Hillsboro, Oregon. All financial record keeping is centralized at our corporate office in Lafayette, California.

Note 3. Debt

Bank Loans Payable

On March 31, 2004, we renewed our revolving credit facility with a six-bank lending group led by Bank of America. The facility, which matures on March 31, 2007, consists of a $150 million secured line of credit with an accordion feature that gives us the option to expand the facility to $200 million, if needed. Interest on the facility is at a floating rate equal to either the lender’s prime rate or LIBOR plus a margin ranging from 1.30% to 1.75%, depending on our leverage level as defined in the credit agreement. As of March 31, 2005, the facility had a total outstanding balance of $30,875,000 and an effective interest rate of 4.16%, and was collateralized by our interests in 20 properties with a net book value of approximately $149,758,000. These properties collectively accounted for approximately 23% of our annualized base rent for 2005 and approximately 21% of our total real estate assets at March 31, 2005. As of December 31, 2004, the facility did not have an outstanding balance due to the paydown of the balance with sales proceeds from assets sold in December 2004. In the first quarter of 2005, the net borrowing of $30,875,000 was used to partially fund the special common stock dividend paid on January 18, 2005.

The daily weighted average outstanding balance was $28,876,000 and $71,683,000 for the three months ended March 31, 2005 and 2004, respectively. The weighted average annual interest rates in each of these periods were 4.31% and 2.79%, respectively.

We were in compliance with the various covenants and requirements of our credit facility during the three months ended March 31, 2005 and during the year ended December 31, 2004.

 9

Mortgage Loans Payable

Mortgage loans payable at March 31, 2005 consist of the following (in thousands):

⁺

Interest rates are fixed unless otherwise indicated by footnote.

⁽¹⁾

At maturity, the loan balance is expected to be paid in full with proceeds from asset sales and funding from our line of credit.

⁽²⁾

At maturity, the loan balance is expected to be paid in full with funding from our line of credit.

⁽³⁾

Floating rate based on 30-day LIBOR plus 1.40% (adjusted monthly). Effective July 3, 2003, the floating 30-day LIBOR rate was swapped to a fixed rate of 1.595% for an all-in rate of 2.995% until maturity.

⁽⁴⁾

Maturity date of November 1, 2005 represents the first of two interest rate reset dates, at which time we may opt to reject the new rate and pay the outstanding balance on the mortgage. The second interest rate reset date is November 1, 2008 with a final maturity date of November 1, 2011. We expect to accept the interest rate reset on November 1, 2005, extending the maturity date to November 1, 2008.

⁽⁵⁾

Floating rate based on LIBOR plus 1.60%. The current rate of 4.14% is fixed until May 19, 2005, at which time we have the option of fixing the LIBOR rate for a period of 1 month, 3 months, 6 months, or 12 months.

⁽⁶⁾

In addition, a letter of credit in the amount of $5,720,000 serves as security for this loan pending replacement of the Laguna Hills Square property sold in 2004, which previously served as collateral for this loan.

⁽⁷⁾

Floating rate based on a 12-month average of U.S. Treasury security yields plus 2.60% (adjusted semi-annually).

*

The two Sun Life Assurance Company mortgages are collateralized by a single property.

 10

The 67 operating properties that served as collateral for our mortgages had a net book value of approximately $505,136,000 as of March 31, 2005. We were in compliance with the covenants and requirements of our various mortgages during the three months ended March 31, 2005 and during the year ended December 31, 2004.

The following table presents scheduled principal payments on mortgage loans for each of the twelve-month periods ending March 31 (in thousands):

Note 4.  Stockholders' Equity

Series A Preferred Stock

On August 5, 2003, we issued and sold 805,000 shares of our 8.75% Series A Cumulative Redeemable Preferred Stock at a price of $50.00 per share for a gross total of $40,250,000. The offering was made only to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. We pay cumulative dividends on the shares from the date of original issuance at the rate of 8.75% of the $50.00 liquidation preference per share per year, which is equivalent to $4.375 per share per year. Dividends on the shares are paid quarterly in arrears and are recorded when declared. A dividend of $880,000 or $1.09375 per share was declared on March 31, 2005 and paid on April 15, 2005 for the first quarter of 2005.

The Series A preferred shares have no stated maturity, are not subject to any sinking fund or mandatory redemption, and are not convertible into any other securities. The shares are redeemable at our option beginning in August 2008, or earlier if necessary in limited circumstances to preserve our status as a REIT.

Series B Preferred Stock

On April 6, 2004, we issued and sold 2,400,000 shares of our 7.625% Series B Cumulative Redeemable Preferred Stock in a public offering at a price of $25.00 per share for a gross total of $60,000,000. We pay cumulative dividends on the shares from the date of original issuance at the rate of 7.625% of the $25.00 liquidation preference per share per year, which is equivalent to $1.90625 per share per year.  Dividends on the shares are paid quarterly in arrears beginning on July 15, 2004 and are recorded when declared.  A dividend of $1,144,000 or $0.47656 per share was declared on March 31, 2005 and paid on April 15, 2005 for the first quarter of 2005.  

The Series B preferred shares have no stated maturity, are not subject to any sinking fund or mandatory redemption, and are not convertible into any other securities.  The shares are redeemable at our option beginning in April 2009, or earlier if necessary in limited circumstances to preserve our status as a REIT.

 11

 11

The following schedule presents changes in the number of outstanding shares of common stock and preferred stock during the period from January 1, 2005 through March 31, 2005:

In July 1998, our board of directors approved a share repurchase program of 3 million shares which was increased first to 4.5 million shares in September 1999, then to 8 million shares in September 2000 and later to 10 million shares in January 2002. The share repurchase program does not require us to purchase a specified number of shares and it does not have an expiration date. For the three months ended March 31, 2005 and 2004, we repurchased 30,074 and 38,885 shares, respectively, for annual average prices of $25.65 and $28.92, respectively. These shares were repurchased from employees to satisfy payroll tax obligations upon the vesting of restricted stock and in connection with stock option exercises.

Note 5.  Discontinued Operations

In December 2004, we sold four industrial properties in South San Francisco, California; one industrial property in Santa Rosa, California; one industrial property in Napa, California; two office properties in Seattle, Washington; one office property and a 4.3 acre parcel of land in San Diego, California; and an office building in Laguna Hills, California for net sale prices totaling $175,110,000, which resulted in an aggregate gain of $70,235,000. In January 2005, we sold an industrial property in San Diego, California for a sale price of $15,800,000, resulting in a gain of approximately $6,894,000. In addition, we recorded a gain of $250,000 from funds released from escrow in the first quarter of 2005 in connection with one of the properties we sold in December 2004. As of March 31, 2005, we classified five operating properties as held for sale in accordance with our policy.

Income from the properties held for sale and sold is presented in the income statement as discontinued operations for all periods presented.  Income from discontinued operations includes allocations of interest expense based on the percentage of the cost basis of each property held for sale and sold to the cost basis of total real estate assets as of the respective balance sheet date.  The following schedule presents the calculation of income from discontinued operations (in thousands):

 12

 12

Assets and liabilities related to properties held for sale as of March 31, 2005 and December 31, 2004 were as follows (in thousands):

 Note 6. Segment Disclosure

We view our operations as several geographic segments reflecting the regional management structure of our operating portfolio. We have five operating segments organized by the regions in which we own properties as follows: Northern California (includes Reno, Nevada), Arizona, Southern California (includes Las Vegas, Nevada), Northwest (greater Seattle, Washington and Portland, Oregon) and Colorado. The corporate and other segment includes amounts associated with general business activities not specifically related to our properties.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. We evaluate performance based upon income from operations from the combined properties in each segment.

⁽¹⁾  The interest income in the Northern California and Northwest segments represents interest earned from tenant notes receivables.

 13

⁽¹⁾

The interest income in the Northern California and Northwest segments represents interest earned from tenant notes receivable.

⁽²⁾

The negative amount in the Northwest segment is due to the transfer of an operating property to development at net book value.

Note 7.  Notes Receivable

In connection with the sale of a property in December 2004, we hold a note receivable from the buyer and other related entities with an outstanding principal balance of $6,500,000 as of March 31, 2005. The note carries an interest rate of 6% and is secured by a deed of trust on the property.  The note had an original maturity date of March 17, 2005 which was extended until March 31, 2005. The note and accrued interest were paid in full on April 1, 2005.

We hold a note receivable from one of our former tenants in the amount of $13,000 as of March 31, 2005.

 14

Note 8. Acquisitions and Pro Forma Financial Information

During 2004, we acquired six operating properties, one redevelopment project, one development project, and three parcels of land for contract prices totaling approximately $103,641,000. Pro forma amounts include estimates for rental income, rental expenses, and interest expense, and are presented as if these properties had been acquired at the beginning of 2004. The following table presents pro forma financial information for the three months ended March 31, 2004 (dollars in thousands, except share and per share amounts):

During 2005, we acquired one parcel of land for a contract price of $366,768. Pro forma amounts have not been presented due to the insignificant impact of this transaction on our financial results.

