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(ARDEN LOGO)



Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-Q

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

For the quarter ended June 30, 2004

Commission file number 000-30571

ARDEN REALTY LIMITED PARTNERSHIP

(Exact name of registrant as specified in its charter)
     
Maryland   95-4599813
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

11601 Wilshire Boulevard,
4th Floor
Los Angeles, California 90025-1740

(Address and zip code of principal executive offices)

Registrant’s telephone number, including area code: (310) 966-2600

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 Act).

Yes   [  ]   No   [X]

As of August 10, 2004 there were 67,180,170 shares of the registrant’s common operating partnership units issued and outstanding.



 


ARDEN REALTY LIMITED PARTNERSHIP
FORM 10-Q
TABLE OF CONTENTS

         
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 Exhibit 31.1
 Exhibit 32.1

 


Table of Contents

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Arden Realty Limited Partnership
Consolidated Balance Sheets
(in thousands, except unit amounts)

                 
    June 30,   December 31,
    2004
  2003
    (unaudited)    
Assets
               
Investment in real estate:
               
Land
  $ 467,325     $ 467,216  
Buildings and improvements
    2,184,023       2,122,216  
Tenant improvements and leasing commissions
    363,583       345,604  
 
   
 
     
 
 
 
    3,014,931       2,935,036  
Less: accumulated depreciation and amortization
    (483,022 )     (455,261 )
 
   
 
     
 
 
 
    2,531,909       2,479,775  
Properties under development
    8,769       75,627  
Land available for development
    23,749       23,723  
Properties held for disposition, net
    8,053       67,574  
 
   
 
     
 
 
Net investment in real estate
    2,572,480       2,646,699  
Cash and cash equivalents
    9,924       4,707  
Restricted cash
    13,655       19,694  
Rent and other receivables, net of allowance of $3,310 and $4,041 at June 30, 2004 and December 31, 2003, respectively
    5,522       3,688  
Due from general partner
          4,972  
Deferred rent, net of allowance of $1,782 and $2,216 at June 30, 2004 and December 31, 2003, respectively
    43,853       44,203  
Prepaid financing costs, expenses and other assets, net of accumulated amortization of $11,811 and $13,781 at June 30, 2004 and December 31, 2003, respectively
    22,201       22,442  
 
   
 
     
 
 
Total assets
  $ 2,667,635     $ 2,746,405  
 
   
 
     
 
 
Liabilities
               
Mortgage loans payable
  $ 386,632     $ 564,829  
Unsecured lines of credit
    282,000       161,000  
Unsecured term loan
    125,000       125,000  
Unsecured senior notes, net of discount
    497,349       498,952  
Accounts payable and accrued expenses
    48,535       54,317  
Security deposits
    23,089       22,321  
 
   
 
     
 
 
Total liabilities
    1,362,605       1,426,419  
 
   
 
     
 
 
Minority interest
    2,690       2,717  
Partners’ Capital
               
Preferred partner, 2,000,000 Series B Cumulative Redeemable Preferred Units outstanding at June 30, 2004 and December 31, 2003
    50,000       50,000  
General and limited partners, 67,180,170 and 66,113,119 common OP Units outstanding as of June 30, 2004 and December 31, 2003, respectively
    1,262,986       1,282,822  
Deferred compensation
    (14,448 )     (14,952 )
Accumulated other comprehensive income (loss)
    3,802       (601 )
 
   
 
     
 
 
Total partners’ capital
    1,302,340       1,317,269  
 
   
 
     
 
 
Total liabilities and partners’ capital
  $ 2,667,635     $ 2,746,405  
 
   
 
     
 
 

See accompanying notes to consolidated financial statements.

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Table of Contents

Arden Realty Limited Partnership
Consolidated Statements of Income
(in thousands, except per unit data)
(unaudited)

                                 
    Three Months Ended   Six Months Ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
Property revenues
  $ 105,398     $ 102,308     $ 209,877     $ 203,284  
Property operating expenses
    34,163       32,631       68,260       63,974  
 
   
 
     
 
     
 
     
 
 
 
    71,235       69,677       141,617       139,310  
General and administrative expenses
    4,665       3,391       9,149       6,595  
Interest expense
    21,184       23,254       44,497       46,289  
Depreciation and amortization
    31,936       29,487       62,212       57,895  
Interest and other loss (income)
    435       (149 )     (331 )     (253 )
 
   
 
     
 
     
 
     
 
 
Income from continuing operations before impairment on investment in securities and minority interest
    13,015       13,694       26,090       28,784  
Impairment on investment in securities
    (2,700 )           (2,700 )      
Minority interest
    (47 )     (33 )     (61 )     (56 )
 
   
 
     
 
     
 
     
 
 
Income from continuing operations
    10,268       13,661       23,329       28,728  
Discontinued operations
    (279 )     1,367       646       4,238  
Gain on sale of discontinued properties
    400       6,021       6,829       5,382  
 
   
 
     
 
     
 
     
 
 
Net income
  $ 10,389     $ 21,049     $ 30,804     $ 38,348  
 
   
 
     
 
     
 
     
 
 
Net income allocated to:
                               
Preferred partner
  $ 1,078     $ 1,078     $ 2,156     $ 2,156  
 
   
 
     
 
     
 
     
 
 
General and limited partner
  $ 9,311     $ 19,971     $ 28,648     $ 36,192  
 
   
 
     
 
     
 
     
 
 
Basic net income per common operating partnership unit:
                               
Income from continuing operations
  $ 0.14     $ 0.20     $ 0.32     $ 0.41  
Income from discontinued operations
    0.00       0.11       0.11       0.15  
 
   
 
     
 
     
 
     
 
 
Net income per common operating partnership unit – basic
  $ 0.14     $ 0.31     $ 0.43     $ 0.56  
 
   
 
     
 
     
 
     
 
 
Weighted average number of common operating partnership units – basic
    67,136       64,903       66,816       64,830  
 
   
 
     
 
     
 
     
 
 
Diluted net income per common operating partnership unit:
                               
Income from continuing operations
  $ 0.14     $ 0.20     $ 0.32     $ 0.41  
Income from discontinued operations
    0.00       0.11       0.11       0.15  
 
   
 
     
 
     
 
     
 
 
Net income per common operating partnership unit – diluted
  $ 0.14     $ 0.31     $ 0.43     $ 0.56  
 
   
 
     
 
     
 
     
 
 
Weighted average number of common operating partnership units – diluted
    67,430       65,132       67,173       64,976  
 
   
 
     
 
     
 
     
 
 

See accompanying notes to consolidated financial statements.

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Arden Realty Limited Partnership
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

                 
    Six Months Ended
    June 30,
    2004
  2003
Operating Activities:
               
Net income
  $ 30,804     $ 38,348  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Minority interest
    61       56  
Gain on sale of discontinued properties
    (6,829 )     (5,382 )
Impairment on investment in securities
    2,700        
Depreciation and amortization, including discontinued operations
    62,319       59,670  
Amortization of loan costs
    2,083       1,924  
Non-cash compensation expense
    1,531       837  
Changes in operating assets and liabilities:
               
Rent and other receivables
    (1,834 )     913  
Due from general partner
          (905 )
Deferred rent
    (1,982 )     89  
Prepaid financing costs, expenses and other assets
    (2,205 )     (3,662 )
Accounts payable and accrued expenses
    (4,911 )     (3,682 )
Security deposits
    876       512  
 
   
 
     
 
 
Net cash provided by operating activities
    82,613       88,718  
 
   
 
     
 
 
Investing Activities:
               
Improvements to commercial properties
    (47,367 )     (40,729 )
Proceeds from sale of properties
    68,284       78,719  
 
   
 
     
 
 
Net cash provided by investing activities
    20,917       37,990  
 
   
 
     
 
 
Financing Activities:
               
Repayments of mortgage loans
    (178,197 )     (2,090 )
Proceeds from unsecured lines of credit
    244,000       41,500  
Repayments of unsecured lines of credit
    (123,000 )     (92,087 )
Proceeds from issuance of common operating partnership units
    22,391       5,298  
Distributions to preferred operating partnership unit holders
    (2,156 )     (2,156 )
Decrease (increase) in restricted cash
    6,039       (211 )
Distributions to minority interests
    (78 )     (71 )
Distributions and redemptions paid to common operating partnership units
    (67,312 )     (65,389 )
 
   
 
     
 
 
Net cash used in financing activities
    (98,313 )     (115,206 )
 
   
 
     
 
 
Net increase in cash and cash equivalents
    5,217       11,502  
Cash and cash equivalents at beginning of period
    4,707       4,063  
 
   
 
     
 
 
Cash and cash equivalents at end of period
  $ 9,924     $ 15,565  
 
   
 
     
 
 
Supplemental Disclosure of Cash Flow Information:
               
Cash paid during the period for interest, net of amounts capitalized
  $ 44,069     $ 47,214  
 
   
 
     
 
 

See accompanying notes to consolidated financial statements.

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Arden Realty Limited Partnership
Notes to Consolidated Condensed Financial Statements
June 30, 2004
(unaudited)

1. Description of Business

     The terms “us”, “we” and “our” as used in this report refer to Arden Realty Limited Partnership. The term “Arden Realty” refers to Arden Realty, Inc.

   Organization and Formation of the Company

     We are an operating partnership that owns, manages, leases, develops, renovates and acquires commercial properties located in Southern California. Arden Realty, a real estate investment trust, or REIT, is our sole general partner and, as of June 30, 2004, owned 97.4% of our common operating partnership units, or common OP Units. Arden Realty conducts substantially all of its operations through us and our subsidiaries. Commencing with its taxable year ended December 31, 1996, Arden Realty has operated and qualified as a REIT for federal income tax purposes.

     As of June 30, 2004, our portfolio was comprised of 128 primarily suburban office properties, consisting of 210 buildings with approximately 18.8 million net rentable square feet. As of June 30, 2004, our operating portfolio was 89.6% occupied.

     Arden Realty’s interest in us entitles it to share in our cash distributions, and in our profits and losses in proportion to its percentage ownership. Certain individuals and entities own our remaining common OP Units, including Messrs. Ziman and Coleman, Arden Realty’s Chairman and Chief Executive Officer and President and Chief Operating Officer, respectively, together with other entities and persons. Each limited partner holding common OP Units is entitled to cause us to redeem the limited partner’s common OP Units for cash. We may, however, elect to exchange those common OP Units for shares of Arden Realty’s common stock on a one-for-one basis, subject to certain limitations, instead of paying cash. With each redemption or exchange of common OP Units, Arden Realty’s percentage interest in us will increase.

     As our sole general partner, Arden Realty generally has the exclusive power under our partnership agreement to manage us and conduct our business, subject to limited exceptions. Arden Realty’s board of directors manages our affairs. Our existence as a limited partnership cannot be terminated until 2096 without the approval of a majority of our partners or in connection with the sale of all or substantially all of our assets, a business combination, a judicial decree or the redemption of all the common OP Units held by our limited partners.

     We are a Maryland limited partnership. Arden Realty is a Maryland corporation. Arden Realty’s common stock is listed on the New York Stock Exchange under the symbol “ARI.”