 15

Note 9. Earnings Per Share

Following is a reconciliation of earnings per share (in thousands, except share and per share amounts):

Stock option grants and restricted stock awards with an exercise or issuance price on the date of grant that is above the average market price during the period are considered antidilutive and have been excluded from the weighted average share calculations. For the three months ended March 31, 2005, 420,842 of our stock options and restricted stock awards have been excluded from the “weighted average number of shares – diluted.” Stock options and restricted stock awards of  187 have been excluded from the “weighted average number of shares – diluted” for the three months ended March 31, 2004.

 16

Note 10. Related Party Transactions

We have occasionally used the services of the law firm Bartko, Zankel, Tarrant & Miller of which a member of our Board of Directors, Martin I. Zankel, is a partner. During the three months ended March 31, 2004, we paid Bartko, Zankel, Tarrant & Miller approximately $200 in legal fees.  During the three months ended March 31, 2005, no payments were made to the firm.

Note 11. Commitments and Contingencies

As of March 31, 2005, we had outstanding contractual construction commitments of approximately $5.3 million relating to development in progress and tenant improvements on recently developed properties. We had outstanding undrawn letters of credit against our credit facility of approximately $11,557,000 as of March 31, 2005.

From time to time, we are subject to legal claims in the ordinary course of business. We are not aware of any legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, prospects, financial condition, operating results or cash flows.

 17

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

Bedford Property Investors, Inc. is a self-administered and self-managed equity real estate investment trust (REIT). We own, manage, acquire and develop multi-tenant industrial and suburban office properties proximate to metropolitan areas in the western United States. As of March 31, 2005, we owned 90 operating properties totaling approximately 7.3 million rentable square feet and 12 parcels of land totaling approximately 47 acres. In addition, we owned three office properties and one industrial property that are currently under redevelopment. Of the 90 operating properties, 60 are industrial buildings and 30 are suburban offices. Our properties are located in California, Arizona, Washington, Colorado, Oregon, and Nevada.

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the financial statements and notes to financial statements included in this report, as well as our annual report on Form 10-K for the year ended December 31, 2004. When used in the following discussion, the words “believe,” “expect,” “intend,” “plan,” “anticipate” and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed, expected or implied by the forward-looking statements. These risks and uncertainties are described in our filings with the Securities and Exchange Commis sion, including our annual report on Form 10-K for the year ended December 31, 2004, and are set forth in the section below entitled "Potential Factors Affecting Future Operating Results." Readers are cautioned not to place undue reliance on these forward-looking statements because they only reflect information available as of the date of this filing. We do not undertake to update forward-looking information contained herein or elsewhere to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking information.

OVERVIEW

Significant Events During the Quarter

On January 20, 2005, we sold a 109,780 square-foot industrial property in San Diego, California for $15,800,000. This sale generated a gain of approximately $6,894,000.

On February 28, 2005, we acquired a 1.05 acre parcel of land in Las Vegas, Nevada for approximately $367,000. The land will be held as a future development site.

Market Conditions

The Northwest Region

We believe that the Puget Sound area of Washington is still experiencing the effects of significant job loss resulting from the technology and telecommunication industry slowdowns. We also believe that these economic conditions have affected most commercial real estate markets causing excess space, both in the direct leasing and sub-leasing markets, and weaker deal terms. At March 31, 2005, our Northwest operating portfolio, which includes three Oregon properties, was 93% occupied with 43,000 square feet vacant in three operating properties. We believe that this comparatively strong occupancy has insulated us from the worst effects of local market conditions. In February 2004, one of our largest tenants in this region vacated our approximately 334,000 square-foot five-building complex in Renton, Washington upon expiration of its lease. We have transferred this property to our development portfolio and have commenced a program to reposition the complex as a campus-style multi-tenant office park. In September 2004, we completed the first phase of this repositioning and have signed three leases for an aggregate of 79,969 square feet, bringing the project to 21% leased as of March 31, 2005.

 18

The Northern California Region

Our properties in Northern California are located throughout the San Francisco Bay Area and include one property in Reno, Nevada. The Bay Area market has also been impacted by the technology industry slowdown, particularly in the Silicon Valley area, where we own 14 properties totaling 1,217,207 square feet as of March 31, 2005. In this sub-market, we believe that the job loss associated with the recent recession has been significant, resulting in increased vacancy and reduced rental rates. While the California employment situation has shown some improvement in recent months, the oversupply of space and reduced rental rates continue to be a challenge.  In addition, we expect higher than usual lease expirations in the Silicon Valley to continue through 2005, which creates the potential for increasing vacancy in our portfolio. We have responded to these challenges by improving our marketing processes and the marketability of our vacant space s. For example, we are making capital improvements to our vacant spaces to render them near move-in condition for prospective tenants. Other Bay Area sub-markets have not been as dramatically affected as the Fremont, Milpitas, and San Jose markets in Silicon Valley. In Sonoma County, Napa County, and Contra Costa County sub-markets, while demand has slowed during the past three years, vacancy rates have not climbed to the extent they have in Silicon Valley.

Another Bay Area sub-market that has demonstrated some weakness during the last few years is the South San Francisco industrial market. In December 2004, we sold four of our five properties in South San Francisco, leaving one 81% leased property remaining in this sub-market as of March 31, 2005.

The Southern California Region

In Southern California, we have properties in three relatively healthy sub-markets. These sub-markets are Orange County, San Diego, and the Inland Empire. We have two properties in Orange County and maintained them at, or close to, 100% occupancy during 2004 and in the first quarter of 2005. In the Inland Empire, we have a bulk industrial property in Ontario, California, which was 100% leased as of March 31, 2005. We also have three recently developed properties in the Inland Empire: Jurupa Business Center Phase I, which was 100% leased as of March 31, 2005; Jurupa Business Center Phase II, which was 91% leased as of March 31, 2005; and Jurupa Business Center Phase IV, which was 100% leased as of March 31, 2005. In addition, the Jurupa Business Center Phase III became shell complete during the fourth quarter of 2004 and is 41% leased as of March 31, 2005. Finally, in San Diego, our properties were 100% leased during the year 2004 and in the fir st quarter of 2005.

In Las Vegas, Nevada, we own two industrial properties totaling 224,543 square feet, which were 98% occupied as of March 31, 2005. In addition, we own 4 parcels of land totaling 5.74 acres, which are being held for future development. The Las Vegas market continues to be one of the strongest in the country with employment growth of 7.3% during the first quarter of 2005.

The Arizona Region

Most of our properties in Arizona are in Phoenix, a market that has been characterized by the same weakness in demand for office, research and development, and industrial space that we have experienced in other regions. During the first quarter of 2005, the Phoenix region has shown some improvement as evidenced by employment growth of 4.6% and positive net absorption of approximately 400,000 and 800,000 square feet in the office and industrial markets, respectively. However, despite this improvement, re-leasing space in Phoenix continues to be challenging. As of March 31, 2005, our properties in this region were 93% leased, with approximately 138,000 square feet of vacant space in eight properties.

 19

The Colorado Region

All of our properties in Colorado are in the southeast Denver suburban office market. We believe that market conditions in Denver reflect the effects of the significant job losses experienced in this region during the last several years, similar to other markets. Our ten-story office property at 4601 DTC Boulevard was 80% leased to a single tenant under a lease that expired on January 31, 2005, which the tenant opted not to renew. In preparation for this expected vacancy, we made significant capital improvements to the property and began actively marketing the space in 2004. With the addition of replacement leases signed this year, including a 31,366 square-foot lease with a national engineering firm, the property was 49% leased as of March 31, 2005. Additional capital improvements to this property are currently underway, including a new lobby, entry-way, and parking garage. We expect these additions to enhance the competitive position ing of the property.

Future Trends and Events

Acquisitions and Dispositions

In September 2004, we announced that our board of directors would undertake a review of a broad range of strategic alternatives for our company. These alternatives included the potential sale or merger of our company, selling certain of our properties and either reinvesting these proceeds in other properties or dividending out the proceeds to our stockholders. On February 2, 2005, the board of directors announced the conclusion of its review of strategic alternatives. The board of directors determined that the interests of our stockholders would be best served by the company’s continuation as an independent, publicly traded REIT. As a result, we are continuing to operate in the office, service and industrial space, with a shift in focus to properties with multi-tenant configurations.  

Capitalization rates continue to remain low as the result of the large amount of capital available in the marketplace and the low cost of debt. While we have, in the past, been successful at acquiring properties that we believe will enhance our portfolio, it has become increasingly challenging to find properties that meet our target capitalization rate of 9%.  However, we will continue to evaluate, and may capitalize on, opportunities to acquire attractive properties or portfolios of properties as and when they arise.  To accomplish our goal of continuing to reposition ourselves as a multi-tenant REIT, we may also enter into complementary acquisitions of other businesses.

In addition, we intend to continue to sell selected properties in order to reposition our portfolio and to take advantage of the current low capitalization rates in the market.  Properties that will be considered for sale include those that we believe have reached their full potential and can produce a significant gain on sale.  As part of continuing to reposition ourselves as a multi-tenant REIT, we are also shifting our focus away from single-tenant properties to multi-tenant properties in an effort to reduce the vacancy risk associated with large, single-tenant buildings. As a result, we may also sell properties that do not meet our multi-tenant configuration criteria, as and when appropriate opportunities arise.