2. Summary of Significant Accounting Policies

     Basis of Presentation

     The accompanying consolidated financial statements include our accounts and the accounts of Arden Realty and our subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

     We consolidate all entities for which we have controlling financial interest as measured by a majority of the voting interest. For entities in which the controlling financial interest is not clearly indicated by ownership of a majority of the voting interest, we would consolidate those entities that we control by agreement. We would also consolidate all variable interest entities for which we were the primary beneficiary.

     We and Arden Realty currently own 100% of all of our consolidated subsidiaries and we do not have any unconsolidated investments other than a $2.7 million investment in the securities of a non-publicly traded company (see Note 4). Because we do not control this company contractually nor exert significant influence over its operating and financial policies, we account for this investment under the cost method of accounting.

     Interim Financial Data

     The accompanying consolidated condensed financial statements should be read in conjunction with our 2003 Annual Report on Form 10-K as filed with the Securities and Exchange Commission. The accompanying financial information reflects all adjustments, which are, in our opinion, of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods. Interim results of operations are not necessarily indicative of the results to be expected for the full year.

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     Reclassifications

     Certain prior year amounts have been reclassified to conform with the current period presentation.

3. Property Dispositions

     We recovered a $400,000 environmental reserve during the second quarter of 2004 relating to the approximate 133,000 square foot retail property located in Riverside County which was sold in the first quarter of 2004. This amount has been included in the gain on sale of discontinued properties line item in our consolidated statements of income.

4. Non-Real Estate Investments

     During the three months ended June 30, 2004, an impairment of $2.7 million was recognized in conjunction with our investment in the securities of a non-publicly traded company that provides distributed energy generation to commercial property owners. This impairment represents our entire investment in this company.

     We recorded this impairment after analyzing information received from this company over the past several months regarding their current business and financial strategies which indicated to us that the recoverability of our investment is doubtful.

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5. Outstanding Indebtedness

     A summary of our outstanding indebtedness as of June 30, 2004 and December 31, 2003 is as follows:

                                     
                    Stated Annual            
                    Interest Rate at       Number of    
    June 30,   December 31,   June 30,   Rate   Properties    
Type of Debt
  2004
  2003
  2004
  Fixed/Floating
  Securing Loan
  Maturity
    (in thousands)                    
Mortgage Loans Payable:
                                   
Fixed Rate
                                   
Mortgage Financing I(1)
  $     $ 175,000        —%          
Mortgage Financing III(2)
    133,624       134,544     6.74%   Fixed   22     4/08  
Mortgage Financing IV(2)
    109,229       109,960     6.61%   Fixed   12     4/08  
Mortgage Financing V(2)
    104,723       105,899     6.94%   Fixed   12     4/09  
Mortgage Financing VI(2)
    21,472       21,578     7.54%   Fixed      3     4/09  
Activity Business Center(2)
    7,317       7,394     8.85%   Fixed      1     5/06  
145 South Fairfax(2)
    3,891       3,912     8.93%   Fixed      1     1/27  
Marin Corporate Center(2)
    2,656       2,724     9.00%   Fixed      1     7/15  
Conejo Business Center(2)
    2,602       2,669     8.75%   Fixed   (Note 3)     7/15  
Conejo Business Center(2)
    1,118       1,149     7.88%   Fixed   (Note 3)     7/15  
 
   
 
     
 
                     
 
    386,632       564,829                      
Unsecured Lines of Credit:
                                   
Floating Rate
                                   
Wells Fargo — $310 mm(4)
    272,000       158,000     2.54%   LIBOR + 0.90% (Notes 5,6)       4/06  
City National Bank — $20 mm(4)
    10,000       3,000     2.13%   (Note 7)       8/04  
 
   
 
     
 
                     
 
    282,000       161,000                      
Unsecured Term Loan:
                                   
Fixed Rate
                                   
Wells Fargo — $125 mm(4)
    125,000       125,000     4.14%   Fixed (Note 8)       6/06  
Unsecured Senior Notes:
                                   
Fixed Rate
                                   
2005 Notes(9)
    199,923       199,872     8.88%   Fixed       3/05  
2007 Notes(9)
    148,190       149,907     7.00%   (Note 10)       11/07  
2010 Notes(9)
    49,765       49,744     9.15%   Fixed       3/10  
2010 Notes(9)
    99,471       99,429     8.50%   Fixed       11/10  
 
   
 
     
 
                     
 
    497,349       498,952                      
 
   
 
     
 
                     
Total Debt
  $ 1,290,981     $ 1,349,781                      
 
   
 
     
 
                     


(1)   This mortgage financing was repaid in full on April 9, 2004 with proceeds from recent asset dispositions and funds from our unsecured lines of credit.
 
(2)   Requires monthly payments of principal and interest.
 
(3)   Both mortgage loans are secured by the Conejo Business Center property.
 
(4)   Requires monthly payments of interest only, with outstanding principal balance due upon maturity.
 
(5)   This line of credit also has an annual 20 basis point facility fee on the entire $310 million commitment amount. In June 2004, we amended this line of credit to reduce the interest rate from LIBOR + 1.00% to LIBOR + 0.90%.
 
(6)   We have entered into interest rate swap agreements that fixed the interest rate on $50 million of the outstanding balance on this line of credit at 3.95% through April of 2006.
 
(7)   In December 2003, we expanded this line of credit to $20 million at an interest rate of LIBOR + 1.00% or Prime Rate – 1.875%.
 
(8)   In 2002, we entered into interest rate swap agreements that fixed the interest rate on the entire balance of this loan. In June 2004, we amended this loan to reduce its effective interest rate by 20 basis points. After this amendment and after taking into effect the interest rate swap agreements for this loan, it will have an effective interest rate of approximately 4.14% for the remainder of 2004, 4.55% in 2005 and 4.70% in 2006.
 
(9)   Requires semi-annual interest payments only, with principal balance due upon maturity.
 
(10)   During the fourth quarter of 2003, we entered into interest rate swap agreements to float the interest rate on $100 million of the outstanding balance of these notes at a rate of LIBOR + 3.1% through November of 2007. Including these swap agreements, the effective interest rate on these notes was approximately 6.20% as of June 30, 2004.

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6. Interest Rate Swap Agreements

     We have entered into interest rate swap agreements to effectively convert floating rate debt into fixed rate debt, to convert fixed rate debt to floating rate debt and to lock the current Treasury rate in anticipation of future debt issuances. Net amounts received or paid under these agreements are recognized as an adjustment to interest expense when such amounts are incurred or earned. Our objective in using interest rate swap agreements is to manage our exposure to interest rate movements.

     During 2002, such agreements were used to fix the floating interest rate associated with $50 million of the Wells Fargo unsecured line of credit and the entire $125 million balance of the unsecured term loan. Since June of 2003, we have also entered into $150 million of forward-starting swaps that effectively fixed the 10-year Treasury rate at an average rate of approximately 4.1% for borrowings that are anticipated to occur in 2004 to refinance some of our scheduled debt maturities. The forward-starting interest rate swaps were entered into at current market rates and, therefore, had no initial cost.

     In October and November of 2003, we also entered into reverse interest rate swap agreements to float $100 million of the fixed interest rate associated with the 7.00% senior unsecured notes due in November of 2007. Under these reverse swaps, we will receive interest at a fixed rate of 7.00% and pay interest at a variable rate averaging six-month LIBOR in arrears plus 3.10%. The interest rate swaps mature at the same time the notes are due. These swaps qualify as fair value hedges for accounting purposes. Net semi-annual interest payments will be recognized as increases or decreases in interest expense. The fair value of the interest rate swaps will be recognized on our balance sheet and the carrying value of the senior unsecured notes will be increased or decreased by an offsetting amount.

     Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), as amended and interpreted, establishes accounting and reporting standards for derivative instruments and for hedging activities. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

     For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (loss), outside of earnings and subsequently recognized to earnings when the hedged transaction affects earnings.

     Under SFAS 133, our $175 million in floating-to-fixed swaps and our $150 million in forward-starting swaps outstanding as of June 30, 2004 are classified as cash flow hedges with their fair value of approximately $3.8 million reported in accumulated other comprehensive income on our balance sheet. The estimated fair value of these interest rate swap agreements are dependent on changes in market interest rates and other market factors that affect the value of such agreements. Consequently, the estimated current fair value may significantly change during the term of the agreements. Any estimated gain or loss from these agreements will be amortized into earnings as we recognize the interest expense for the underlying floating-rate loans at the fixed interest rate provided under our agreements in the case of the fixed-to-floating swaps or as part of interest expense for future borrowings in the case of the forward starting swaps. If the underlying debt related to these swaps were to be repaid prior to maturity, we would recognize into interest expense any unamortized gain or loss at the time of such early repayment.

     Under SFAS 133, our $100 million in fixed-to-floating hedges are classified as fair value hedges with their fair value of approximately $1.3 million reported in both the unsecured senior notes and accounts payable and accrued expenses line items on our balance sheet. The estimated fair value of these interest rate hedge agreements are dependent on changes in market interest rates and other market factors that affect the value of such agreements. Consequently, the estimated current fair value may significantly change during the term of the agreements. Any estimated gain or loss from these agreements will be amortized into earnings as we recognize the interest expense for the underlying fixed-rate loan at the floating interest rate provided under our agreements in the case of the floating-to-fixed hedges. If the underlying debt related to these hedges were to be repaid prior to maturity, we would recognize into interest expense any unamortized gain or loss at the time of such early repayment.

7. Partners’ Capital

     A common Operating Partnership unit, or common OP Unit, and a share of Arden Realty’s common stock have essentially the same economic characteristics as they share equally in the total net income or loss and distributions. A common OP Unit may be redeemed for cash or, at our election, for shares of Arden Realty’s common stock on a one-for-one basis.

     Included in our partner’s capital balance is $50 million of 8.625% Series B Cumulative Redeemable Preferred Operating Partnership Units, or Preferred OP Units. These Preferred OP Units were issued in September of 1999, are callable by us after September 2004 and are exchangeable after ten years by the holder into our 8.625% Series B Cumulative Redeemable Preferred Stock, on a one-for-one basis. The Preferred OP Units and Series B Cumulative Redeemable Preferred Stock have no stated maturity or mandatory redemption and are subordinate to all debt.

     On April 21, 2004, we made a distribution of $0.505 per common operating partnership unit. In addition, on June 30, 2004, we made a distribution of approximately $1.1 million to our preferred unit holders.