Development and Redevelopment

In response to decreasing demand for office and industrial space, our development activities over the past two years have been limited to our Jurupa Business Center project in Ontario, California. As of March 31, 2005, the 41,726 square-foot Phase I was 100% leased, and the 41,390 square-foot Phase II, which was shell complete in December 2002, was 91% leased. In October 2004, we completed construction on the final two phases. As of March 31, 2005, the 15,490 square-foot Phase III was 41% leased and the 24,805 square-foot Phase IV was 100% leased.  In total, the four phases of the Jurupa Business Center comprise 123,411 square feet and are 89% leased as of March 31, 2005.

In March 2004, we also began redevelopment of our approximately 334,000 square-foot five-building facility in Renton, Washington. The construction process for site work, shell enhancement, construction of lobbies, and the upgrade of common areas is expected to take place over a 48-month period. The construction is being completed in phases, with the completion and leasing of the buildings occurring during the 48-month period. Phase I of exterior and common area construction of this redevelopment project was completed in September 2004. Shortly thereafter, the first two leases, which commenced in the first quarter of 2005, were secured for 19,649 square feet, or 13% of the Phase I square footage.  In addition, a lease with a commencement date of August 2005 has been secured for an entire building in this complex, comprising 60,320 square feet.

 20

In April 2004, we purchased a 130,639 square-foot industrial building in Phoenix, Arizona with the intent to redevelop the property to accommodate the expansion requirements of one of our existing tenants in another property.  The redevelopment began in August 2004 and has an expected completion date in the second quarter of 2005 and an estimated redevelopment cost of approximately $7.8 million, of which approximately $3.3 million is being funded by us and approximately $4.5 million is being funded by the tenant.  

In September 2004, we purchased an 83,244 square-foot office/research and development property in Hillsboro, Oregon.  The property was acquired in shell complete condition with the intent to complete the final build-out and lease-up of the building.  The expected cost of development to bring this property to operating status is approximately $2.7 million over an 18-month period.

Capital Expenditures

We expect the higher than usual lease expirations in our portfolio that occurred during 2004 to continue throughout 2005. Prior to 2004, annual lease expirations in our portfolio ranged from approximately 12% to 15% of our annualized base rents. As of March 31, 2005, our expected remaining lease expirations for 2005 were 17% of annualized base rents. As a result, we have been incurring, and we expect to continue to incur, significant capital expenditures in 2005, including the costs of leasing commissions and tenant improvements related to renewing or replacing the expiring leases. In several instances, these lease expirations may occur in markets that have experienced considerable weakness due to job loss and excess inventory. This market weakness, combined with a higher level of lease expirations, may require us to incur more capital expenditures than we have experienced historically to renew or re-lease these spaces.

In addition, we are continuing to renovate two properties that were each leased by single tenants who did not renew their leases, which will also result in additional capital expenditures in 2005. These properties are 4601 DTC Boulevard in Denver, Colorado and Time Square in Renton, Washington. We believe that these renovations are necessary to render the properties competitive in their respective markets.  

The combination of these factors will require that we manage our capital resources carefully. We intend to closely monitor these situations and continually assess our actual expenditures against our planned expenditures. We believe that we will have sufficient funds to meet the needs of these situations. We plan to spend approximately $13 million in capital expenditures during the remainder of the year 2005.

Share Repurchases

Since the inception of our share repurchase program in November of 1998, we have repurchased a total of 8,515,981 shares of our common stock at an average cost of $19.26 per share, which represents 38% of the shares of common stock outstanding at November 1998. We intend to continue to repurchase shares of our common stock on the open market when the opportunities exist. Our share repurchase strategy takes into consideration several factors, including the dividend yield on our stock price, the cost of capital and its alternative uses, existing yields on potential acquisitions, market trading volume, trading regulations, and debt covenants. We currently have board approval to repurchase up to a total of 10 million shares of our common stock. During the three months ended March 31, 2005, we repurchased or acquired 30,074 shares of our common stock at an average price of $25.65. We acquired these shares from employees to satisfy payroll tax obliga tions upon the vesting of restricted stock.

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Occupancy and Rental Rates

As of March 31, 2005, our operating portfolio occupancy was at 89%, a 2 percentage point decrease from the 91% occupancy as of December 31, 2004. This decrease in occupancy is primarily due to the loss of a large tenant at our 4601 DTC Boulevard property in Denver, Colorado. Maintaining our occupancy rate has been our highest priority during this economic downturn. In order to retain tenants in the current market, we have sometimes found it necessary to negotiate lower current rental rates in exchange for extended terms, which we refer to as “blend and extend” leases. While this has a negative impact on our current income from operations, we believe the negative impact of losing good credit tenants in the long-term would surpass the immediate incremental loss due to reduced rental rates. We intend to continue this strategy in order to maximize our occupancy rate when a tenant's credit and other factors merit consideration of a “b lend and extend” lease. During the three months ended March 31, 2005, we renewed or re-leased 26 of 35 expiring leases or 47% of our expiring square footage and experienced a 10% decline in weighted average rental rates on these leases.

Leasing

Over the next three years, we will be facing significant lease rollovers. During the remainder of 2005, in 2006, and in 2007, leases representing 17%, 15%, and 16% of annualized base rent, respectively, will expire. As of March 31, 2005, the expirations as a percentage of annualized base rent by region are as follows:

 22

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP) requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We believe that our critical accounting policies are those that require significant judgments and estimates such as those related to valuation of real estate investments, classification of discontinued operations, accounting for development costs, revenue recognition and allowance for doubtful accounts, stock compensation expense, and qualification as a REIT, each of which is discussed in more detail below. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could vary from those estimates, and those estimates could be different under different assumptions or conditions.

Valuation of Real Estate Investments

Real estate investments are recorded at cost less accumulated depreciation. The cost of real estate includes the purchase price and other related acquisition costs. In accordance with Statement of Financial Accounting Standards (SFAS) 141, “Business Combinations,” a portion of the purchase price is allocated to tenant improvements and identifiable intangible assets or liabilities. For acquired properties with rental guarantees from the seller, amounts received under the rental guarantee are recorded as a reduction to the basis of the asset upon receipt. Expenditures for maintenance and repairs that do not add to the value or prolong the useful life of the property are expensed. Expenditures for asset replacements or significant improvements that extend the life or increase the property’s value are capitalized. Real estate properties are depreciated using the straight-line method over estimated useful lives. When circumstances suc h as adverse market conditions indicate an impairment of a property, we will recognize a loss to the extent that the carrying value exceeds the fair value of the property. The fair value of a property is determined by using an internally developed discounted cash flow analysis. The evaluation of the fair value of individual properties requires significant management judgments and assumptions that affect the amount of any impairment loss that we may recognize.  Significant changes in the facts and circumstances underlying these judgments and assumptions in future periods could cause significant impairment adjustments to be recorded.

The acquisition of real estate investments results in the allocation of a portion of the purchase price to tenant improvements and identifiable intangible assets or liabilities. Tenant improvements represent the tangible assets associated with the existing leases valued on a historical basis prorated over the remaining lease terms. They are classified as an asset under real estate investments and are depreciated over the remaining lease terms. Identifiable intangible assets and liabilities relate to the value of in-place operating leases as follows: (i) origination value, which represents the value associated with “cost avoidance” of acquiring in-place leases, such as lease commissions paid under terms generally experienced in our markets; (ii) value of in-place leases, which represents the estimated loss of revenue and of costs incurred for the period required to lease the “assumed vacant” property to the occupancy level wh en purchased; (iii) fair market value of acquired leases, which represents the difference between the contractual rents and market rents at the time of the acquisition, discounted for tenant credit risks; and (iv) value of tenant relationships, which reflects estimated future benefits from enhanced renewal probabilities and cost savings in lease commissions and tenant improvements. Origination value is recorded as an other asset and is amortized over the remaining lease terms. Value of in-place leases is recorded as an other asset and amortized over the average term of the acquired leases. Fair market value of acquired leases is classified as an other asset or liability, depending on whether the contractual terms are above or below market, and the asset or liability is amortized to rental revenue over the remaining terms of the leases. Value of tenant relationships is classified as an other asset and is amortized over the anticipated term of the customer relationship, not to exceed the remaining depreciable life of the building.

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Classification of Discontinued Operations

We record real estate investments that are considered held for sale at the lower of carrying amount or fair value less estimated costs to sell, and such properties are no longer depreciated. We classify real estate assets as held for sale in the period in which both of the following criteria are met:

§

management has obtained board approval to sell the asset, and

§

a letter of intent has been signed by an officer of the company and the buyer.

We present the net operating results of properties held for sale and sold during the year, less allocated interest expense, as income from discontinued operations for all periods presented. The gain on sale of operating properties sold, net of sale costs, is presented as income from discontinued operations. We allocate interest expense based on the percentage of the cost basis of each property held for sale and sold to the total cost basis of real estate assets as of the respective year-end, pro-rated for the number of days prior to sale.

Accounting for Development Costs

In accordance with SFAS 67, “Accounting for Costs and Initial Rental Operations of Real Estate,” costs associated with the development of real estate include acquisition and direct construction costs as well as capitalization of real estate taxes, insurance, incidental revenue and expenses, and a portion of salaries and overhead of personnel responsible for development activity.  In addition, we capitalize interest expense to the development projects according to SFAS 34, “Capitalization of Interest Cost.”  The amount of interest capitalized during a period is determined by applying the weighted average rate of our borrowings to the average accumulated costs, excluding interest, of the project. The capitalization of interest, real estate taxes, insurance, and incidental revenue and expenses begins when construction of a project commences and ends when a project or a portion of the project is placed in service, not to exceed twelve months from the cessation of construction activities. The capitalization of salaries and overhead of development personnel begins upon acquisition of a land parcel or upon commencement of active development for redevelopment and rehabilitation projects and ends with completion of the project.

Revenue Recognition and Allowance for Doubtful Accounts

Base rental income is recognized on a straight-line basis over the terms of the respective lease agreements. Differences between rental income recognized and amounts contractually due under the lease agreements are credited or charged, as applicable, to rent receivable. The amount of straight-line rent receivable is charged against income upon early termination of a lease or as a reduction of gain on sale of the property. In the event a tenant downsizes into a smaller space with reduced rent, a pro-rated amount of the straight-line rent receivable is charged against income based on square footage.  Lease termination income is recorded when we have an executed lease termination agreement with no further contractual obligations that must be met before the fee is due to us. If a tenant remains in the leased space following the execution of a definitive termination agreement, the applicable termination fees are deferred and recognized over the term of such tenant’s occupancy. In accordance with SFAS 141, “Business Combinations,“ a portion of the purchase price of acquired properties is allocated to the market value of in-place leases. The market value of in-place leases is classified as an other asset or liability and is amortized to rental income over the remaining terms of the leases. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required payments, which results in a reduction to income. Management determines the adequacy of this allowance by continually evaluating individual tenant receivables, taking into account the tenant’s financial condition, security deposits, any letters of credit, any lease guarantees, and current economic conditions.  Significant judgments and estimates must be made by management and used in connection with establishing this allowance in any accounting period.  In the event that the allowance for doubtful accounts is in sufficient to cover the actual amount of accounts that are subsequently written off in an accounting period, additional bad debt expense would be recognized as a current period charge in our income statement.

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Stock Compensation Expense

Beginning January 1, 2003, we voluntarily adopted the recognition provisions of SFAS 123, “Accounting for Stock-Based Compensation,” using the modified prospective method as prescribed in SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS 123.” The modified prospective method provides for the calculation of the compensation expense as if the fair value based accounting method had been used to account for all stock options granted in fiscal years after December 15, 1994. Management is required to make certain assumptions in calculating the amount of any stock-based compensation expense, including assumptions relating to the fair value of options.  In determining the fair value of options, we make assumptions about the future volatility of our stock, the expected term to exercise the options, the expected dividend yields, and the risk-free interest rate.  The underly ing assumptions affect amounts reported in future periods.

Qualification as a REIT

We have elected to be taxed as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended. A REIT is generally not subject to federal income tax on that portion of real estate investment trust taxable income that is distributed to stockholders, provided that at least 90% of such taxable income is distributed and other requirements are met. If we were to fail to qualify as a REIT, we would be, among other things, required to provide for federal income taxes on our income and reduce the level of distributions made to our stockholders.

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RESULTS OF OPERATIONS

Our operations consist of developing, owning and operating industrial and suburban office properties located primarily in the western United States.

The following table presents changes in our portfolio during the three months ended March 31, 2004 and during the period from April 1, 2004 through March 31, 2005:

⁽¹⁾

One 334,000 square-foot five-building office property was transferred from operating to development on March 1, 2004 as a redevelopment project. Two of the buildings from the five-building property were transferred to operating as lease-up properties in November 2004 and are included as two properties in redevelopment in the above table. One industrial property was acquired on April 21, 2004 as a redevelopment project.

⁽²⁾

One property was acquired on September 27, 2004 as a development project and is currently under lease-up.

⁽³⁾

Properties are included in development based on the date of shell completion.

Three Months Ended March 31, 2005 Compared with Three Months Ended March 31, 2004

Income from Operations

Income from operations, defined as rental income less rental expenses (which includes operating expenses, real estate taxes, depreciation and amortization, and general and administrative expenses), decreased $2,274,000 or 26% in the three months ended March 31, 2005 compared to the same period in 2004. This decrease is attributable to an increase in rental income of $887,000, offset by an increase in rental expenses of $3,161,000.

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The following table presents the change in income from operations for the three months ended March 31, 2005 compared with the same period in 2004, detailing amounts contributed by properties acquired, properties redeveloped, properties developed, and properties that remained stable during the period from January 1, 2004 to March 31, 2005 (in thousands):

⁺

Includes one five-building property transferred from operating to development on March 1, 2004, and one property acquired for redevelopment on April 21, 2004.

⁺⁺

Includes two properties with a shell completion date of October 18, 2004.

⁽¹⁾

Stabilized properties includes properties that were fully operating during the period.

The increase in rental income of $887,000 is primarily attributable to property acquisitions, offset by a decrease in rental income on stabilized properties. The decrease in rental income of $2,120,000 on the stabilized properties is generally attributable to decreased rental rates on new leases, renewed leases, and blend and extend leases, as well as decreased occupancy rates.

The increases in operating expenses of $885,000 or 24%, real estate taxes of $429,000 or 17%, and depreciation and amortization of $1,292,000 or 21% are primarily due to additional expenses incurred for properties acquired during 2004. The increase of $335,000 in operating expenses on the stabilized properties is primarily due to increased property management personnel costs including salaries, restricted stock expense, and incentive bonuses.

General and administrative expenses increased $555,000 or 37% in the first three months of 2005 compared to 2004, primarily as a result of increased personnel costs of approximately $418,000 for salaries, restricted stock expense, incentive bonuses, and employer 401(K) matching expense.

Interest Expense

Total interest expense decreased $596,000 from $6,121,000 in 2004 to $5,525,000 in 2005, primarily as a result of a lower weighted average outstanding balance on the line of credit as well as increased capitalized interest in 2005. Interest associated with continuing operations increased $334,000 or 7% in the first three months of 2005 compared with 2004 primarily due to a higher interest allocation to discontinued operations of $930,000 in the first quarter of 2004 as compared to the first quarter of 2005 as presented in the table below:

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Discontinued Operations

In December 2004, we sold four industrial properties in South San Francisco, California; one industrial property in Santa Rosa, California; one industrial property in Napa, California; two office properties in Seattle, Washington; one office property and a 4.3 acre parcel of land in San Diego, California; and an office building in Laguna Hills, California for net sale prices totaling $175,110,000, which resulted in an aggregate gain of $70,235,000. In January 2005, we sold an industrial property in San Diego, California for a sale price of $15,800,000, resulting in a gain of approximately $6,894,000. In addition, we recorded a gain of $250,000 from funds released from escrow in the first quarter of 2005 in connection with one of the properties we sold in December 2004. As of March 31, 2005, we classified five operating properties as held for sale in accordance with our policy. Net operating income relating to all of these properties is classifi ed as discontinued operations for all periods presented.

Dividends

Common stock dividends to stockholders declared for each of the first quarters of 2005 and 2004 were $0.51 per share. Quarterly dividends on our Series A preferred stock of $1.09375 per share were declared for each of the first quarters of 2005 and 2004. Quarterly dividends on our Series B preferred stock of $0.47656 per share were declared for the first quarter of 2005. The Series B preferred stock was issued in April 2004, and therefore there were no Series B dividends paid for the first quarter of 2004.

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LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

Operating Activities

Net cash provided by operating activities decreased approximately $7,928,000 to $4,254,000 for the three months ended March 31, 2005 as compared to $12,182,000 for the same period in 2004. This decrease was primarily due to decreased net operating income resulting from the sale of 11 operating properties in December 2004, as well as increased payments in 2005 for accrued expenses including bonuses paid in January 2005, decreased rents received as a result of decreased occupancy, and decreased rents received due to the redevelopment of our five-building complex in Renton, Washington, which commenced on March 1, 2004.   

Investing Activities

Net cash provided by investing activities increased approximately $13,570,000 to $11,437,000 for the three months ended March 31, 2005 as compared to cash used in investing activities of $2,133,000 for the same period in 2004. The increase in cash provided by investing activities was primarily due to net proceeds from the sale of an operating property in 2005 of approximately $15,777,000. These proceeds were offset by the acquisition of a land parcel in 2005 as well as increased spending on building improvements and tenant improvements on existing operating properties.