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8. Revenue from Rental Operations and Property Expenses

     Revenue from rental operations and property expenses for properties held for use are summarized as follows (in thousands):

                                 
    Three Months Ended   Six Months Ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
Revenue from Rental Operations:
                               
Scheduled cash rents
  $ 90,962     $ 88,776     $ 181,494     $ 176,946  
Straight-line rents
    448       114       1,340       493  
Tenant reimbursements
    4,850       5,138       9,603       11,175  
Parking, net of expenses
    6,121       5,525       11,821       10,648  
Other rental operations
    3,017       2,755       5,619       4,022  
 
   
 
     
 
     
 
     
 
 
 
  $ 105,398     $ 102,308     $ 209,877     $ 203,284  
 
   
 
     
 
     
 
     
 
 
Property Expenses:
                               
Repairs and maintenance
    11,529       10,671       22,870       20,709  
Utilities
    8,083       7,934       15,650       15,817  
Real estate taxes
    7,875       7,041       15,896       14,317  
Insurance
    1,994       2,030       4,055       4,104  
Ground rent
    207       322       332       364  
Administrative
    4,475       4,633       9,457       8,663  
 
   
 
     
 
     
 
     
 
 
 
    34,163       32,631       68,260       63,974  
 
   
 
     
 
     
 
     
 
 
 
  $ 71,235     $ 69,677     $ 141,617     $ 139,310  
 
   
 
     
 
     
 
     
 
 

9. Income (Loss) from Taxable REIT Subsidiary

     Beginning in the first quarter of 2004, we have reclassified for financial presentation purposes the operating results of Nextedge, our taxable REIT subsidiary, or TRS, from general and administrative expenses to interest and other income (loss) in our consolidated statements of income. Nextedge provides energy consulting services to commercial real estate owners. The following is a breakdown of the components of interest and other income (loss) for each of the periods presented (in thousands):

                                 
    Three Months Ended   Six Months Ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
Net income (loss) from TRS
  $ (517 )   $ (229 )   $ 121     $ (257 )
Interest and other income
    82       378       210       510  
 
   
 
     
 
     
 
     
 
 
 
  $ (435 )   $ 149     $ 331     $ 253  
 
   
 
     
 
     
 
     
 
 

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10. Stock Option Plan

     Beginning on January 1, 2003, we adopted the provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” under which we began expensing the costs of new stock options granted to employees in 2003 in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation.” We used the Black-Scholes option valuation model to estimate the fair value of the stock options granted. During the three months ended June 30, 2004 and June 30, 2003, we expensed approximately $8,000 of stock option based employee compensation costs.

     The following table reflects pro forma net income and earnings per share had we elected to expense all options granted by Arden Realty prior to 2003 assuming the fair value method and using the Black-Scholes option valuation model (in thousands, except per share amounts):

                                 
    Three Months Ended   Six Months Ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
Net income allocated to general and limited partners, as reported
  $ 9,311     $ 19,971     $ 28,648     $ 36,192  
Stock based employee compensation costs for options granted prior to 2003 assuming fair value method
    (77 )     (259 )     (154 )     (523 )
 
   
 
     
 
     
 
     
 
 
Net income allocated to general and limited partners, as adjusted
  $ 9,234     $ 19,712     $ 28,494     $ 35,669  
 
   
 
     
 
     
 
     
 
 
Earnings per share:
                               
Basic as reported
  $ 0.14     $ 0.31     $ 0.43     $ 0.56  
 
   
 
     
 
     
 
     
 
 
Basic as adjusted
  $ 0.14     $ 0.30     $ 0.43     $ 0.55  
 
   
 
     
 
     
 
     
 
 
Diluted as reported
  $ 0.14     $ 0.31     $ 0.43     $ 0.56  
 
   
 
     
 
     
 
     
 
 
Diluted as adjusted
  $ 0.14     $ 0.30     $ 0.42     $ 0.55  
 
   
 
     
 
     
 
     
 
 

11. Comprehensive Income

     Comprehensive income represents net income, plus the results of certain non-shareholders’ equity changes not reflected in the Consolidated Statements of Income. The components of comprehensive income are as follows (in thousands):

                                 
    Three Months Ended   Six Months Ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
Net income
  $ 10,389     $ 21,049     $ 30,804     $ 38,348  
Other comprehensive income (loss):
                               
Unrealized derivative gain (loss) on cash flow hedges
    12,451       (1,812 )     4,403       (2,909 )
 
   
 
     
 
     
 
     
 
 
Comprehensive income
  $ 22,840     $ 19,237     $ 35,207     $ 35,439  
 
   
 
     
 
     
 
     
 
 

12. Commitments and Contingencies

     We are presently subject to various lawsuits, claims and proceedings arising in the ordinary course of business, none of which if determined unfavorably to us is expected to have a material adverse effect on our cash flows, financial condition or results of operations. There were no material changes in our legal proceedings during the three months ended June 30, 2004.

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

Overview

     The following discussion relates to our unaudited consolidated financial statements included herein, which should be read in conjunction with the financial statements and related notes thereto included elsewhere in this Form 10-Q and in our 2003 Annual Report on Form 10-K.

     This form 10-Q, including the documents incorporated herein by reference, contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act pertaining to, among other things, our future results of operations, cash available for distribution, acquisitions, lease renewals, property development, property renovation, capital requirements and general business, industry and economic conditions applicable to us. Also, documents we subsequently file with the SEC and incorporated herein by reference will contain forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and the matters set forth or incorporated in this form 10-Q generally. We caution you, however, that this list of factors may not be exhaustive, particularly with respect to future filings.

     We are an operating partnership that owns, manages, leases, develops, renovates and acquires commercial properties located in Southern California. We are managed by 7 senior executive officers who have experience in the real estate industry ranging from 13 to 34 years and who collectively have an average of 19 years experience. We perform all property and development management, accounting, finance and acquisition, disposition activities and a majority of our leasing transactions with our staff of approximately 300 employees.

     As of June 30, 2004, Arden Realty, our general partner, was Southern California’s largest publicly traded office landlord as measured by total net rentable square feet owned. As of that date, our portfolio was comprised of 128 primarily suburban office properties, consisting of 210 buildings with approximately 18.8 million net rentable square feet. As of June 30, 2004 and December 31, 2003, our operating portfolio was 89.6% and 90.4% occupied, respectively.

Business Strategy

     Our primary business strategy is to actively manage our portfolio to seek to achieve gains in rental rates and occupancy, control operating expenses and maximize income from ancillary operations and services. When market conditions permit, we may also renovate existing or new properties or selectively develop or acquire new properties that add value and fit strategically into our portfolio. We may also sell existing properties and place the proceeds into investments we believe will generate higher long-term value.

     We continue to seek to build a tenant base of smaller, diverse companies that limits our exposure to any single tenant or industry. Smaller tenants typically translate into shorter-term leases. Shorter-term leases provide greater opportunity for renewing a substantial portion of our portfolio at higher rental rates each year during strong markets, but create challenges to maintain occupancy and rates when markets weaken. The average term of our leases is 4 to 5 years, resulting in approximately 15% to 20% of our leases expiring annually.

     We closely monitor our operating expenses and capital expenditures to sustain or improve operating margins and dividend coverage. We may defer discretionary operating expenses and capital expenditures until market conditions improve.

Impact of Economic Climate

     Our short and long-term liquidity, ability to refinance existing indebtedness, ability to issue long-term debt and equity securities at favorable rates and our dividend policy are significantly impacted by the operating results of our properties, all of which are located in Southern California. Our ability to lease available space and increase rates when leases expire is largely dependent on the demand for office space in the markets where our properties are located.

     The timing and extent of future changes in the national and local economy and their effects on our properties and results of operations are difficult to accurately predict. It is likely, however, that if national and regional economic conditions deteriorate they would directly affect our operating results in the future, making it more difficult for us to lease and renew available space, to increase or maintain rental rates as leases expire and to collect amounts due from our tenants. For additional information, see “Risk Factors – Further declines in the economic activity of Southern California will adversely affect our operating results,” “– The financial condition and solvency of our tenants may reduce our cash flow,” and “– Rising energy costs and power outages in California may have an adverse effect on our operations and revenue,” in our 2003 Annual Report on Form 10-K.

Critical Accounting Policies

     Refer to our 2003 Annual Report on Form 10-K for a discussion of our critical accounting policies, which include, among other things, revenue recognition, allowance for doubtful accounts and depreciation. There have been no material changes to these policies in 2004.

Off-Balance Sheet Arrangements

     As of June 30, 2004, there are no off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have a current or future material effect on our financial condition, changes in our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

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RESULTS OF OPERATIONS

     Our financial position and operating results primarily relate to our portfolio of commercial properties and income derived from those properties. Therefore, the comparability of financial data from period to period will be affected by the timing of property developments, acquisitions and dispositions.

Comparison of the three months ended June 30, 2004 to the three months ended June 30, 2003
(in thousands, except number of properties and percentages):

                                 
    Three Months Ended        
    June 30,
      Percent
    2004
  2003
  Change
  Change
Total Portfolio:
                               
Revenue from rental operations:
                               
Scheduled cash rents
  $ 90,962     $ 88,776     $ 2,186       3 %
Straight-line rents
    448       114       334       293  
Tenant reimbursements
    4,850       5,138       (288 )     (6 )
Parking, net of expense
    6,121       5,525       596       11  
Other rental operations
    3,017       2,755       262       10  
 
   
 
     
 
     
 
     
 
 
Total revenue from rental operations
    105,398       102,308       3,090       3  
 
   
 
     
 
     
 
     
 
 
Property expenses:
                               
Repairs and maintenance
    11,529       10,671       858       8  
Utilities
    8,083       7,934       149       2  
Real estate taxes
    7,875       7,041       834       12  
Insurance
    1,994       2,030       (36 )     (2 )
Ground rent
    207       322       (115 )     (36 )
Administrative
    4,475       4,633       (158 )     (3 )
 
   
 
     
 
     
 
     
 
 
Total property expenses
    34,163       32,631       1,532       5  
 
   
 
     
 
     
 
     
 
 
Property Operating Results (1)
    71,235       69,677       1,558       2  
General and administrative
    4,665       3,391       1,274       38  
Interest expense
    21,184       23,254       (2,070 )     (9 )
Depreciation and amortization
    31,936       29,487       2,449       8  
Interest and other loss (income)
    435       (149 )     584       392  
 
   
 
     
 
     
 
     
 
 
Income from continuing operations before impairment on investment in securities and minority interest
  $ 13,015     $ 13,694     $ (679 )     (5 )%
 
   
 
     
 
     
 
     
 
 
Discontinued operations
  $ (279 )   $ 1,367     $ (1,646 )     (120 )%
 
   
 
     
 
     
 
     
 
 
Number of Properties:
                               
Disposed of during period
          (5 )                
Completed and placed in service during period
    1                        
In service at end of period
    128       130                  
Net Rentable Square Feet:
                               
Disposed of during period
          (376 )                
Completed and placed in service during period
    283                        
In service at end of period
    18,785       18,617                  
Same Property Portfolio(2):
                               
Revenue from rental operations
  $ 103,167     $ 102,189     $ 978       1 %
Property expenses
    33,296       32,426       870       3  
 
   
 
     
 
     
 
     
 
 
 
  $ 69,871     $ 69,763     $ 108       %
 
   
 
     
 
     
 
     
 
 
Straight-line rents
  $ 65     $ 118     $ (53 )     (45 )%
 
   
 
     
 
     
 
     
 
 
Number of non-development properties
    126                          
Number of buildings
    207                          
Average occupancy
    89.1 %     88.9 %                
Net rentable square feet
    18,299                          


(1)   Property Operating Results is commonly used by investors to evaluate the performance of REITs, to determine trends in earnings and to compute the fair value of properties as it is not affected by (1) the cost of funds of the property owner or (2) the impact of depreciation and amortization expenses as well as gains or losses from the sale of operating real estate assets that are included in net income computed in accordance with Generally Accepted Accounting Principles, or GAAP. The first factor is commonly eliminated from net income because it is specific to the particular financing capabilities and constraints of the owner. The second factor is commonly eliminated because it may not accurately represent the actual change in value in real estate properties that results from use or changes in market conditions. We believe that eliminating these costs from net income gives investors an additional

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    measure of operating performance that, when used as an adjunct to net income computed in accordance with GAAP, can be a useful measure of our operating results.
 