Financing Activities

Net cash used in financing activities increased approximately $26,839,000 to $35,511,000 for the three months ended March 31, 2005 as compared to $8,672,000 for the same period in 2004. The increase in cash used in financing activities was primarily due to increased dividend payments in 2005 for the special dividend resulting from 2004 gains on sales as well as dividends for the Series B preferred stock. These increases in cash used were partially offset by increased net borrowings on our credit facility to fund the special dividend.

Available Borrowings, Capital Resources, and Cash Balances

We expect to meet our long-term liquidity and capital requirements, such as funding capital expenditures, costs associated with lease renewals and re-leasing of space, the cost of acquisitions, repayment of indebtedness, share repurchases, development of properties, and dividends from:

-

cash flow from operations;

-

borrowings under our credit facility and, if available, other indebtedness which may include indebtedness assumed in acquisitions or the refinancing of existing indebtedness;

-

the sale of real estate investments; and

-

issuance of long-term debt and equity securities.

Our line of credit, which has a total commitment of $150 million plus an accordion feature for expansion of $50 million, had an outstanding balance of $30,875,000 and letters of credit issued and undrawn of $11,557,000 at March 31, 2005, leaving approximately $157,568,000 of available borrowing capacity. We anticipate utilizing this available borrowing capacity and/or sale proceeds from real estate assets to fund our investing activities in 2005, including estimated remaining development and redevelopment costs of approximately $28 million and estimated remaining capital expenditures of approximately $13 million.

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As of March 31, 2005, we had approximately $4,398,000 in cash and cash equivalents, including approximately $22,000 of restricted cash.  Restricted cash represents security deposits held in interest bearing cash deposit accounts in accordance with tenant leases. Unrestricted cash includes approximately $2,914,000 held in an investment account investing in money market instruments backed by U.S. government short-term securities. The balance of the unrestricted cash is in a demand deposit account which is used to fund our disbursements.

We anticipate that the cash flow generated by our real estate investments and funds available under our credit facility will be sufficient to meet our short-term liquidity requirements.

Debt Financing

Our ability to continue to finance operations is subject to several uncertainties. For example, our ability to obtain mortgage loans on income producing property is dependent upon our ability to attract and retain tenants and the economics of the various markets in which the properties are located, as well as the willingness of mortgage-lending institutions to make loans secured by real property. Approximately 93% of our real estate investments served as collateral for our existing mortgage indebtedness and available borrowing under our credit facility as of March 31, 2005. Our ability to sell real estate investments is partially dependent upon the ability of purchasers to obtain financing at reasonable commercial rates.

We currently have a revolving credit facility with a bank group led by Bank of America. The facility, which matures on March 31, 2007, consists of a $150 million secured line with an accordion feature that allows us at our option to expand the facility to $200 million, if needed. Interest on the facility is at a floating rate equal to either the lender’s prime rate or LIBOR plus a margin ranging from 1.30% to 1.75%, depending on our leverage level. As of March 31, 2005, the facility had an outstanding balance of $30,875,000 and an effective interest rate of 4.16%.

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Mortgage loans payable at March 31, 2005 consist of the following (in thousands):

⁺

Interest rates are fixed unless otherwise indicated by footnote.

⁽¹⁾

At maturity, the loan balance is expected to be paid in full with proceeds from asset sales and funding from our line of credit.

⁽²⁾

At maturity, the loan balance is expected to be paid in full with funding from our line of credit.

⁽³⁾

Floating rate based on 30-day LIBOR plus 1.40% (adjusted monthly). Effective July 3, 2003, the floating 30-day LIBOR rate was swapped to a fixed rate of 1.595% for an all-in rate of 2.995% until maturity.

⁽⁴⁾

Maturity date of November 1, 2005 represents the first of two interest rate reset dates, at which time we may opt to reject the new rate and pay the outstanding balance on the mortgage. The second interest rate reset date is November 1, 2008 with a final maturity date of November 1, 2011. We expect to accept the interest rate reset on November 1, 2005, extending the maturity date to November 1, 2008.

⁽⁵⁾

Floating rate based on LIBOR plus 1.60%. The current rate of 4.14% is fixed until May 19, 2005, at which time we have the option of fixing the LIBOR rate for a period of 1 month, 3 months, 6 months, or 12 months.

⁽⁶⁾

In addition, a letter of credit in the amount of $5,720,000 serves as security for this loan pending replacement of the Laguna Hills Square property sold in 2004, which previously served as collateral for this loan.

⁽⁷⁾

Floating rate based on a 12-month average of U.S. Treasury security yields plus 2.60% (adjusted semi-annually).

*

The two Sun Life Assurance Company mortgages are collateralized by a single property.

The 67 operating properties that served as collateral for our mortgages had a net book value of approximately $505,136,000 as of March 31, 2005. We were in compliance with the covenants and requirements of our various mortgage loans payable during the three months ended March 31, 2005 and during the year ended December 31, 2004.

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CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The following summarizes our contractual obligations and other commitments at March 31, 2005, and the effect such obligations could have on our liquidity and cash flow in future periods (in thousands):

RELATED PARTY TRANSACTIONS

We occasionally use the services of the law firm Bartko, Zankel, Tarrant & Miller of which a member of our Board of Directors, Martin I. Zankel, is a partner. During the three months ended March 31, 2004, we paid Bartko, Zankel, Tarrant & Miller approximately $200 in legal fees.  During the three months ended March 31, 2005, no payments were made to the firm.

OFF-BALANCE SHEET ARRANGEMENTS

At March 31, 2005 and December 31, 2004, we did not have any relationships with unconsolidated entities or financial partnerships, including entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Therefore, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we were engaged in such relationships.

As of March 31, 2005, we had outstanding undrawn letters of credit against our credit facility of approximately $11,557,000. The letters of credit were required by our various lenders as substitution for insurance and real estate impound accounts, as temporary substitution of collateral for a sold property, and as security for a vacancy in a property serving as collateral for a mortgage.

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POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS

Many factors affect our actual financial performance and may cause our future results to be different from past performance or trends. These factors include the following:

We could experience a reduction in rental income if we are unable to renew or re-lease space on expiring leases on current lease terms, or at all.

A significant portion of our leases is scheduled to expire in the near future. As of March 31, 2005, leases representing 17%, 15%, 16%, and 23% of our total annualized base rent were scheduled to expire during the remainder of 2005, and in 2006, 2007, and 2008, respectively. If the rental rates upon re-leasing or renewal of leases were significantly lower than current rates, or if we were unable to lease a significant amount of space on economically favorable terms, or at all, our results of operations could suffer. We are subject to the risk that, upon expiration, some of these or other leases will not be renewed, the space may not be re-leased, or the terms of renewal or re-leasing, including the costs of required renovations or concessions to tenants, may be less favorable than current lease terms. We could face difficulties re-leasing our space on commercially acceptable terms when it becomes available. In addition, we expect to incur costs in making improvements or repairs to our properties required by new or renewing tenants and expenses associated with brokerage commissions payable in connection with the re-leasing of space. Similarly, our rental income has in the past and could in the future be reduced by vacancies resulting from lease expirations or by rental rates that are less favorable than our current terms. If we are unable to promptly renew leases or re-lease space or if the expenses relating to tenant turnover are greater than expected, our financial results could be harmed.

Our leases with our 25 largest tenants generate approximately 39% of our base rent, and the loss of one or more of these tenants, as well as the inability to re-lease this space on equivalent terms, could harm our results of operations.

As of March 31, 2005, our 25 largest tenants accounted for approximately 39% of our total annualized base rent. In the event that one or more of our larger tenants were to vacate or not renew their lease with us, the re-leasing of the square footage previously leased by these tenants may require considerable capital expenditures and an indeterminate period of time. Losses of our larger tenants and our inability to re-lease vacated properties on favorable terms could limit our ability to make distributions to our stockholders.

A significant portion of our base rent is generated by properties in California, and our business could be harmed by an economic downturn in the California real estate market or a significant earthquake.

As of March 31, 2005, approximately 47% of our total annualized base rent was generated by our properties located in the State of California. As a result of this geographic concentration, a downturn in the performance of the commercial real estate markets and the local economies in various areas within California could adversely affect the value of these properties and the rental income from these properties and, in turn, our results of operations. In addition, the geographic concentration of our properties in California in close proximity to regions known for their seismic activity exposes us to the risk that our operating results could be harmed by a significant earthquake.

Future declines in the demand for commercial space in the greater San Francisco Bay Area could harm our results of operations and, consequently, our ability to make distributions to our stockholders.

Approximately 30% of our net operating income, including income from discontinued operations, for the three months ended March 31, 2005 was generated by our properties located in the greater San Francisco Bay Area. As a result, our business is somewhat dependent on the condition of the San Francisco Bay Area economy. The market for commercial space in the San Francisco Bay Area is recovering from of one of the most severe downturns of the past several decades. This downturn was precipitated by the unprecedented collapse of many technology and so-called “dot com” businesses that, during the 1998-2001 period, had been chiefly responsible for generating demand for, and increased prices of, local office properties. This downturn has harmed, and may continue to harm, our

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results of operations. In the event economic conditions in the San Francisco Bay Area fail to improve or worsen, it could harm the market value of our properties, the results derived from such properties and our ability to make distributions to our stockholders.

Real estate investments are inherently risky, and many of the risks involved are beyond our ability to control.

Real property investments are subject to numerous risks. The yields available from an equity investment in real estate depend on the amount of income generated and costs incurred by the related properties. If the properties in which we invest do not generate sufficient income to meet costs, including debt service, tenant improvements, third-party leasing commissions, and capital expenditures, our results of operations and ability to make distributions to our stockholders could suffer. Revenues and values of our properties may also be harmed by a number of other factors, some of which are beyond our control, including:

-

the national economic climate;

-

the local economic climate;

-

local real estate conditions, including an oversupply of space or a reduction in demand for real estate in an area;

-

the attractiveness of our properties to tenants;

-

competition from other available space;

-

our ability to provide adequate maintenance and insurance to cover other operating costs, government regulations and changes in real estate, zoning or tax laws, and interest rate levels;

-

the availability of financing; and

-

potential liabilities under environmental and other laws.

If our tenants experience financial difficulty or seek the protection of bankruptcy laws, our cash from operating activities could suffer.

Our commercial tenants may, from time to time, experience downturns in their business operations and finances due to adverse economic conditions, which may result in their failure to make rental payments to us on a timely basis or at all. Missed rental payments, in the aggregate, could impair our cash flows and, as a result, our ability to make distributions to our stockholders.

At any time, a tenant could seek the protection of the bankruptcy laws, which might result in the modification or termination of the tenant’s lease and cause a reduction in our cash flow. During the three months ended March 31, 2005, one of our tenants, representing less than 1% of our year-to-date base rent, had filed for bankruptcy. In the event of default by or bankruptcy of a tenant, we may experience delays in enforcing our rights as lessor and may incur substantial costs in protecting our investment. The default, bankruptcy, or insolvency of a few major tenants may harm us and our ability to pay dividends to our stockholders.

Our dependence on smaller businesses to rent office space could negatively affect our cash flow.

Many of the tenants in our properties operate smaller businesses that may not have the financial strength of larger corporate tenants. Smaller companies generally experience a higher rate of failure and are generally more susceptible to financial risks than large, well-capitalized enterprises. Dependence on these companies could create a higher risk of tenant defaults, turnover, and bankruptcies, all of which could harm our ability to pay dividends.

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The acquisition and development of real estate is subject to numerous risks, and the cost of bringing any acquired property to standards for its intended market position could exceed our estimates.

A significant portion of our leases is scheduled to expire in 2005. To supplement the losses in net operating income caused by the leasing turnover, we expanded our acquisitions program in 2003 and during the first ten months of 2004. Acquisitions totaled approximately $85.1 million in 2003 and $103.6 million in 2004. The goal of our acquisitions program was to purchase additional properties, the net operating income from which would supplement the declines in net operating income we have been experiencing and will experience from rental rate declines and from our high tenant turnover rate in 2004 and 2005. Due to the fact that we were unable to acquire sufficient properties that met our targets for return on investment at the end of 2004, we determined that we would focus instead on selling individual properties in the current seller-favorable market in order to supplement our net operating income with gains from sales. Following the conclusio n of our review of strategic alternatives, and as part of repositioning ourselves as a multi-tenant REIT, we intend to continue to pursue acquisitions of additional properties as opportunities arise. We may acquire industrial and suburban office properties and portfolios of these properties, which may include the acquisition of other companies and business entities owning the properties. Although we engage in due diligence review for each new acquisition, we may not be aware of all potential liabilities and problems associated with a property. We may have limited contractual recourse, or no contractual recourse, against the sellers of a property.

We may abandon development opportunities resulting in direct expenses to us.

From time to time, we may invest significant time and resources exploring development opportunities that we subsequently decide are not in our best interest. The costs of investigating these opportunities will still be considered a direct expense and may harm our financial condition.

Our uninsured or underinsured losses could result in a loss in value of our properties.

We currently maintain general liability coverage with primary limits of $1 million per occurrence and $2 million in the aggregate, as well as $40 million of umbrella/excess liability coverage. This coverage protects us against liability claims as well as the cost of legal defense. We carry property “All Risks” insurance of $200 million on a replacement value basis covering both the cost of direct physical damage and the loss of rental income. Separate flood and earthquake insurance is provided with an annual aggregate limit of $10 million, subject to a deductible of the greater of $100,000 or 5% of total insurable value per building and respective rent loss with respect to earthquake coverage. Additional excess earthquake coverage with an aggregate limit of $20 million is provided for properties located in California, which represent approximately 47% of our portfolio’s annualized base rent as of March 31, 2005. Some losses, including those due to acts of war, nuclear accidents, pollution, mold, or terrorism, may be either uninsurable or not economically insurable. However, we do presently carry insurance for terrorism losses as defined under the Terrorism Risk Insurance Act of 2002 under our “All Risks” property policies, liability policies, primary and umbrella/excess policies. In addition, “non-certified” terrorism coverage is provided under our property policy for losses in excess of $10 million up to the $200 million limit.

Some losses could exceed the limits of our insurance policies or could cause us to bear a substantial portion of those losses due to deductibles under those policies. If we suffer an uninsured loss, we could lose both our invested capital in and anticipated cash flow from the property while being obligated to repay any outstanding indebtedness incurred to acquire the property. In addition, a majority of our properties are located in areas that are subject to earthquake activity. Although we have obtained earthquake insurance policies for all of our properties, if one or more properties sustain damage as a result of an earthquake, we may incur substantial losses up to the amount of the deductible under the earthquake insurance policy and, additionally, to the extent that the damage exceeds the policy’s maximum coverage, we would not have insurance compensation for that portion of the losses. Although we have obtained owner’s title insu rance policies for each of our properties, the title insurance may be in an amount less than the current market value of some of the properties. If a title defect results in a loss that exceeds insured limits, we could lose all or part of our investment in, and anticipated gains, if any, from, the property. Furthermore, the current insurance market is characterized by rising premium rates, increasing deductibles, and more restrictive coverage language. Continued increases in the costs of insurance coverage or increased limits or exclusions in insurance policy coverage could negatively affect our financial results.

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If we fail to maintain our qualification as a real estate investment trust, we could experience adverse tax and other consequences, including the loss of deductibility of dividends in calculating our taxable income and the imposition of federal income tax at regular corporate rates.

We have elected to qualify as a real estate investment trust (REIT) under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended. We believe that we have been organized and have operated in a manner so as to have satisfied the REIT qualification requirements since 1985. However, the IRS could challenge our qualification as a REIT for taxable years still subject to audit, and we may fail to qualify as a REIT in the future.

Qualification as a REIT involves the application of highly technical and complex tax provisions, and the determination of various factual matters and circumstances not entirely within our control may have an impact on our ability to maintain our qualification as a REIT. For example, in order to qualify as a REIT, at least 95% of our gross income in any year must be derived from qualifying sources and we must make distributions to stockholders aggregating annually at least 90% of our REIT taxable income, excluding net capital gains. In addition, we cannot assure that new legislation, Treasury Regulations, administrative interpretations, or court decisions will not significantly change the tax laws with respect to our qualification as a REIT or the federal income tax consequences of such qualification. We are not aware of any proposal to amend the tax laws that would significantly and negatively affect our ability to continue to operate as a REIT .

If we fail to maintain our qualification as a REIT, or are found not to have qualified as a REIT for any prior year, we would not be entitled to deduct dividends paid to our stockholders and would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. In addition, unless entitled to statutory relief, we would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost. This treatment would reduce amounts available for investment or distribution to stockholders because of any additional tax liability for the year or years involved. In addition, we would no longer be required by the Internal Revenue Code to make any distributions. As a result, disqualification as a REIT would harm us and our ability to make distributions to our stockholders. To the extent that distributions to stockholders have been ma de in anticipation of our qualification as a REIT, we might be required to borrow funds or to liquidate investments to pay the applicable tax.

We must comply with strict income distribution requirements to maintain favorable tax treatment as a REIT. If our cash flow is insufficient to meet our operating expenses and the distribution requirements, we may need to incur additional borrowings or otherwise obtain funds to satisfy these requirements.

To maintain REIT status, we are required each year to distribute to our stockholders at least 90% of our REIT taxable income, excluding net capital gains. In addition, we are subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income and 95% of our capital gain net income for the calendar year plus any amount of such income not distributed in prior years. Although we anticipate that cash flow from operations will be sufficient to pay our operating expenses and meet the distribution requirements, we cannot assure you that this will occur, and we may need to incur borrowings or otherwise obtain funds to satisfy the distribution requirements associated with maintaining the REIT qualification. In addition, differences in timing between the receipt of income and payment of expenses in arriving at our taxable income could require us to incu r borrowings or otherwise obtain funds to meet the distribution requirements necessary to maintain our qualification as a REIT. We cannot assure you that we will be able to borrow funds or otherwise obtain funds if and when necessary to satisfy these requirements.

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As a REIT, we are subject to complex constructive ownership rules that limit any holder to 9.8% in value of our outstanding common and preferred stock, taken together. Any shares transferred in violation of this rule are subject to redemption by us and any such transaction is voidable.