    Property Operating Results captures trends in occupancy rates, rental rates and operating costs. However, Property Operating Results excludes general and administrative costs, interest expense, interest income, depreciation and amortization expense and gains or losses from the sale of properties, changes in value in our real estate properties that result from use or permanent impairment to carrying costs as stipulated by GAAP, the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, all of which are significant economic costs. Therefore, Property Operating Results may fail to capture significant trends which limits its usefulness.
 
    Property Operating Results is a non-GAAP measure of performance. Property Operating Results is not a substitute for net income as computed in accordance with GAAP. It excludes significant expense components such as depreciation and amortization expense and financing costs. This measure should be analyzed in conjunction with net income and cash flow from operating activities as computed in accordance with GAAP. Other companies may use different methods for calculating Property Operating Results or similarly entitled measures and, accordingly, our Property Operating Results may not be comparable to similarly entitled measures reported by other companies that do not define the measure exactly as we do.
 
    The following is a reconciliation of net income computed in accordance with GAAP to Property Operating Results (in thousands):

                 
    Three Months Ended June 30,
    2004
  2003
Net income
  $ 10,389     $ 21,049  
Add:
               
General and administrative expense
    4,665       3,391  
Interest expense
    21,184       23,254  
Depreciation and amortization
    31,936       29,487  
Minority interest
    47       33  
Interest and other loss
    435        
Discontinued operations
    279        
Impairment on investment in securities
    2,700        
Less:
               
Interest and other income
          (149 )
Gain on sale of discontinued properties
    (400 )     (6,021 )
Discontinued operations
          (1,367 )
 
   
 
     
 
 
Property Operating Results
  $ 71,235     $ 69,677  
 
   
 
     
 
 

(2)   Consists of non-development properties classified as part of continuing operations and owned for the entirety of the periods presented.

VARIANCES FOR RESULTS OF OPERATIONS

     Our Property Operating Results for the three months ended June 30, 2004 compared to the same period in 2003 were primarily affected by our acquisitions, dispositions and development activities since January 1, 2003.

     As a result of these changes within our portfolio of properties since January 1, 2003, we do not believe the Property Operating Results presented above are comparable from period to period. Therefore, in the table above, we have also presented the Property Operating Results for our same store portfolio.

Revenue from Rental Operations

     The increase in revenue from rental operations for the total portfolio was primarily due to the approximate 101,000 square foot acquisition we made in December 2003 consisting of an office property in San Diego County and revenues from our 6100 Center Drive development property in Los Angeles County which was placed in service during the second quarter of 2004 and from scheduled rent increases in our existing leases.

     The increase in revenue from rental operations for the same property portfolio was primarily due to an approximate $600,000 increase in cash rents, an approximate $450,000 increase in parking income and an approximate $350,000 increase in other rental operations, all of which were partially offset by an approximate $400,000 decrease in tenant reimbursements. The increase in cash rents was primarily related to scheduled rent increases in existing leases and by the 0.2% increase in average occupancy for these properties. The increase in parking income is primarily due to higher average occupancy in 2004 and special event parking in 2004 in some of our buildings. The increase in other rental operations was primarily related to higher lease termination fees and higher after-hour utility recoveries in 2004. The decrease in tenant reimbursements was primarily due to higher prior year reimbursement reconciliation billings in 2003.

Property Expenses

     The increase in property expenses for the total portfolio was partially due to the property acquired in December 2003 and the placement in service of our 6100 Center Drive property in the second quarter of 2004.

     The increase in property expenses for the same property portfolio was primarily due to an approximate $600,000 increase in repairs and maintenance and an approximate $600,000 increase in real estate taxes, all of which were partially offset by an approximate $200,000 decrease in property administrative expense and an approximate $100,000 decrease in ground rent expense. Repairs and maintenance increased primarily due to higher costs for contracted services and the timing of certain projects. Real estate taxes increased primarily due to refunds received on final reassessments in 2003 for certain properties. Property administrative expenses primarily decreased due to start-up costs associated with employee training programs implemented in 2003 and lower legal expenses relating to

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unlawful detainers and tenant rent disputes in 2004. Ground rent expense decreased primarily due to higher contingent ground rent recorded in 2003 relating to one of our properties.

General and Administrative

     General and administrative expenses as a percentage of total revenues were approximately 4.4% for the three months ended June 30, 2004 compared to approximately 3.5% for the same period in 2003. The approximate $1.3 million increase in general and administrative expenses was primarily related to higher personnel costs associated with annual merit increases and non-cash compensation expense associated with restricted stock grants issued in 2004 and 2003 as well as higher corporate governance costs in 2004.

Interest Expense

     Interest expense decreased approximately $2.1 million, or 9%, for the three months ended June 30, 2004 compared to the same period in 2003. This decrease was primarily due to the paydown in the second quarter of 2004 of a $175 million, 7.52% mortgage financing loan with disposition proceeds and funds from our unsecured line of credit and the fixed to floating swaps entered into on our unsecured senior notes in 2003, all of which were partially offset by lower capitalized interest in 2004. Capitalized interest was lower in 2004 as we stopped capitalizing interest on our 6100 Center Drive property in May 2003.

Depreciation and Amortization

     Depreciation and amortization expense increased by approximately $2.4 million, or 8%, for the three months ended June 30, 2004 compared to the same period in 2003, primarily due to depreciation related to a property acquired in December 2003 and depreciation related to capital expenditures, tenant improvements and leasing commissions placed in service subsequent to the first quarter of 2003.

Interest and Other Income (Loss)

     Beginning January 1, 2004, we reclassified the operating results of Nextedge, our taxable REIT subsidiary, or TRS, that provides energy consulting services to commercial real estate owners from general and administrative expenses into the interest and other income (loss) line item to more clearly present our general and administrative costs as well as the operating results of Nextedge. We also reclassified the operating results of our TRS in the second quarter of 2003 to conform to the 2004 presentation.

     Interest and other income (loss) decreased by approximately $600,000 for the three months ended June 30, 2004 compared to the same period in 2003, primarily due to operating losses from Nextedge.

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Comparison of the six months ended June 30, 2004 to the six months ended June 30, 2003
(in thousands, except number of properties and percentages):

                                 
    Six Months Ended            
    June 30,
          Percent
    2004
  2003
  Change
  Change
Total Portfolio:
                               
Revenue from rental operations:
                               
Scheduled cash rents
  $ 181,494     $ 176,946     $ 4,548       3 %
Straight-line rents
    1,340       493       847       172  
Tenant reimbursements
    9,603       11,175       (1,572 )     (14 )
Parking, net of expense
    11,821       10,648       1,173       11  
Other rental operations
    5,619       4,022       1,597       40  
 
   
 
     
 
     
 
     
 
 
Total revenue from rental operations
    209,877       203,284       6,593       3  
 
   
 
     
 
     
 
     
 
 
Property expenses:
                               
Repairs and maintenance
    22,870       20,709       2,161       10  
Utilities
    15,650       15,817       (167 )     (1 )
Real estate taxes
    15,896       14,317       1,579       11  
Insurance
    4,055       4,104       (49 )     (1 )
Ground rent
    332       364       (32 )     (9 )
Administrative
    9,457       8,663       794       9  
 
   
 
     
 
     
 
     
 
 
Total property expenses
    68,260       63,974       4,286       7  
 
   
 
     
 
     
 
     
 
 
Property Operating Results (1)
    141,617       139,310       2,307       2  
General and administrative
    9,149       6,595       2,554       39  
Interest expense
    44,497       46,289       (1,792 )     (4 )
Depreciation and amortization
    62,212       57,895       4,317       7  
Interest and other income
    (331 )     (253 )     (78 )     31  
 
   
 
     
 
     
 
     
 
 
Income from continuing operations before impairment on investment in securities and minority interest
  $ 26,090     $ 28,784     $ (2,694 )     (9 )%
 
   
 
     
 
     
 
     
 
 
Discontinued operations
  $ 646     $ 4,238     $ (3,592 )     (85 )%
 
   
 
     
 
     
 
     
 
 
Number of Properties:
                               
Disposed of during period
    (2 )     (6 )                
Completed and placed in service during period
    1                        
In service at end of period
    128       130                  
Net Rentable Square Feet:
                               
Disposed of during period
    (295 )     (515 )                
Completed and placed in service during period
    283                        
In service at end of period
    18,785       18,617                  
Same Property Portfolio(2):
                               
Revenue from rental operations
  $ 205,230     $ 202,836     $ 2,394       1 %
Property expenses
    66,525       63,587       2,938       5  
 
   
 
     
 
     
 
     
 
 
 
  $ 138,705     $ 139,249     $ (544 )     %
 
   
 
     
 
     
 
     
 
 
Straight-line rents
  $ 447     $ 477     $ (30 )     (6 )%
 
   
 
     
 
     
 
     
 
 
Number of non-development properties
    126                          
Number of buildings
    207                          
Average occupancy
    89.6 %     89.2 %                
Net rentable square feet
    18,299                          


(1)   Property Operating Results is commonly used by investors to evaluate the performance of REITs, to determine trends in earnings and to compute the fair value of properties as it is not affected by (1) the cost of funds of the property owner or (2) the impact of depreciation and amortization expenses as well as gains or losses from the sale of operating real estate assets that are included in net income computed in accordance with Generally Accepted Accounting Principles, or GAAP. The first factor is commonly eliminated from net income because it is specific to the particular financing capabilities and constraints of the owner. The second factor is commonly eliminated because it may not accurately represent the actual change in value in real estate properties that results from use or changes in market conditions. We believe that eliminating these costs from net income gives investors an additional measure of operating performance that, when used as an adjunct to net income computed in accordance with GAAP, can be a useful measure of our operating results.
 
    Property Operating Results captures trends in occupancy rates, rental rates and operating costs. However, Property Operating Results excludes

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    general and administrative costs, interest expense, interest income, depreciation and amortization expense and gains or losses from the sale of properties, changes in value in our real estate properties that result from use or permanent impairment to carrying costs as stipulated by GAAP, the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, all of which are significant economic costs. Therefore, Property Operating Results may fail to capture significant trends which limits its usefulness.
 
    Property Operating Results is a non-GAAP measure of performance. Property Operating Results is not a substitute for net income as computed in accordance with GAAP. It excludes significant expense components such as depreciation and amortization expense and financing costs. This measure should be analyzed in conjunction with net income and cash flow from operating activities as computed in accordance with GAAP. Other companies may use different methods for calculating Property Operating Results or similarly entitled measures and, accordingly, our Property Operating Results may not be comparable to similarly entitled measures reported by other companies that do not define the measure exactly as we do.
 
    The following is a reconciliation of net income computed in accordance with GAAP to Property Operating Results (in thousands):

                 
    Six Months Ended June 30,
    2004
  2003
Net income
  $ 30,804     $ 38,348  
Add:
               
General and administrative expense
    9,149       6,595  
Interest expense
    44,497       46,289  
Depreciation and amortization
    62,212       57,895  
Minority interest
    61       56  
Impairment on investment in securities.
    2,700        
Less:
               
Interest and other income
    (331 )     (253 )
Gain on sale of discontinued properties
    (6,829 )     (5,382 )
Discontinued operations
    (646 )     (4,238 )
 
   
 
     
 
 
Property Operating Results
  $ 141,617     $ 139,310  
 
   
 
     
 
 

(2)   Consists of non-development properties classified as part of continuing operations and owned for the entirety of the periods presented.