To maintain REIT qualification, our charter provides that no holder is permitted to own more than 9.8% in value of our outstanding common and preferred stock, taken together, or more than 9.8% (in value or number) of our outstanding common stock. In addition, no holder is permitted to own any shares of any class of our stock if that ownership would cause more than 50% in value of our outstanding common and preferred stock, taken together, to be owned by five or fewer individuals, would result in our stock being beneficially owned by less than 100 persons or would otherwise result in our failure to qualify as a REIT. Acquisition or ownership of our common or preferred stock in violation of these restrictions results in automatic transfer of the stock to a trust for the benefit of a charitable beneficiary or, under specified circumstances, the violative transfer may be deemed void or we may choose to redeem the violative shares. Peter B. Bedford, our Chairman of the Board and Chief Executive Officer, is subject to higher ownership limitations than our other stockholders. Specifically, Mr. Bedford is not permitted to own more than 15% of the lesser of the number or value of the outstanding shares of our common stock.

The ownership limitations described above are applied using the constructive ownership rules of the Internal Revenue Code. These rules are complex and may cause common or preferred stock owned beneficially or constructively by a group of related individuals and/or entities to be constructively owned by one individual or entity. As a result, the acquisition of less than 9.8% of our outstanding common or preferred stock or the acquisition of an interest in an entity that owns our common or preferred stock by an individual or entity could cause that individual or entity or another individual or entity to constructively own stock in excess of the limits and subject that stock to the ownership restrictions in our charter.

If we fail to maintain an effective system of internal controls or discover material weaknesses in our internal controls over financial reporting, we may not be able to report our financial results accurately or detect fraud, which could harm our business and the trading price of our stock.

Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. We are required to periodically evaluate the effectiveness of the design and operation of our internal controls. These evaluations may result in the conclusion that enhancements, modifications or changes to our internal controls are necessary or desirable. While management evaluates the effectiveness of our internal controls on a regular basis, we cannot provide absolute assurance that these controls will always be effective.  There are inherent limitations on the effectiveness of internal controls including collusion, management override, and breakdowns in human judgment. Because of this, control procedures are designed to reduce rather than eliminate business risks. If we fail to maintain an effective system of internal control or if management or our independent registered public accounting f irm were to discover material weaknesses in our internal controls, we may be unable to produce reliable financial reports or prevent fraud and it could harm our financial condition and results of operations and result in loss of investor confidence and a decline in our stock price.

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We rely on the services of our key personnel, and their expertise and knowledge of our business would be difficult to replace.

We are highly dependent on the efforts of our senior officers.  While we believe that we could find suitable replacements for these key personnel, the loss of their services could harm our business.  On April 20, 2004, our board of directors announced that they had launched a search to replace Peter Bedford as our chief executive officer upon his retirement.  After conducting this search for several months and as a result of subsequent developments in the real estate market, in September 2004, the board of directors determined that it would be in the best interests of our stockholders to pursue various strategic alternatives, including a possible sale or merger of our company to a third party or selling certain of our assets. Based on this shift in strategy, the board requested, and Peter Bedford agreed, to defer his retirement and remain as our CEO while we evaluated and pursued these strategic alternatives. In connection with t he board's conclusion of its review of strategic alternatives in February 2005, the board decided to discontinue its previously suspended search for a successor candidate to serve as CEO and Peter Bedford's term of employment as CEO was extended until December 31, 2007. In addition, James Moore, our President and former chief operating officer, has also announced his intention to retire in July 2005. As a result, we have restructured our organization and Stephen M. Silla assumed the position of chief operating officer, effective January 31, 2005. Changes in our senior management and any future departures of key employees or other members of senior management could have a material adverse effect on our ability to implement our business strategy and on our results of operations.

The commercial real estate industry is highly competitive, and we compete with companies, including REITs, that may be able to purchase properties at lower capitalization rates than would be accretive for us.

We have historically sought to grow our asset base through the acquisition of industrial and suburban office properties and portfolios of these properties, as well as through the development of new industrial and suburban office properties. Many real estate companies, including other REITs, compete with us in making bids to acquire new properties. The level of competition to acquire income-producing properties is largely measured by the capitalization rates at which properties are trading. The capitalization rate is the annual yield that property produces on the investment. Currently, capitalization rates are low due to the amount of capital available for investment and attractive debt financing terms. As a result, we may not be able to compete effectively with companies, including REITs, that may be able to purchase properties at lower capitalization rates than would be accretive for us.

Many of our properties are located in markets with an oversupply of space, and our ability to compete effectively with other properties to attract tenants may be limited to the extent that competing properties may be newer, better capitalized or in more desirable locations than our properties.

Numerous industrial and suburban office properties compete with our properties in attracting tenants. Some of these competing properties are newer, better located, or better capitalized than our properties. Many of our investments are located in markets that have a significant supply of available space, resulting in intense competition for tenants and lower rents. We believe the oversupply of available space relative to demand has increased in recent years due to the softened U.S. economy. The number of competitive properties in a particular area could negatively impact our ability to lease space in the properties or at newly acquired or developed properties.

We could incur costs from environmental liabilities even though we did not cause, contribute to, or know about them.

Under various federal, state, and local laws, ordinances and regulations, an owner or operator of real estate may be held liable for the costs of removal or remediation of hazardous or toxic substances released on, above, under or in a property. These laws often impose liability regardless of whether the owner knew of, or was responsible for, the presence of the hazardous or toxic substances. In addition, environmental laws often impose liability on a previous owner of property for hazardous or toxic substances present during the prior ownership period. A transfer of the property may not relieve an owner of all liability. Accordingly, we could be liable for properties previously sold or otherwise divested. The costs of removal or remediation could be substantial. Additionally, the presence of the substances, or the failure to properly remove them, may harm our ability to borrow using the real estate as collateral.

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All of our properties have had Phase I environmental site assessments, which involve inspection without soil sampling or groundwater analysis, by independent environmental consultants and have been inspected for hazardous materials as part of our acquisition inspections. None of the Phase I assessments has revealed any environmental problems requiring material costs for clean up. The Phase I assessment for Milpitas Town Center, however, indicates that the groundwater under that property either has been or may in the future be, impacted by the migration of contaminants originating off-site. According to information available to us, the responsible party for this offsite source has been identified and has begun clean up. We do not believe that this environmental matter will impair the future value of Milpitas Town Center in any significant respect or that we will be required to fund any portion of the cost of remediation. We cannot assure you, ho wever, that these Phase I assessments or our inspections have revealed all environmental liabilities and problems relating to this or any other of our properties.

We believe that we are in compliance in all material respects with all federal, state, and local laws regarding hazardous or toxic substances. To date, compliance with federal, state, and local environmental protection regulations has not had a material effect on us. However, we cannot assure you that costs relating to the investigation and remediation of environmental issues for properties currently or previously owned by us, or properties that we may acquire in the future, or other expenditures or liabilities, including claims by private parties, resulting from hazardous substances present in, on, under, or above the properties or resulting from circumstances or other actions or claims relating to environmental matters, will not harm us and our ability to pay dividends to our stockholders.

Costs associated with moisture infiltration and resulting mold remediation may be significant.

Concern about indoor exposure to mold, fungi, and mycotoxins has been increasing because this exposure is allegedly linked to various adverse effects on health. Increasingly, insurance companies are excluding mold-related risks from their policy coverage, and it is now excluded from our coverage. Costs and potential liability stemming from tenant exposure to mold and the increased costs of renovating and remodeling buildings with exposure to mold could harm our financial position and results. We have in the past incurred costs for mold remediation in certain of our properties and may incur such costs in the future.

We could incur unanticipated costs to comply with the Americans with Disabilities Act, and any non-compliance could result in fines.

Under the Americans with Disabilities Act (the ADA), all public accommodations and commercial facilities are required to meet federal requirements related to access and use by disabled persons. Compliance with the ADA requires removal of access barriers, and any non-compliance may result in the imposition of fines by the U.S. government or an award of damages to private litigants. Although we believe that our properties are substantially in compliance with these requirements, in the future we may incur costs to comply with the ADA with respect to both existing properties and properties acquired in the future, which could limit our ability to make distributions to stockholders.

We are subject to numerous federal, state, and local regulatory requirements, and any changes to existing regulations or new laws may result in significant, unanticipated costs.

Our properties are, and any properties we may acquire in the future will be, subject to various other federal, state, and local regulatory requirements, including local building codes. Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. We believe that our properties are currently in substantial compliance with all applicable regulatory requirements, although expenditures at properties owned by us may be necessary to comply with changes in these laws. Although no material expenditures are contemplated at this time to comply with any laws or regulations, we cannot assure you that these requirements will not be changed or that new requirements will not be imposed that would require significant unanticipated expenditures by us, which could harm us and our ability to make distributions to our stockholders. Similarly, changes in laws increasing the p otential liability for environmental conditions existing on our properties could result in significant unanticipated expenditures.

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Our $150 million credit agreement and our mortgage loans are collateralized by approximately 93% of our total real estate assets, and in the event of default under any of these debt instruments, our lenders could foreclose on the collateral securing this indebtedness.