VARIANCES FOR RESULTS OF OPERATIONS

     Our Property Operating Results for the six months ended June 30, 2004 compared to the same period in 2003 were primarily affected by our acquisitions, dispositions and development activities since January 1, 2003.

     As a result of these changes within our portfolio of properties since January 1, 2003, we do not believe the Property Operating Results presented above are comparable from period to period. Therefore, in the table above, we have also presented the Property Operating Results for our same property portfolio.

Revenue from Rental Operations

     The increase in revenue from rental operations for the total portfolio was primarily due to the approximate 101,000 square foot acquisition we made in December 2003 of an office property in San Diego County and revenues from our 6100 Center Drive development property which was placed in service during the second quarter of 2004 and from scheduled rent increases in our existing leases that were partially offset by the decline in average occupancy.

     The increase in revenue from rental operations for the same property portfolio was primarily due to an approximate $2.0 million increase in other rental operations, a $1.1 million increase in cash rents and an approximate $900,000 increase in parking income, all of which were partially offset by an approximate $1.7 million decrease in tenant reimbursements. The increase in other rental operations was primarily related to higher lease termination fees in 2004 and lower reserves for tenant receivables. The increase in parking income is primarily due to higher average occupancy in 2004 and special event parking in 2004 in some of our buildings. The increase in cash rents was primarily related to scheduled rent increases in existing leases and by the 0.4% increase in average occupancy for these properties. The decrease in tenant reimbursements was primarily due to higher prior year reimbursement reconciliation billings in 2003.

Property Expenses

     The increase in property expenses for the total portfolio was partially due to the property acquired in December 2003 and placing our 6100 Center Drive property in service in the second quarter of 2004.

     The increase in property expenses for the same property portfolio was primarily due to an approximate $1.8 million increase in repairs and maintenance, and an approximate $1.1 million increase in real estate taxes and an approximate $650,000 increase in property administrative expenses, all of which were partially offset by an approximate $500,000 decrease in utility expenses. Repairs and maintenance increased primarily due to higher costs for contracted services and the timing of certain projects. Real estate taxes increased primarily due to the timing of final reassessments and property tax refunds received in 2003 for certain properties. Property administrative expenses increased due to higher personnel costs from annual merit increases and other non-recurring separation costs, partially offset by start-up costs associated with employee training programs implemented in 2003 and lower legal expenses relating to unlawful detainers and tenant rent disputes in 2004. Utility expenses decreased primarily due to lower usage in the first quarter of 2004 due primarily to the temporary decline in average occupancy in the first quarter of 2004.

General and Administrative

     General and administrative expenses as a percentage of total revenues were approximately 4.3% for the six months ended June 30, 2004 compared to approximately 3.3% for the same period in 2003. The approximate $2.6 million increase in general and

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administrative expenses was primarily related to higher personnel costs associated with annual merit increases and non-cash compensation expense associated with restricted stock grants issued in 2004 and 2003 and higher corporate governance costs in 2004.

Interest Expense

     Interest expense decreased approximately $1.8 million, or 4%, for the six months ended June 30, 2004 compared to the same period in 2003. This decrease was primarily due to the paydown in the second quarter of 2004 of a $175 million, 7.52% mortgage financing loan with proceeds from our first quarter 2004 dispositions and funds from our unsecured line of credit in 2004 and the fixed to floating swaps entered into on our unsecured senior notes in 2003, all of which were partially offset by lower capitalized interest in 2004. Capitalized interest was lower in 2004 as we stopped capitalizing interest on our 6100 Center Drive property in May 2003.

Depreciation and Amortization

     Depreciation and amortization expense increased by approximately $4.3 million, or 7%, for the six months ended June 30, 2004 compared to the same period in 2003, primarily due to depreciation related to a property acquired in December 2003 and depreciation related to capital expenditures, tenant improvements and leasing commissions placed in service subsequent to the second quarter of 2003.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

     Cash provided by operating activities decreased by approximately $6.1 million to $82.6 million for the six months ended June 30, 2004 compared to $88.7 million for the same period in 2003. This decrease was primarily due to the loss of operating cash flows from ten properties sold since the beginning of 2003 as part of our capital recycling program, partially offset by the increased cash flows from a property acquired in the fourth quarter of 2003 and our 6100 Center Drive development property, which was placed in service during the second quarter of 2004.

     Cash provided by investing activities decreased by approximately $17.1 million to $20.9 million for the six months ended June 30, 2004 compared to $38.0 million for the same period in 2003. This decrease was primarily due to fewer asset sales and lower disposition proceeds in 2004.

     Cash used in financing activities decreased by approximately $16.9 million to $98.3 million for the six months ended June 30, 2004 compared to $115.2 million for the same period in 2003. This change was primarily due to higher proceeds from issuances of common operating partnership units in 2004.

Available Borrowings, Cash Balance and Capital Resources

     We have an unsecured line of credit with a total commitment of $20 million from City National Bank. This line of credit accrues interest at LIBOR + 1.00% or the City National Bank Prime Rate less 0.875% and is scheduled to mature in August 2004. Proceeds from this line of credit are used, among other things, to provide funds for tenant improvements and capital expenditures and provide for working capital and other corporate purposes. As of June 30, 2004, there was $10 million outstanding on this line of credit and $10 million was available for additional borrowings.

     We also have an unsecured line of credit with a group of banks led by Wells Fargo. In June 2004, this line of credit was amended to reduce the interest rates by approximately 10 to 15 basis points depending on our secured debt rating and revise certain covenants. As a result of this amendment, this line of credit provides for borrowings up to $310 million with an option to increase the amount to $350 million and bears interest at a rate ranging between LIBOR + 0.65% and LIBOR + 1.15% (including an annual facility fee ranging from 0.15% to 0.40% based on the aggregate amount of the line of credit) depending on our unsecured debt rating. This line of credit matures in April 2006. In addition, as long as we maintain an unsecured debt rating of BBB-/Baa3 or better, the agreement contains a competitive bid option, whereby the lenders may bid on the interest rate to be charged for up to $150 million of the unsecured line of credit. We also have the option to convert the interest rate on this line of credit to the higher of Wells Fargo’s prime rate or the Federal Funds rate plus 0.5%. As of June 30, 2004, $272 million was outstanding on this line of credit and $38 million was available for additional borrowings.

     As of June 30, 2004, we had approximately $23.6 million in cash and cash equivalents, including $13.7 million in restricted cash. Restricted cash consisted of $9.7 million in interest bearing cash deposits required by four of our mortgage loans payable and $4.0 million in cash impound accounts for real estate taxes and insurance as required by several of our mortgage loans payable.

     We entered into $150 million of forward-starting swaps during 2003 to effectively fix the 10-year Treasury rate at an average rate of approximately 4.1% for borrowings that are anticipated to occur in 2004 to refinance some of our scheduled debt maturities. The forward-starting interest rate swaps were entered into at current market rates and, therefore, had no initial cost.

     In October and November of 2003, we also entered into reverse interest rate swap agreements to float $100 million of the fixed interest rate associated with the 7.00% senior unsecured notes due in November of 2007. Under these reverse swaps, we will receive interest at a fixed rate of 7.00% and pay interest at a variable rate averaging six-month LIBOR in arrears plus 3.10%. These interest rate swaps mature at the same time the notes are due.

     In June 2004, we amended our $125 million unsecured term loan with Wells Fargo to reduce its effective interest rate by 20 basis points. This loan was scheduled to increase from LIBOR + 1.25% to LIBOR + 1.45% in June 2004. In 2002, we entered into interest rate swap agreements that fixed the interest rate on the entire balance of this loan. As a result of the amendment and taking into effect the interest rate swap agreements for this loan, it will have an effective interest rate of approximately 4.14% for the remainder of 2004, 4.55% in 2005 and 4.70% in 2006.

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     We expect to continue meeting our short-term liquidity and capital requirements generally through net cash provided by operating activities and proceeds from our unsecured lines of credit. We believe the foregoing sources of liquidity will be sufficient to fund our short-term liquidity needs over the next twelve months, including recurring non-revenue enhancing capital expenditures, tenant improvements and leasing commissions.

     We expect to meet our long-term liquidity and capital requirements such as scheduled principal repayments, development costs, property acquisitions, if any, and other non-recurring capital expenditures through net cash provided by operations, refinancing of existing indebtedness and the issuance of long-term debt and equity securities.

Capital Recycling Program

     No properties were disposed of during the three months ended June 30, 2004.

Debt Summary

     Following is a summary of scheduled principal payments for our total debt outstanding as of June 30, 2004 (in thousands):

         
Year
  Amount
2004
  $ 13,461  
2005
    207,470  
2006
    411,859 (1)
2007
    157,166  
2008
    230,985  
2009
    112,550  
2010
    150,565  
2011
    710  
2012
    768  
2013
    845  
Thereafter
    4,602  
 
   
 
 
Total
  $ 1,290,981  
 
   
 
 


(1)   Includes $272 million outstanding on our Wells Fargo unsecured line of credit.

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     Following is certain other information related to our outstanding indebtedness as of June 30, 2004:

Unsecured and Secured Debt:

                                 
                    Weighted   Weighted
                    Average   Average
    Balance
  Percent
  Interest Rate (1)
  Maturity (in years)
    (000’s)                        
Unsecured Debt
  $ 904,349       70 %     6.09 %     2.5  
Secured Debt
    386,632       30       7.15       4.4  
 
   
 
     
 
     
 
     
 
 
Total Debt
  $ 1,290,981       100 %     6.40 %     3.1  
 
   
 
     
 
     
 
     
 
 

Floating and Fixed Rate Debt:

                                 
                    Weighted   Weighted
                    Average   Average
    Balance
  Percent
  Internet Rate (1)
  Maturity (in years)
    (000’s)                        
Floating Rate Debt(2)
  $ 332,000       26 %     3.72 %     2.2  
Fixed Debt(3)
    958,981       74       7.33       3.4  
 
   
 
     
 
     
 
     
 
 
Total Debt
  $ 1,290,981       100 %     6.40 %     3.1  
 
   
 
     
 
     
 
     
 
 


(1)   Includes amortization of prepaid financing costs.

(2)   Includes $100 million of fixed rate debt that has been converted to floating rate through interest rate swap agreements.

(3)   Includes $175 million of floating rate debt that has been fixed through interest rate swap agreements.

     Total interest incurred and the amount capitalized was as follows (in thousands):

                                 
    Three Months Ended June 30,
  Six Months Ended June 30,
    2004
  2003
  2004
  2003
Total interest incurred
  $ 21,382     $ 24,169     $ 44,851     $ 48,439  
Amount capitalized
    (198 )     (915 )     (354 )     (2,150 )
 
   
 
     
 
     
 
     
 
 
Amount expensed
  $ 21,184     $ 23,254     $ 44,497     $ 46,289  
 
   
 
     
 
     
 
     
 
 

   Consolidated Income Available for Debt Service and Compliance with Principal Financial Covenants

     Consolidated Income Available for Debt Service is a non-GAAP measurement of our performance and liquidity. Consolidated Income Available for Debt Service is presented below because this data is used by investors and our management as a supplemental measure to (a) evaluate our operating performance and compare it to other real estate companies, (b) determine trends in earnings, (c) determine our ability to service debt and (d) determine our ability to fund future capital expenditure requirements. As discussed more fully below, Consolidated Income Available for Debt Service is also used in several financial covenants we are required to satisfy each quarter under the terms of our principal debt agreements.

     Consolidated Income Available for Debt Service permits investors and management to view income from our operations on an unleveraged basis before the effects of non-cash depreciation and amortization expense. By excluding interest expense, Consolidated Income Available for Debt Service measures our operating performance independent of our capital structure and indebtedness and, therefore, allows for a more meaningful comparison of our operating performance between quarters as well as annual periods and to compare our operating performance to that of other companies, and to more readily identify and evaluate trends in earnings.

     The usefulness of Consolidated Income Available for Debt Service is limited because it does not reflect interest expense, taxes, gains or losses on sales of property, losses on valuations of derivatives, asset impairment losses, cumulative effect of a change in accounting principle, extraordinary items as defined by GAAP and depreciation and amortization costs. These costs have been or may in the future be incurred by us, each of which affects or could effect our operating performance and ability to finance our investments at competitive borrowing costs, successfully maintain our REIT status, and acquire and dispose of real estate properties at favorable prices to us. Some of these costs also reflect changes in value in our properties that result from use or changes in market conditions and the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties. Due to the significance of the net income components excluded from Consolidated Income Available for Debt Service, this measure should not be considered an alternative to (and should be considered in conjunction with) net income, cash flow from operations, and other performance or liquidity measures prescribed by GAAP. This measure should also be analyzed in conjunction with discussions elsewhere in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding the items eliminated in the calculation of Consolidated Income Available for Debt Service.

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     The reader is cautioned that Consolidated Income Available for Debt Service, as calculated by Arden Realty, may not be comparable to similar measures reported by other companies (under names such as or similar to Consolidated Income Available for Debt Service, EBITDA or adjusted EBITDA) that do not define this measure exactly the same as we do.

     The following is a reconciliation of net cash provided by operating activities and net income computed in accordance with GAAP for Arden Realty to Consolidated Income Available for Debt Service (in thousands):

                                 
    Three Months Ended   Six Months Ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
Net cash provided by operating activities
  $ 38,693     $ 39,217     $ 82,535     $ 88,647  
Add:
                               
Interest expense
    21,184       23,254       44,497       46,289  
Less:
                               
Amortization of loan costs and fees
    (1,004 )     (978 )     (2,083 )     (1,924 )
Amortization of deferred compensation
    (785 )     (448 )     (1,531 )     (837 )
Changes in operating assets and liabilities:
                               
Rent and other receivables
    (223 )     (1,555 )     1,834       (913 )
Deferred rent
    345       (207 )     1,982       (89 )
Prepaid financing costs, expenses and other assets
    1,672       2,168       2,205       3,662  
Accounts payable and accrued expenses
    6,630       6,962       4,989       3,682  
Security deposits
    (605 )     (640 )     (876 )     (512 )
 
   
 
     
 
     
 
     
 
 
Consolidated Income Available for Debt Service
  $ 65,907     $ 67,773     $ 133,552     $ 138,005  
 
   
 
     
 
     
 
     
 
 
                                 
    Three Months Ended   Six Months Ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
Net Income
  $ 9,127     $ 18,903     $ 27,988     $ 34,341  
Add:
                               
Interest expense
    21,184       23,254       44,497       46,289  
Depreciation and amortization
    31,936       29,487       62,212       57,895  
Minority interest
    1,307       1,399       2,689       2,837  
Minority interest from discontinued operations
    2       190       188       250  
Depreciation from discontinued operations
    51       561       107       1,775  
Impairment on investment in securities
    2,700             2,700        
Less:
                               
Gain on sale of discontinued properties
    (400 )     (6,021 )     (6,829 )     (5,382 )
 
   
 
     
 
     
 
     
 
 
Consolidated Income Available for Debt Service
  $ 65,907     $ 67,773     $ 133,552     $ 138,005  
 
   
 
     
 
     
 
     
 
 

     Consolidated Income Available for Debt Service is also presented because it is used in ratios contained in the principal financial covenants of the Indenture governing our publicly traded senior unsecured notes and our Credit Agreement with a syndicate of banks led by Wells Fargo. As of June 30, 2004, our senior unsecured notes represented approximately 39% of our total outstanding debt and amounts outstanding under our Wells Fargo unsecured line of credit represented approximately 21% of our total outstanding debt. The Consolidated Income Available for Debt Service ratios and the other ratios reported below are part of financial covenants we are required to satisfy each fiscal quarter. We believe information about these ratios is useful to (1) confirm that we are in compliance with the financial covenants of our principal loan agreements, (2) evaluate our ability to service our debt, (3) evaluate our ability to fund future capital expenditures, and (4) compare our ratios to other real estate companies, including other REITs, that present the same ratios.

     If we were to fail to satisfy these financial covenants, we would be in default under the terms of the Indenture for the senior unsecured notes and/or the Wells Fargo Credit Agreement. A default under those agreements could accelerate the obligation to repay such debt and could cause us to be in default under our other debt agreements. Depending on the circumstances surrounding such acceleration, we might not be able to repay the debt on terms that are favorable to us, or at all, which could have a material adverse affect on our financial condition and our ability to raise capital in the future.

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     The reader is cautioned that these ratios, as calculated by us, may not be comparable to similarly entitled ratios reported by other companies that do not calculate these ratios exactly the same as we do. These ratios should not be considered as alternatives to the ratio of earnings to fixed charges.

     The following table summarizes the principal ratios contained in the financial covenants of our senior unsecured notes and Wells Fargo unsecured line of credit as of June 30, 2004 (in thousands, except percentage and covenant ratio data):

         
Net investment in real estate
  $ 2,572,480  
Cash and cash equivalents
    9,924  
Restricted cash
    13,655  
Accumulated depreciation and amortization
    483,022  
 
   
 
 
Total Gross Assets
  $ 3,079,081  
 
   
 
 
Gross Value of Unencumbered Assets
  $ 2,107,737  
 
   
 
 
Mortgage loans payable(1)
  $ 386,632  
Unsecured lines of credit
    282,000  
Unsecured term loan
    125,000  
Unsecured senior notes, net of discount
    497,349  
 
   
 
 
Total Outstanding Debt
  $ 1,290,981  
 
   
 
 
Consolidated Income Available for Debt Service(2)
  $ 268,084  
 
   
 
 
Interest incurred(2)
  $ 92,675  
Loan fee amortization(2)
    (3,747 )
 
   
 
 
Debt Service(2)
  $ 88,928  
 
   
 
 
                 
Covenant Ratios
  Test
  Actual
Ratio of Consolidated Income Available for Debt Service to Debt Service
  Greater than 1.5     3.0  
Ratio of Consolidated Income Available for Debt Service to interest expense (3)
  Greater than 2.0     3.2  
Ratio of Consolidated Income Available for Debt Service to fixed charges (4)
  Greater than 1.75     2.3  
Total Outstanding Debt/Total Gross Assets
  Less than 60%     42 %
Secured Debt/Total Gross Assets
  Less than 40%     13 %
Gross Value of Unencumbered Assets/Unsecured Debt
  Greater than 150%     233 %


(1)   Represents 9 secured loans that are secured by 53 properties in our portfolio.
 
(2)   Represents amounts for Arden Realty for the most recent four consecutive quarters. Loan fee amortization excludes discount amortization on senior unsecured notes.
 
(3)   Interest expense consists of interest expense plus capitalized interest and less amortization of loan fees and discounts.
 
(4)   Fixed charges consist of interest costs, whether expensed or capitalized, principal payments on all debt, an amount equal to $0.3125 per quarter multiplied by the weighted average gross leaseable square feet of the portfolio at the end of the period and preferred unit distributions.

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Funds from Operations

     The following table reflects the calculation of our funds from operations for the three and six months ended June 30, 2004 and 2003 (in thousands):

                                 
    Three Months Ended June 30,
  Six Months Ended June 30,
    2004
  2003
  2004
  2003
Funds From Operations:(1)
                               
Net income
  $ 10,389     $ 21,049     $ 30,804     $ 38,348  
Depreciation from discontinued operations
    51       561       107       1,775  
Gain on sale of discontinued properties
    (400 )     (6,021 )     (6,829 )     (5,382 )
Depreciation and amortization
    31,936       29,487       62,212       57,895  
Distribution on Preferred Operating Partnership Units
    (1,078 )     (1,078 )     (2,156 )     (2,156 )
 
   
 
     
 
     
 
     
 
 
Funds From Operations(2)
  $ 40,898     $ 43,998     $ 84,138     $ 90,480  
 
   
 
     
 
     
 
     
 
 
Weighted average common shares and Operating Partnership units outstanding - - Diluted
    67,430       65,132       67,173       64,976  
 
   
 
     
 
     
 
     
 
 


(1)   We believe that funds from operations, or FFO, is a useful supplemental measure of our operating performance. We compute FFO in accordance with standards established by the White Paper on FFO approved by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, in April 2002. The White Paper defines FFO as net income or loss computed in accordance with generally accepted accounting principles, or GAAP, excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property plus real estate-related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures.
 
    We believe that FFO, by excluding depreciation costs, the gains or losses from the sale of operating real estate properties and the extraordinary items as defined by GAAP, provides an additional perspective on our operating results. However, because these excluded items have a real economic effect, FFO is a limited measure of performance.
 
    FFO captures trends in occupancy rates, rental rates and operating costs. FFO excludes depreciation and amortization costs and it does not capture the changes in value in our properties that result from use or changes in market conditions or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, all of which are significant economic costs. Therefore, its ability to measure performance is limited.
 
    Because FFO excludes significant economic components of net income determined in accordance with GAAP, FFO should be used as an adjunct to net income and not as an alternative to net income. FFO should also not be used as an indicator of our financial performance, or as a substitute for cash flow from operating activities determined in accordance with GAAP or as a measure of our liquidity. FFO is not by itself indicative of funds available to fund our cash needs, including our ability to pay dividends or service our debt.
 
    FFO is used by investors to compare our performance with other real estate companies. Other real estate companies may use different methods for calculating FFO and, accordingly, our FFO may not be comparable to other real estate companies.
 
(2)   Includes $785,000 and $448,000 in non-cash compensation expense for the three months ended June 30, 2004 and 2003, respectively, and approximately $1.5 million and $837,000 in non-cash compensation expense for the six months ended June 30, 2004 and 2003, respectively.

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Portfolio and Lease Information

     The following tables set forth certain information regarding our properties as of June 30, 2004.

PORTFOLIO SUMMARY
As of June 30, 2004

                                                                                 
                                                    Property Operating Results(1)
                                                    Three Months Ended June   Six Months Ended
                                                    30, 2004   June 30, 2004
                                    Approximate Net   (in thousands and   (in thousands and
    Number of Properties
  Number of Buildings
  Rentable (Sq. Ft.)
  unaudited)
  unaudited)
Location
  Total
  % of Total
  Total
  % of Total
  Total
  % of Total
  Total
  % of Total
  Total
  % of Total
Los Angeles County
                                                                               
West(2)
    30       23 %     32       15 %     5,051,880       27 %   $ 26,313       37 %   $ 53,164       37 %
North
    27       21 %     43       21 %     3,172,622       17 %     10,929       15 %     21,260       15 %
South
    16       13 %     21       10 %     3,085,689       16 %     9,911       14 %     19,415       14 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Subtotal
    73       57 %     96       46 %     11,310,191       60 %     47,153       66 %     93,839       66 %
Orange County
    23       18 %     55       26 %     3,609,394       19 %     11,190       16 %     22,866       16 %
San Diego County
    26       20 %     41       19 %     2,971,482       16 %     10,400       14 %     19,889       14 %
Ventura/Kern Counties
    6       5 %     17       8 %     794,574       4 %     2,510       4 %     5,018       4 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Subtotal
    128       100 %     209       99 %     18,685,641       99 %   $ 71,253       100 %   $ 141,612       100 %
Renovation Building(3)
                1       1 %     99,119       1 %     (18 )           5        
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Total
    128       100 %     210       100 %     18,784,760       100 %   $ 71,235       100 %   $ 141,617       100 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 


(1)   Excludes the operating results of two properties sold during the first quarter of 2004 and one property currently classified as held for disposition. The operating results for these properties are reported as part of discontinued operations in our quarterly and year-to-date operating results.
 
(2)   Includes a retail property with approximately 37,000 net rentable square feet.
 
(3)   Comprised of one building in a business park containing a total of four buildings. After completion of the renovation, the total square footage of this building will expand to 130,000 square feet.

PORTFOLIO OCCUPANCY AND IN-PLACE RENTS
As of June 30, 2004

                                 
                    Annualized Base Rent
                    Per Leased Square Foot (1)
    Percent   Percent   Portfolio   Full Service
Location
  Occupied
  Leased
  Total
  Gross Leases(2)
Los Angeles County
                               
West
    91.8 %     94.3 %   $ 27.89     $ 27.90  
North
    90.1 %     91.3 %     21.94       22.75  
South
    86.4 %     88.7 %     19.04       20.10  
 
   
 
     
 
     
 
     
 
 
Subtotal
    89.8 %     91.9 %   $ 23.90     $ 24.62  
Orange County
    88.2 %     89.7 %     18.82       22.10  
San Diego County
    88.8 %     90.5 %     19.43       23.87  
Ventura/Kern Counties
    95.7 %     96.5 %     18.84       19.40  
 
   
 
     
 
     
 
     
 
 
Subtotal/Weighted Average
    89.6 %     91.5 %   $ 22.01     $ 23.91  
Renovation Building
          100.0 %     17.40        
 
   
 
     
 
     
 
     
 
 
Total
    89.0 %     91.5 %   $ 21.97     $ 23.91  
 
   
 
     
 
     
 
     
 
 


(1)   Based on monthly contractual base rent under existing leases as of June 30, 2004, multiplied by 12 and divided by leased net rentable square feet; for those leases where rent has not yet commenced or which are in a free rent period, the first month in which rent is to be received is used to determine annualized base rent.
 
(2)   Excludes 34 properties and approximately 3.7 million square feet under triple net and modified gross leases.

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TEN LARGEST TENANTS
As of June 30, 2004

                                                 
            Weighted Average   Percentage of   Percentage of            
            Remaining   Aggregate Portfolio   Aggregate Portfolio           Annualized
            Lease Term   Leased   Annualized   Net Rentable Square   Base Rent
Tenant
  Number of Locations
  in Months
  Square Feet
  Base Rent(1)
  Feet
  (in thousands)
State of California
    22       44       2.22 %     2.16 %     379,686     $ 8,115  
Vivendi Universal
    2       70       1.36 %     2.12 %     231,681       7,980  
University of Phoenix
    6       48       0.97 %     0.99 %     166,195       3,719  
Ceridian Corporation
    2       70       0.89 %     0.96 %     152,071       3,619  
Atlantic Richfield
    1       27       0.84 %     0.92 %     143,885       3,453  
Pepperdine University
    1       173       0.66 %     0.84 %     113,488       3,173  
Haight, Brown & Bonesteel, LLP
    2       83       0.37 %     0.73 %     63,262       2,737  
Westfield Corporation
    1       106       0.57 %     0.72 %     96,876       2,714  
State Compensation Insurance Fund
    1       45       0.67 %     0.71 %     113,513       2,656  
Walt Disney Pictures and Television
    1       49       0.67 %     0.69 %     114,922       2,588  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total/Weighted Average(2)
    39       64       9.22 %     10.84 %     1,575,579     $ 40,754  
 
   
 
     
 
     
 
     
 
     
 
     
 
 


(1)   Annualized base rent is calculated as monthly contractual base rent under existing leases as of June 30, 2004 multiplied by 12; for those leases where rent has not yet commenced or which are in a free rent period, the first month in which rent is to be received is used to determine annualized base rent.
 
(2)   The weighted average calculation is based on net rentable square footage leased by each tenant.

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LEASING ACTIVITY

                 
    Three Months Ended   Six Months Ended
    June 30, 2004
  June 30, 2004
Net Absorption (square feet)
    262,247       (7,948 )
 
   
 
     
 
 
Gross New Leasing Activity (square feet)
    422,126       1,019,356  
 
   
 
     
 
 
Gross Renewal Leasing Activity (square feet)
    600,948       1,458,393  
 
   
 
     
 
 
Retention Rate
    65.7 %     59.1 %
 
   
 
     
 
 
Cash Rent Growth(1):
               
Expiring Rate
  $ 22.81     $ 22.97  
 
   
 
     
 
 
New / Renewed Rate
  $ 21.03     $ 20.77  
 
   
 
     
 
 
Decrease
    (8 )%     (10 )%
 
   
 
     
 
 
GAAP Rent Growth(2):
               
Expiring Rate
  $ 21.98     $ 22.14  
 
   
 
     
 
 
New / Renewed Rate
  $ 22.36     $ 22.28  
 
   
 
     
 
 
Increase
    2 %     1 %
 
   
 
     
 
 
Weighted Average Lease Term in Months — New
    52       55  
 
   
 
     
 
 
Weighted Average Lease Term in Months — Renewal
    42       41  
 
   
 
     
 
 
Tenant Improvements and Commissions (per square foot):
               
New(3)
  $ 21.83     $ 20.97  
 
   
 
     
 
 
Renewal
  $ 10.39     $ 8.91  
 
   
 
     
 
 
Capital Expenditures (per square foot):
               
Recurring
  $ 0.06     $ 0.13  
 
   
 
     
 
 
Non-recurring
  $ 0.01     $ 0.04  
 
   
 
     
 
 


(1)   Represents the difference between initial market rents on new and renewed leases as compared to the expiring cash rents on the same space.
 
(2)   Represents estimated cash rent growth adjusted for straight-line rents.
 
(3)   Excludes development/renovation space.

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PORTFOLIO DIVERSIFICATION
As of June 30, 2004

                         
            Occupied    
    NAICS   Square   Percentage of Total
North American Industrial Classification System Description
  Code
  Feet
  Occupied Portfolio
Professional, Scientific, and Technical Services
    541       4,355,879       26.01 %
Finance and Insurance
    521-525       2,841,077       16.97 %
Information
    511-519       1,720,032       10.27 %
Manufacturing
    311-339       1,341,723       8.01 %
Health Care and Social Assistance
    621-624       1,168,085       6.97 %
Administrative and Support and Waste Management and Remediation Services
    561-562       751,234       4.49 %
Public Administration
    921-928       736,069       4.40 %
Educational Services
    611       748,680       4.47 %
Real Estate, Rental and Leasing
    531-533       710,730       4.24 %
Wholesale Trade
    423-425       553,723       3.31 %
Transportation and Warehousing
    481-493       394,249       2.35 %
Arts, Entertainment, and Recreation
    711-713       313,778       1.87 %
Construction
    236-238       287,980       1.72 %
Other Services (except Public Administration)
    811-814       287,851       1.72 %
Accommodation and Food Services
    721-722       171,792       1.03 %
Retail Trade
    441-454       121,673       0.73 %
Mining
    211-213       58,392       0.35 %
Management of Companies and Enterprises
    551       28,305       0.17 %
Utilities
    221       8,975       0.05 %
Agriculture, Forestry, Fishing and Hunting
    111-115       6,261       0.04 %
Other — Uncategorized
          138,911       0.83 %
 
           
 
     
 
 
 
            16,745,399       100.00 %
 
           
 
     
 
 

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LEASE EXPIRATIONS — ANNUAL
As of June 30, 2004

                                                     
                                                2009 and
        2004
  2005
  2006
  2007
  2008
  Thereafter
Los Angeles County:
                                                   
West
  Expiring SF (1)     287,598       633,370       542,349       615,436       523,235       2,126,458  
 
  % of Leased SF (2)     1.68 %     3.71 %     3.18 %     3.60 %     3.06 %     12.45 %
 
  Rent per SF (3)   $ 29.04     $ 28.11     $ 28.65     $ 29.06     $ 30.14     $ 33.11  
North
  Expiring SF (1)     308,349       458,499       453,394       477,906       603,566       567,628  
 
  % of Leased SF (2)     1.81 %     2.68 %     2.65 %     2.80 %     3.53 %     3.32 %
 
  Rent per SF (3)   $ 20.28     $ 23.13     $ 24.17     $ 22.63     $ 24.58     $ 22.47  
South
  Expiring SF (1)     144,879       817,796       321,260       287,809       410,700       729,830  
 
  % of Leased SF (2)     0.85 %     4.78 %     1.88 %     1.68 %     2.41 %     4.27 %
 
  Rent per SF (3)   $ 19.65     $ 16.05     $ 22.46     $ 22.30     $ 21.77     $ 22.18  
 
       
 
     
 
     
 
     
 
     
 
     
 
 
Subtotal - Los Angeles County
  Expiring SF (1)     740,826       1,909,665       1,317,003       1,381,151       1,537,501       3,423,916  
 
  % of Leased SF (2)     4.34 %     11.17 %     7.71 %     8.08 %     9.00 %     20.04 %
 
  Rent per SF (3)   $ 23.56     $ 21.75     $ 25.60     $ 25.43     $ 25.72     $ 29.01  
Orange County
  Expiring SF (1)     373,705       588,433       639,736       586,620       313,507       691,357  
 
  % of Leased SF (2)     2.19 %     3.45 %     3.74 %     3.43 %     1.83 %     4.04 %
 
  Rent per SF (3)   $ 15.94     $ 20.65     $ 21.15     $ 18.55     $ 20.45     $ 22.05  
San Diego County
  Expiring SF (1)     210,439       606,897       437,134       240,913       264,630       878,309  
 
  % of Leased SF (2)     1.23 %     3.55 %     2.56 %     1.41 %     1.55 %     5.14 %
 
  Rent per SF (3)   $ 19.13     $ 18.67     $ 23.40     $ 23.00     $ 25.19     $ 23.41  
All Others
  Expiring SF (1)     84,397       182,744       181,951       54,365       75,143       186,593  
 
  % of Leased SF (2)     0.49 %     1.07 %     1.06 %     0.32 %     0.44 %     1.09 %
 
  Rent per SF (3)   $ 18.46     $ 20.11     $ 20.58     $ 19.89     $ 21.45     $ 18.58  
 
       
 
     
 
     
 
     
 
     
 
     
 
 
Total Portfolio
  Expiring SF (1)     1,409,367       3,287,739       2,575,824       2,263,049       2,190,781       5,180,175  
 
       
 
     
 
     
 
     
 
     
 
     
 
 
 
  % of Leased SF (2)     8.25 %     19.24 %     15.07 %     13.24 %     12.82 %     30.31 %
 
       
 
     
 
     
 
     
 
     
 
     
 
 
 
  Rent per SF (3)   $ 20.57     $ 20.89     $ 23.76     $ 23.25     $ 24.76     $ 26.76  
 
       
 
     
 
     
 
     
 
     
 
     
 
 


(1)   Represents the rentable square footage of expiring leases. For 2004, represents expirations from April 1, 2004 through December 31, 2004, not including month-to-month tenants.
 
(2)   Percentage of total rentable square footage expiring during the period.
 
(3)   Represents annualized ending cash rents of expiring leases.

LEASE EXPIRATIONS — NEXT FOUR QUARTERS
As of June 30, 2004

                                     
        Q3-04
  Q4-04
  Q1-05
  Q2-05
Los Angeles County:
                                   
West
  Expiring SF (1)     130,839       156,759       119,284       142,443  
 
  % of Leased SF (2)     0.76 %     0.92 %     0.70 %     0.83 %
 
  Rent per SF (3)   $ 27.99     $ 29.92     $ 28.69     $ 27.25  
North
  Expiring SF (1)     107,254       201,095       65,714       98,343  
 
  % of Leased SF (2)     0.63 %     1.18 %     0.39 %     0.58 %
 
  Rent per SF (3)   $ 23.08     $ 18.79     $ 23.25     $ 23.83  
South
  Expiring SF (1)     84,680       60,199       118,512       218,750  
 
  % of Leased SF (2)     0.50 %     0.35 %     0.69 %     1.28 %
 
  Rent per SF (3)   $ 18.50     $ 21.27     $ 17.98     $ 18.56  
 
       
 
     
 
     
 
     
 
 
Subtotal - Los Angeles County
  Expiring SF (1)     322,773       418,053       303,510       459,536  
 
  % of Leased SF (2)     1.89 %     2.45 %     1.78 %     2.69 %
 
  Rent per SF (3)   $ 23.87     $ 23.32     $ 23.33     $ 22.38  
Orange County
  Expiring SF (1)     144,120       229,585       146,666       167,088  
 
  % of Leased SF (2)     0.85 %     1.34 %     0.85 %     0.98 %
 
  Rent per SF (3)   $ 19.30     $ 13.83     $ 19.03     $ 18.85  
San Diego County
  Expiring SF (1)     109,577       100,862       145,269       99,783  
 
  % of Leased SF (2)     0.64 %     0.59 %     0.85 %     0.58 %
 
  Rent per SF (3)   $ 23.99     $ 13.85     $ 21.93     $ 20.83  
All Others
  Expiring SF (1)     16,419       67,978       44,137       21,347  
 
  % of Leased SF (2)     0.09 %     0.40 %     0.26 %     0.13 %
 
  Rent per SF (3)   $ 19.89     $ 18.11     $ 19.67     $ 18.20  
 
       
 
     
 
     
 
     
 
 
Total Portfolio
  Expiring SF (1)     592,889       816,478       639,582       747,754  
 
       
 
     
 
     
 
     
 
 
 
  % of Leased SF (2)     3.47 %     4.78 %     3.74 %     4.38 %
 
       
 
     
 
     
 
     
 
 
 
  Rent per SF (3)   $ 22.67     $ 19.05     $ 21.78     $ 21.27  
 
       
 
     
 
     
 
     
 
 


(1)   Represents the square footage of expiring leases, not including month-to-month tenants.
 
(2)   Percentage of total rentable square footage expiring during the period.
 
(3)   Represents annualized ending cash rents of expiring leases.

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RENOVATION SUMMARY
As of June 30, 2004

                                                                 
                                            Estimated        
                                            Year 1        
                                            Stabilized        
            Costs                   Estimated   Cash Property   Estimated   Estimated
            Incurred   Estimated   Percent   Construction   Operating   Year 1   Year 1
    Square   To Date   Total Cost   Leased at   Completion   Results   Annual   Annual
Building
  Feet
  (in thousands)
  (in thousands)
  8/3/04
  Date
  (in thousands)
  Cash Yield
  GAAP Yield
22745 Savi Ranch Parkway
    130,000     $ 191     $ 9,244       100 %     4th Qtr 2004     $ 1,881       10.0 %     11.7 %
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 


(1)   Estimated Year 1 Annual GAAP Yield includes an adjustment for straight-line rents.

     In addition, we have preliminary architectural designs completed for additional build-to-suit projects at the Howard Hughes Center totaling approximately 475,000 net rentable square feet of office space. We also have construction entitlements at the Howard Hughes Center for up to 600 hotel rooms. Build-to-suit projects consist of properties constructed to the tenant’s specifications in return for the tenant’s long-term commitment to the property. We do not intend to commence construction on any additional build-to-suit or multi-tenant projects at the Howard Hughes Center until development plans and budgets are finalized with terms allowing us to achieve yields commensurate with the project’s development risk.

     In addition to our development at the Howard Hughes Center, we have completed preliminary designs and are marketing an approximate 170,000 square foot build-to-suit office building at our Long Beach Airport Business Park. Also, as part of our Gateway Towers acquisition in August 2002, we acquired a 5-acre developable land parcel in Torrance, California that we intend to market for a build-to-suit office building. We currently do not intend to commence construction on these projects until build-to-suit tenant leases are signed with terms allowing us to achieve yields commensurate with the project’s development risk.

     We expect to finance our development activities over the next 24 months through net cash provided by operating activities, proceeds from asset sales, proceeds from our unsecured lines of credit or other secured borrowings.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

     Market risk is the exposure or loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which we are exposed is interest rate risk, which is sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control.

Interest Rate Risk

     In order to modify and manage the interest characteristics of our outstanding debt and limit the effects of interest rates on our operations, we use a variety of financial instruments, including interest rate swaps, caps, floors and other interest rate exchange contracts. The use of these types of instruments to hedge our exposure to changes in interest rates carries additional risks such as counter-party credit risk. We do not enter into any transactions for speculative or trading purposes. During 2002, we entered into interest rate swap agreements fixing the interest rates on variable debt with notional amounts totaling $175.0 million. During 2003, we entered into $150 million of forward-starting swap agreements fixing the 10-year Treasury rate for borrowings that are anticipated to occur in 2004 to refinance some of our scheduled debt maturities. In October and November of 2003, we also entered into reverse interest rate swap agreements to float $100 million of the fixed interest rate associated with the 7.00% senior unsecured notes due in November 2007.

     Some of our future earnings, cash flows and fair values relating to financial instruments are dependent upon prevailing market rates of interest, such as LIBOR. Based on interest rates and outstanding balances as of June 30, 2004, a 1% increase in interest rates on our $332.0 million of floating rate debt would decrease annual future earnings and cash flows by approximately $3.3 million and would not have an impact on the fair value of the floating rate debt. Conversely, a 1% decrease in interest rates on our $332.0 million of floating rate debt would increase annual future earnings and cash flows by approximately $3.3 million and would not have an impact on the fair value of the floating rate debt. The weighted average interest rate on our floating debt as of June 30, 2004 was 3.72%.

     Our fixed rate debt totaled $959.0 million as of June 30, 2004 with a weighted average interest rate of 7.33% and a total fair value of approximately $998.4 million. A 1% decrease in interest rates would increase the fair value of our fixed rate debt by approximately $29.7 million and would not have an impact on future earnings and cash flows. A 1% increase in interest rates would decrease the fair value of our fixed rated debt by approximately $27.9 million and would not have an impact on future earnings and cash flows.

     These amounts are determined by considering the impact of hypothetical interest rates on our borrowing cost. These analyses do not consider the effects of the reduced level of overall economic activity that could exist in that environment. Further, in the event of a change of this magnitude, we would consider taking actions to further mitigate our exposure to the change. Due to the uncertainty of the specific actions that would be taken and their possible effects, however, this sensitivity analysis assumes no changes in our capital structure.

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Item 4. Controls and Procedures

     We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching our desired disclosure control objectives. Also, we have an investment in an unconsolidated entity. Because we do not control or manage this entity, our disclosure controls and procedures with respect to such entity is necessarily substantially more limited than those we maintain with respect to our consolidated subsidiaries.

     As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including Arden Realty’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the second quarter of 2004 covered by this report. Based on the foregoing, Arden Realty’s Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective and were operating at the reasonable assurance level.

     There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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Table of Contents

Part II OTHER INFORMATION

Item 1. Legal Proceedings

     We are presently subject to various lawsuits, claims and proceedings arising in the ordinary course of business, none of which if determined unfavorably to us is expected to have a material adverse effect on our cash flows, financial condition or results of operations. There were no material changes in our legal proceedings during the three months ended June 30, 2004.

Item 2. Changes in Securities — None

Item 3. Defaults Upon Senior Securities — None

Item 4. Submission of Matters to a Vote of Security Holders — None

Item 5. Other Information — None

Item 6. Exhibits and Reports on Form 8-K

(a)   Exhibits

     
10.46*
  Second Amended and Restated Agreement of Limited Partnership of Arden Realty Limited Partnership, dated September 7, 1999, filed as an exhibit to Arden Realty’s quarterly report on Form 10-Q filed with the Commission on November 15, 1999.
 
   
10.47*
  Admission of New Partners and Amendment to Limited Partnership Agreement entered into as of the 20th day of December, 2000, by and between Arden Realty Limited Partnership and the persons identified as the “New Partners” therein, filed as an exhibit to Arden Realty Limited Partnership’s annual report on Form 10-K filed with the Commission on March 30, 2001.
 
   
10.48*
  Second Amendment to Limited Partnership Agreement entered into as of September 13, 2003, by Arden Realty Limited Partnership, filed as an exhibit to Arden Realty Limited Partnership’s quarterly report on Form 10-Q filed with the Commission on November 13, 2003.
 
   
31.1
  Officers’ certifications pursuant to Rule 13a — 14(a) or Rule 15d — 14(a).
 
   
32.1
  Officers’ certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)


(*)   Incorporated by reference.
 
(1)   In accordance with SEC Release No. 33-8212, the following exhibit is being furnished, and is not being filed as part of this Report or as a separate disclosure document, and is not being incorporated by reference into any Securities Act of 1933 registration statement.

(b)   Reports on Form 8-K- None

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Table of Contents

SIGNATURES

     Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

         
    ARDEN REALTY LIMITED PATNERSHIP
By: ARDEN REALTY, INC.
Its: General Partner
 
       
Date: August 10, 2004
  By:   /s/ Andrew J. Sobel
      Andrew J. Sobel
      Executive Vice President — Strategic Planning
      and Operations
 
       
Date: August 10, 2004
  By:   /s/ Richard S. Davis
     
      Richard S. Davis
      Senior Vice President and
      Chief Financial Officer

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