As of March 31, 2005, our $150 million credit facility was collateralized by mortgages on 20 properties that accounted for approximately 23% of our annualized base rent and approximately 21% of our total real estate assets. All of our mortgage loans were collateralized by 67 properties that accounted for approximately 73% of our annualized base rent and approximately 72% of our total real estate assets. If we fail to meet our obligations under the credit facility, the mortgage loans, or any other debt instruments we may enter into from time to time, including failure to comply with financial covenants, the holders of this indebtedness generally would be entitled to demand immediate repayment of the principal and to foreclose upon any collateral securing this indebtedness. In addition, default under or acceleration of any debt instrument could, pursuant to cross-default clauses, cause or permit the acceleration of other indebtedness. Any default or acceleration would harm us, jeopardizing our qualification as a REIT and threatening our continued viability. In addition, upon the sale of any property subject to a mortgage loan or which forms part of the collateral for our credit facility, we would be required to apply the proceeds of any such sale first to pay off any mortgage loan on the property or (to the extent the total value of the collateral securing our credit facility after such sale is less than the total amount outstanding under the credit facility) to pay down our credit facility, as applicable.

Our $150 million credit agreement and some of our mortgage loans carry floating interest rates, and increases in market interest rates could harm our results of operations.

As of March 31, 2005, our $150 million credit facility had an outstanding balance of approximately $30.9 million, and we had other outstanding floating rate loans of $35.9 million. Borrowings under our credit facility bear interest at a floating rate, and we may from time to time incur or assume other indebtedness also bearing interest at a floating rate. In that regard, our results of operations in recent years have benefited from low levels of interest rates. Should this trend in interest rates reverse itself, our operating results could be harmed.

We use borrowings to finance the acquisition, development and operation of properties and to repurchase our common stock, and we cannot assure you that financing will be available on commercially reasonable terms, or at all, in the future.

We borrow money to pay for the acquisition, development, and operation of our properties, to repurchase our common stock, and for other general corporate purposes. Our credit facility currently expires on March 31, 2007, when the principal amount of all outstanding borrowings must be paid. Since the term of our credit facility is limited, our ability to fund acquisitions and provide funds for working capital and other cash needs following the expiration or utilization of the credit facility will depend primarily on our ability to obtain additional private or public equity or debt financing.  Such financing may not be available to us on commercially reasonable terms, or at all, at the time we may require such financing.

A downturn in the economy could make it difficult for us to borrow money on favorable terms. If we are unable to borrow money on favorable terms, we may need to sell some of our assets at unfavorable prices in order to pay our loans. We could encounter several problems, including:

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insufficient cash flow to meet required payments of principal and interest;

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an increase on variable interest rates on indebtedness; and

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an inability to refinance existing indebtedness on favorable terms or at all.

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Our leverage could harm our ability to operate our business and fulfill our debt obligations.

We have significant debt service obligations. As of March 31, 2005, we had total liabilities of approximately $412.7 million, excluding unused commitments under our credit facility, and total stockholders’ equity of approximately $349.3 million. Payments to service our outstanding debt obligations during the three months ended March 31, 2005 totaled approximately $7.3 million. Our debt level increases the possibility that we could be unable to generate cash sufficient to pay the principal of, interest on, or other amounts due in respect of our indebtedness. In addition, we may incur additional debt from time to time to fund our stock buy back program, finance strategic acquisitions, investments, or for other purposes, subject to the restrictions contained in our debt instruments.

We have not used derivatives extensively to mitigate our interest rate risks.

Historically, we have not used interest rate swaps, caps and floors, or other derivative transactions extensively to help us mitigate our interest rate risks because we have determined that the cost of these transactions outweighed their potential benefits and could have, in some cases, jeopardized our status as a REIT. We have entered into a swap agreement to hedge our exposure to the variable interest rate on a mortgage with a remaining principal balance of approximately $11.4 million as of March 31, 2005. Even if we were to use derivative transactions more extensively, we would not be fully insulated from the prepayment and interest rate risks to which we are exposed. However, we do not have any policy that prohibits us from using derivative transactions or other hedging strategies more extensively in the future. If we do engage in additional derivative transactions in the future, we cannot assure you that a liquid secondary market will exis t for any instruments purchased or sold in those transactions, and we may be required to maintain a position until exercise or expiration, which could result in losses.

An increase in market interest rates could cause the respective prices of our common stock and preferred stock to decrease.

One of the factors that may influence the respective market prices of our shares of common stock and preferred stock will be the annual dividend yield on the price paid for shares of our common stock or preferred stock as compared to yields on other financial instruments. An increase in market interest rates may lead prospective purchasers of our stock to seek a higher annual yield from their investments, which may adversely affect the respective market prices of our common stock and preferred stock. As of March 31, 2005, interest rates in the U.S. remained relatively low.

We may incur additional indebtedness, which may harm our financial position and cash flow and potentially impact our ability to pay dividends.

Our existing debt instruments permit us to incur additional indebtedness and other liabilities, subject to the restrictions contained in those debt instruments. As of March 31, 2005, we had approximately $380.5 million of indebtedness outstanding. We may incur additional indebtedness and become more highly leveraged, which could harm our financial position and potentially limit our cash available to pay dividends. As a result, we may not have sufficient funds to satisfy our dividend obligations relating to our preferred stock or pay dividends on our common stock, if we assume additional indebtedness.

We cannot assure you that we will be able to pay dividends regularly although we have done so in the past.

Our ability to pay dividends in the future is dependent on our ability to operate profitably and to generate cash from our operations. Although we have done so in the past, we cannot guarantee that we will be able to pay dividends on a regular quarterly basis in the future. Furthermore, any new shares of common stock issued will substantially increase the cash required to continue to pay cash dividends at current levels. Any common stock or preferred stock that may in the future be issued to finance acquisitions, upon exercise of stock options or otherwise would have a similar effect. In addition, our existing credit facility covenants have specific limits regarding our ability to pay quarterly dividends to stockholders.

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Our ability to pay dividends is further limited by the requirements of Maryland law.

Our ability to pay dividends on our common stock and preferred stock is further limited by the laws of Maryland. Under the Maryland General Corporation Law, a Maryland corporation may not make a distribution if, after giving effect to the distribution, either the corporation would not be able to pay indebtedness of the corporation as the indebtedness becomes due in the usual course of business or the corporation’s total assets would be less than the sum of the corporation’s total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of stockholders whose preferential rights are superior to those receiving the distribution. Accordingly, we cannot make a distribution, except by dividend, on our common stock or preferred stock if, after giving effect to the distribution, our total assets would be less than the sum of our l iabilities plus the amount that would be needed to satisfy the preferential rights upon dissolution of the holders of any shares of preferred stock then outstanding, or if we would not be able to pay our indebtedness as it became due.

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FINANCIAL PERFORMANCE

Our Funds from Operations (FFO) during the three months ended March 31, 2005 was $7,247,000. During the same period in 2004, FFO was $11,644,000. Although FFO is not a financial measure calculated in accordance with accounting principles generally accepted in the United States of America (GAAP), we believe that FFO may be an appropriate alternative measure of the performance of an equity REIT. Presentation of this information provides the reader with an additional measure to compare the performance of equity REITs. FFO is generally defined by the National Association of Real Estate Investment Trusts as net income (loss) (computed in accordance with GAAP), excluding extraordinary items and gains (losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. We computed our FFO in accordance with this definition. FFO does not represent cash generated by operating acti vities in accordance with GAAP; it is not necessarily indicative of cash available to fund cash needs and should not be considered as an alternative to net income (loss) as an indicator of our operating performance or as an alternative to cash flow as a measure of liquidity. Furthermore, FFO as disclosed by other REITs may not be comparable to our presentation. The most directly comparable financial measure calculated in accordance with GAAP to FFO is net income available to common stockholders. The following table sets forth a reconciliation of the differences between our FFO and our net income available to common stockholders for the three months ended March 31, 2005 and 2004.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to interest rate changes primarily as a result of our line of credit and long-term debt used to maintain liquidity and fund capital expenditures and expansion of our real estate investment portfolio and operations. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, we balance our borrowings between fixed and variable rate debt. During 2003, we significantly increased our level of fixed rate debt to take advantage of historically low interest rates. While we have entered into interest swap agreements to minimize our exposure to interest rate fluctuations, we do not enter into derivative or interest rate transactions for speculative purposes.

We monitor our interest rate risk using a variety of techniques. The table below presents the principal amounts and related weighted average annual interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes (dollars in thousands):

As the table incorporates only those exposures that existed as of March 31, 2005, it does not consider those exposures or positions which could arise after that date. Moreover, because firm commitments are not presented in the table above, the information presented therein has limited predictive value. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, our hedging strategies at that time, and interest rates. If interest rates were to increase by 10%, or an average of 41 basis points, interest expense on our outstanding variable rate debt would increase by approximately $281,000 annually.

Item 4. Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, has conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of March 31, 2005. Based on that evaluation, the chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the quarter ended March 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings