FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

(Mark One)

For quarterly period ended June 30, 2004

For the transition period from _____________ to _____________.

COMMISSION FILE NUMBER    000-23733

CAPITAL AUTOMOTIVE REIT

8270 Greensboro Drive, Suite 950, McLean, Virginia 22102
(Address of principal executive offices and zip code)

(703) 288-3075
(Registrant’s telephone Number, including area code)

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

Yes   X       No ___

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

Yes   X       No ___

     Number of common shares of beneficial interest outstanding as of July 31, 2004 was 36,598,849.

CAPITAL AUTOMOTIVE REIT
FORM 10-Q
INDEX

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PART I — FINANCIAL INFORMATION
ITEM I — FINANCIAL STATEMENTS
CAPITAL AUTOMOTIVE REIT
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

See accompanying Notes to Consolidated Financial Statements.

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CAPITAL AUTOMOTIVE REIT
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

See accompanying Notes to Consolidated Financial Statements.

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CAPITAL AUTOMOTIVE REIT
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

See accompanying Notes to Consolidated Financial Statements.

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CAPITAL AUTOMOTIVE REIT
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY AND OTHER COMPREHENSIVE INCOME
(in thousands, except share data)

See accompanying Notes to Consolidated Financial Statements.

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CAPITAL AUTOMOTIVE REIT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.      ORGANIZATION AND BASIS OF PRESENTATION

Organization

Capital Automotive REIT, which we refer to as the Company, is a Maryland real estate investment trust formed in October 1997. We own interests in real estate and conduct our operations, directly or indirectly, through Capital Automotive L.P., which we refer to as the Partnership, and its subsidiaries. We are the sole general partner of the Partnership and, as of June 30, 2004, owned approximately 81.7% of the common units of limited partnership interest in the Partnership, which we refer to as Common Units, as well as 100% of the Series A and Series B preferred units of limited partnership interest in the Partnership, which we refer to as Preferred Units. References to “we,” “us” and “our” refer to the Company or, if the context requires, the Partnership and our business and operations conducted through the Partnership and/or directly or indirectly owned subsidiaries.

Our primary business strategy is to purchase real estate (land, buildings and other improvements), which we simultaneously lease to operators of franchised automobile dealerships and motor vehicle service, repair or parts businesses, used vehicle businesses and other related businesses under long-term, triple-net leases. Triple-net leases typically require the tenant to pay all operating expenses of a property, including, but not limited to, all real estate taxes, assessments and other government charges, insurance, utilities, repairs and maintenance. We use (i) the term dealerships to refer to these types of businesses that are operated on our properties and (ii) the term dealer group, tenant or operators of dealerships to refer to the persons and companies that lease our properties. We focus on leasing properties to dealer groups that have a long history of operating multi-site, multi-franchised dealerships, generally targeting the largest dealer groups in terms of revenues in the largest metropolitan areas in the U.S. in terms of population. In addition, we provide facility improvement and expansion funding, construction financing and takeout commitments in certain circumstances.

As of June 30, 2004, we had invested more than $2.0 billion in 330 properties located in 31 states, consisting of approximately 2,480 acres of land and containing approximately 14.2 million square feet of buildings and improvements. Our tenants operate 473 motor vehicle franchises on our properties, representing 44 brands of motor vehicles, which include all of the top selling brands in the U.S. The initial lease terms generally range from 10 to 20 years (with a weighted average initial lease term for leases entered into during the quarter ended June 30, 2004 of approximately 17.0 years), with our entire portfolio having a weighted average initial lease term of approximately 14.9 years. As of June 30, 2004, our portfolio had a weighted average remaining lease term of approximately 11.7 years. The leases typically have options to renew upon generally the same terms and conditions for one or more additional periods of five to 10 years each, exercisable at the option of the tenants (with renewal options typically ranging from a total of five to 40 years).

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States, commonly referred to as GAAP, for interim financial information and in conformity with the rules and regulations of the Securities and Exchange Commission, commonly referred to as the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the three months and

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six months ended June 30, 2004, are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with our audited consolidated financial statements and footnotes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

2.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements of the Company have been prepared in accordance with GAAP and include the accounts of the Company, its wholly-owned subsidiaries, and other entities where the Company has a majority ownership, all of which it controls. The equity interests of other limited partners are reflected as minority interest. All significant intercompany transactions and balances have been eliminated in consolidation.

Real Estate and Depreciation

The purchase price of real estate properties acquired is allocated to the various components, such as land, buildings and improvements, and in-place leases as appropriate, in accordance with Statement of Financial Accounting Standards, commonly referred to as SFAS, No. 141, “Business Combinations.” The purchase price is allocated based on the fair value of each component at the time of acquisition. The fair value of the buildings and improvements are recorded at the cost of our acquisition which we believe approximates their replacement costs. We generally do not acquire real estate assets that have in-place leases. We typically execute our leases simultaneously with the purchase of the real estate, and because of this, no value has been ascribed to any in-place leases because we do not believe any exist. Therefore, we have not recorded any lease intangible assets or liabilities on our consolidated balance sheets as of June 30, 2004 and December 31, 2003.

Depreciation is computed using the straight-line method over an estimated useful life of 20 to 45 years for the buildings and improvements. Real estate depreciation expense, including depreciation expense related to discontinued operations, was approximately $8.9 million and $7.6 million for the three months ended June 30, 2004 and 2003, respectively. Real estate depreciation expense, including depreciation expense related to discontinued operations, was approximately $17.7 million and $15.0 million for the six months ended June 30, 2004 and 2003, respectively.

Furniture, Fixtures and Equipment

Furniture, fixtures and equipment are recorded at cost. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets, ranging from three to five years. Total depreciation expense related to our furniture, fixtures and equipment was approximately $16,000 and $18,000 for the three months ended June 30, 2004 and 2003, respectively. Total depreciation expense related to our furniture, fixtures and equipment was approximately $34,000 and $40,000 for the six months ended June 30, 2004 and 2003, respectively.

Improvement Fundings and Construction Financing

We may fund improvements made by our tenants on our existing properties. Improvements include costs incurred on facilities during which the tenant’s business continues to operate without interruption. Improvement fundings are recorded as buildings and improvements on our consolidated balance sheets and the amounts charged to the tenant during the project are recorded as rental revenue. Once the project is completed, the remaining useful life of the buildings and improvements is determined and depreciation expense is adjusted accordingly on a prospective basis.

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We may provide construction financing to our tenants in certain circumstances in which we own the underlying land that is leased to the tenant. Construction financing includes fundings for the construction of new facilities for which operations have not commenced or fundings for major improvements to existing facilities that cause operations to cease during the construction period. Fundings are recorded as construction advances during the period of construction and the amounts charged to our tenant during that time are recorded as interest income. After completion of the project, the construction advances are paid down simultaneously with our purchase of the buildings and improvements. The buildings and improvements are acquired at fair market value and recorded as real estate on our consolidated financial statements. Construction advances are included in other assets and totaled approximately $7.4 million and $5.0 million as of June 30, 2004 and December 31, 2003, respectively.

Cash and Cash Equivalents

Cash and cash equivalents consist of highly liquid instruments purchased with original maturities of three months or less.

Restricted Cash

Restricted cash consists primarily of cash reserved to fund debt service payments and funds held in cash collateral accounts. In addition, as of December 31, 2003, restricted cash also consisted of funds held in escrow accounts related to the substitution of properties within an existing debt agreement. The purpose of the cash collateral accounts is to hold funds, generally in the amount of the interest rate swap valuations at any point in time, to protect lenders in case of an early termination of the existing swaps by us. The cash collateral accounts are controlled by the lenders; however, we earn interest on the funds invested. The purpose of the escrow accounts related to substitutions is to provide temporary collateral in conjunction with property substitutions when the release of a mortgaged property occurs prior to the lender’s acceptance of a replacement property. The amount represents an agreed upon amount of cash held in escrow until such property substitution is completed, at which time the cash is returned to us. Restricted cash is included in other assets and totaled approximately $14.6 million and $20.2 million as of June 30, 2004 and December 31, 2003, respectively.

Deferred Loan Costs

Certain costs incurred in connection with the issuance of debt instruments are capitalized and generally amortized over the terms of the respective issuance using the effective interest method or on a straight-line basis, which approximates the effective interest method. Deferred loan costs include lender fees and other third party costs. These costs, net of accumulated amortization, are included in other assets and totaled approximately $22.5 million and $18.1 million as of June 30, 2004 and December 31, 2003, respectively. Loan cost amortization expense was approximately $712,000 and $661,000 for the three months ended June 30, 2004 and 2003, respectively. Loan cost amortization expense was approximately $1.5 million and $1.2 million for the six months ended June 30, 2004 and 2003, respectively. Upon the early extinguishment of debt instruments, we expense any associated unamortized deferred loan costs in the period of the debt retirement.

Capitalized Leasing Costs

Certain direct costs initially incurred by us in negotiating and consummating a successful lease are capitalized and generally amortized over the initial base term of the lease. Capitalized leasing costs include employee compensation and payroll-related fringe benefits directly related to time spent performing successful leasing-related activities. These activities include evaluating the financial condition of prospective clients, evaluating and recording guarantees, collateral and other security

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arrangements, negotiating lease terms, preparing lease documents and closing the transaction. These costs, net of accumulated amortization, are included in other assets and totaled approximately $1.6 million and $1.4 million as of June 30, 2004 and December 31, 2003, respectively. Leasing cost amortization expense was approximately $50,000 and $43,000 for the three months ended June 30, 2004 and 2003, respectively. Leasing cost amortization expense was approximately $98,000 and $84,000 for the six months ended June 30, 2004 and 2003, respectively.

Income Taxes

We believe we are qualified and will continue to qualify as a real estate investment trust, commonly referred to as a REIT, under the provisions of the Internal Revenue Code of 1986, as amended. As a REIT, we are required to distribute at least 90% of our taxable income to our shareholders and comply with certain other requirements. We generally will not be subject to federal income tax on taxable income that we distribute to our shareholders. The Company is subject to certain state and local income and franchise taxes.

Rental Revenue Recognition

We lease our real estate pursuant to long-term, triple-net leases, under which the tenants typically pay all operating expenses of a property, including, but not limited to, all real estate taxes, assessments and other government charges, insurance, utilities, repairs and maintenance. Our leases are recorded as operating leases under SFAS No. 13, “Accounting for Leases,” for financial reporting purposes. As such, the leased assets remain on our balance sheet and we depreciate them based on their estimated useful lives. Rental income attributable to the leases is recorded monthly when due from tenants. Rental income attributable to the majority of our leases is fixed by the lease agreement. However, under our variable rate lease program, monthly base rent is calculated based on a spread over an applicable index, typically LIBOR. As of June 30, 2004, approximately $424 million of our real estate portfolio, or 21%, was subject to variable rate leases. This compares to $410 million of our real estate portfolio, or 24%, that was subject to variable rate leases as of June 30, 2003. The vast majority of our variable rate lease agreements contain minimum lease rates, generally between 8% and 9%, and fixed rate conversion features generally with minimum rates of 10.0% to 10.25%, and none of these leases contains a maximum rate.

Our leases typically provide for upward periodic adjustments in base rent due from our tenants, usually based on a factor of the change in the consumer price index, commonly referred to as the CPI. In addition, certain of our leases are subject to fixed minimum and/or maximum rent escalators during the initial lease term and extension periods. Our leases typically reset to market during certain renewal periods. The fixed minimum rent escalations are straight-lined into rental income over the initial lease term. Any rent adjustments above the fixed minimum escalations are recorded as revenue in the period they are due from the tenants. Straight-lined rents are included in other assets and totaled approximately $18.4 million and $16.7 million as of June 30, 2004 and December 31, 2003, respectively. Straight-lined rental revenue was approximately $1.1 million and $1.3 million for the three months ended June 30, 2004 and 2003, respectively. Straight-lined rental revenue was approximately $2.2 million and $2.5 million for the six months ended June 30, 2004 and 2003, respectively.

Derivative Instruments

During the normal course of business, we are exposed to certain financial market risks, the most predominant being fluctuations in interest rates. In general, our strategy of match-funding our long-term debt to our leases reduces our exposure to interest rate fluctuations by substantially locking in our investment spreads during the initial term of the leases. As part of this strategy, we have used and may continue to use interest rate swap arrangements to manage or hedge our interest rate risk. We do not enter into interest rate swap arrangements for trading purposes. We will either hedge our variable rate debt to convert it to a fixed interest rate, designating such hedge as a cash flow hedge, or hedge our fixed rate

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debt to convert it to a variable interest rate, designating such hedge as a fair value hedge.

The derivative instruments, including cash flow and fair value hedges that we have entered into, have been designated as highly effective at the inception of the swap arrangements. We continue to evaluate the highly effective nature of those hedges and believe our hedges continue to be highly effective.

For a derivative qualifying as a cash flow hedge, the change in the unrealized gain or loss is recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity on our consolidated balance sheets. The fair value of the swap is recorded as either an asset or liability on our consolidated balance sheets.

For a derivative qualifying as a fair value hedge, the change in the net unrealized gain or loss upon measuring the fair value hedge and the fair value of the debt instrument being hedged is recorded on our consolidated statements of operations. Generally, these amounts offset each other. The fair value of the swap is recorded as either an asset or liability, with a corresponding increase or decrease recorded to the carrying value of the debt instrument being hedged on our consolidated balance sheets.

Share-Based Compensation

The Capital Automotive Group 1998 Equity Incentive Plan (as amended in February 1999 and as restated and amended in February 2002), which we refer to as the Plan, provides equity compensation to our employees, officers, non-employee trustees and certain other service providers. At June 30, 2004, we accounted for our Plan under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. All options granted under this Plan had exercise prices equal to or greater than the market value of the underlying common stock on the date of grant. Therefore, no compensation expense is reflected in net income for stock option-based awards.

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The following table illustrates the effect on net income and earnings per common share if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting For Stock-Based Compensation — Transition and Disclosure,” to share-based compensation (in thousands, except per share data).

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications

Certain amounts in the 2003 consolidated financial statements have been reclassified to conform with the current year presentation.

3.      NEW ACCOUNTING PRONOUNCEMENTS

In June 2004, the Emerging Issues Task Force, commonly referred to as the EITF, reached a tentative conclusion on EITF Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share.” Contingently convertible debt instruments, which are commonly referred to as Co-Cos and include our $110 million of 6% Convertible Notes, combine the features of contingently issuable shares with a convertible debt instrument. These instruments generally become convertible into common stock only if one or more specified events occur, such as the underlying common stock achieving a specified price target. The EITF tentatively concluded that Co-Cos should be included in diluted earnings per share computations using the if-converted method regardless of whether the market price trigger or other

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contingent feature has been met.

Under current interpretations of Statement of Financial Accounting Standards, commonly referred to as SFAS, No. 128, “Earnings Per Share,” issuers of Co-Cos exclude the potential common shares underlying the Co-Co from the calculation of diluted earnings per share until the market price or other contingency is met. When the contingency is met, generally the if-converted method is used to calculate the dilutive impact of the instrument. Under the if-converted method, the instrument is considered converted, with the resulting number of shares included in the denominator of the earnings per share calculation and the interest expense, net of tax, added back to the numerator of the earnings per share calculation.

The EITF agreed the tentative conclusion would be applied by restating previously diluted earnings per share. If approved by the Financial Accounting Standards Board, commonly referred to as the FASB, we do not expect the implementation of EITF Issue No. 04-8 will have a significant impact on our results of operations and earnings per common share.

4.      INVESTMENTS IN REAL ESTATE

During the second quarter, we completed approximately $126 million in real estate investments, including sale-leaseback financing on 14 auto retail properties to six dealer groups, including two new tenants. These dealer groups consist primarily of Top 100 dealer groups, both private and publicly-traded. Also included in the second quarter investments was approximately $18 million in construction improvements, transacted with six existing tenants. Several of the properties acquired this quarter will undergo major renovations by the tenants over the next 12 to 24 months, which we have committed up to $75 million to fund. The second quarter real estate investments contain 28 automotive franchises located in 13 states (California, Florida, Georgia, Illinois, Louisiana, Maryland, Michigan, New Jersey, North Carolina, Ohio, South Carolina, Texas and Virginia) and have a weighted average initial lease term of approximately 17 years, with multiple renewal options exercisable at the option of the tenants. The investments were funded with approximately $70.0 million from borrowings on our short-term credit facilities, with the issuance of $10.1 million in operating partnership units at an average price of $28.61 per unit, and with cash on hand. During the second quarter, a tenant completed the construction of a new facility, totaling $10 million, on land owned by us. The construction was funded through our construction financing program. We acquired this facility upon completion of construction.

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5.      DISCONTINUED OPERATIONS

Beginning in 2002, SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that gains and losses from dispositions of properties and all operating earnings from these properties be reported as “discontinued operations.” This also requires that all past earnings applicable to a property disposed of subsequent to January 1, 2002 be reported as “discontinued operations.” As a result, previously reported “income from continuing operations” will be updated each time a property is sold. This requirement is for presentation only and has no impact on net income.

During the second quarter, we sold two auto retail locations for approximately $3.5 million to one dealer group, resulting in a combined gain of approximately $315,000 before minority interest. In exchange for the early termination of the leases related to these properties, we received approximately $175,000 in lease termination fees, which was recorded during the second quarter. In addition, we sold five auto retail locations back to a tenant for $6.7 million in net proceeds, consisting of $700,000 in cash and a $6.0 million secured first mortgage note, with additional collateral as well as personal guarantees. The secured mortgage is a three-year, interest-only note. The gain related to this sale, totaling approximately $700,000 before minority interest, has been deferred.

The earnings generated from these real estate dispositions, including the combined recognized gain and lease termination fees, have been reported as discontinued operations.

Since January 1, 2003, we have sold 14 auto retail locations with net proceeds totaling approximately $44.1 million. The following table sets forth the components of discontinued operations related to properties sold subsequent to January 1, 2003 (in thousands):

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6.      BALANCE SHEET RESTRUCTURING AND DEBT EXTINGUISHMENT

As previously discussed in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004, we completed a significant restructuring of our balance sheet by paying off a portion of our outstanding debt with Ford Motor Credit Corporation (Ford). We repaid approximately $214 million of mortgage debt outstanding with Ford, of which approximately $161 million was variable rate debt, with a weighted average spread over LIBOR of 226 basis points, and approximately $53 million was variable rate debt swapped to fixed rate debt, bearing interest at approximately 7.6%. The net proceeds used to repay the debt were derived from the following sources:

	•		On April 2, 2004, we issued 1,000,000 common shares in an underwritten public offering at an initial price to the public of $35.15 per share, as further described in the Equity Transactions footnote herein;
	•		On April 15, 2004, we closed on a public offering of $125 million 6.75% senior unsecured monthly income notes at par, as further described in the Mortgages and Notes Payable footnote herein;
	•		On April 27, 2004, we issued 2,500,000 8% Series B Cumulative Redeemable Preferred Shares at $25.00 per share, as further described in the Equity Transactions footnote herein; and
	•		Approximately $23 million from borrowings on our short-term credit facilities, which were subsequently repaid during the second quarter of 2004, and cash on hand due to the timing of the equity and debt transactions noted above.

As a result of this restructuring, on April 1, 2004, we terminated our $60 million unsecured credit facility, which prohibited the issuance of senior unsecured debt. As of March 31, 2004, the facility had no amounts outstanding and was expected to remain principally unused until its expiration in March 2005.

In May 2004, we repaid the remainder of our outstanding Ford debt totaling approximately $92 million, which had an effective interest rate of approximately 7.84%, and paid the related prepayment penalties totaling approximately $2.2 million. The debt was repaid with a portion of the net proceeds derived from our May 12, 2004 public offering of $110 million of 6% Convertible Notes, as further described in the Mortgages and Notes Payable footnote herein.

As a result of these transactions, we incurred debt extinguishment charges totaling approximately $8.7 million, or $0.20 per share to net income available to common shareholders. The debt extinguishment charges consisted of the following:

	•		swap breakage fees totaling approximately $4.0 million related to the repayment of variable rate debt with Ford that had been swapped to a fixed rate;
	•		the write-off of deferred loan fees related to the loans that were paid off and the termination of our $60 million unsecured credit facility totaling approximately $2.5 million; and
	•		prepayment penalties totaling approximately $2.2 million related to the repayment of the fixed rate debt with Ford.

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7.      MORTGAGES AND NOTES PAYABLE

The following is a summary of our total debt outstanding as of June 30, 2004 and December 31, 2003 (dollars in thousands):

*

For the quarter ended June 30, 2004. Includes deferred loan fees amortized over the life of the loans.

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	(1)		The loan requires monthly payments of principal and interest with a final payment at maturity of approximately $24.2 million. The Partnership has provided a guaranty of collection limited to approximately $8.9 million of this loan, contingent upon the lender first making written demand upon and proceeding against the borrower, including obtaining judgment and foreclosing upon all collateral. All amounts recovered from the borrower or collateral following a default reduce such guarantee.
	(2)		This loan requires quarterly interest and level principal payments with a final payment at maturity of approximately $49.6 million. This loan bears interest equal to the 30-day LIBOR rate plus 175 basis points. We have entered into an interest rate swap arrangement with a third party to fix the interest rate on this loan.
	(3)		This loan requires monthly interest and level principal payments with a final payment at maturity of approximately $9.2 million.
	(4)		This loan requires quarterly interest and level principal payments with a final payment at maturity of approximately $13.4 million. This loan bears interest equal to the three-month LIBOR rate plus 225 basis points. We have entered into an interest rate swap arrangement with a third party to fix the interest rate on this loan.
	(5)		During 2002, we issued $325 million in four classes of Triple Net Lease Mortgage Notes, Series 2002. CARS Loan Servicer L.L.C., one of our subsidiaries, is servicer of the notes on behalf of the noteholders. The following is a breakdown of the Triple Net Lease Mortgage Notes, Series 2002 by class:

			Classes A-1a and A-1b are fully-amortizing in succession over their respective terms and Classes A-2 and A-3 are fully-amortizing in succession over 20 years. The Partnership has provided a guaranty of collection limited to approximately $35 million of this loan, contingent upon the trustee first making written demand upon and proceeding against the borrower, including obtaining judgment and foreclosing upon all collateral. All amounts recovered from the borrower or collateral following a default reduce such guarantee. In connection with the issuance of this debt, the Company guarantees certain customary, non-recourse, carveout indemnities. Additionally, in conjunction with the servicing of the debt, the Company guarantees CARS Loan Servicer, L.L.C.’s obligations to make certain principal, interest and property protection advances.
	(6)		During 2003, we issued $228 million in two classes of Triple Net Lease Mortgage Notes, Series 2003-1. CARS Loan Servicer L.L.C. is servicer of the notes on behalf of the noteholders. The following is a breakdown of the Triple Net Lease Mortgage Notes, Series 2003-1 by class:

			The notes amortize in succession over a 20-year amortization schedule with the Class A-1 notes fully-amortizing and the Class A-2 notes requiring a final payment at maturity of approximately $70.8 million. In connection with the issuance of this debt, the Company guarantees certain customary, non-recourse, carveout indemnities. Additionally, in conjunction with the servicing of the debt, the Company guarantees CARS Loan Servicer, L.L.C.’s obligations to make certain principal, interest and property protection advances.
	(7)		This represents debt outstanding with Ford which was repaid during the second quarter of 2004, as further described in the Balance Sheet Restructuring and Debt Extinguishment footnote herein. The debt consisted of approximately $92 million of fixed rate debt at an effective interest rate of 7.84%, scheduled to mature on July 6, 2011, and approximately $53 million of variable rate debt swapped to fixed rate with an effective interest rate of 7.6%, scheduled to mature at the end of 2012.
	(8)		This loan, totaling $135.6 million, bearing interest at a spread of 227 basis points over the 30-day LIBOR, was repaid during the second quarter of 2004, as further described in the Balance Sheet Restructuring and Debt Extinguishment footnote herein.
	(9)		The loans outstanding bear interest at variable rates ranging from 185 to 357 basis points above the 30-day LIBOR rate or the three-month LIBOR rate and have maturity dates ranging from November 30, 2008 to June 2, 2015. The terms of the various loans require either quarterly interest and level principal payments, monthly level payments of

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			principal and interest, or interest-only payments until maturity, at which time the loans require final payments totaling approximately $105.0 million. One of these loans, totaling $51.3 million as of June 30, 2004, is cross defaulted with the revolving credit facilities discussed in footnote (15) and (16). Six of these loans totaling $56.3 million as of June 30, 2004 and issued by subsidiaries of the Company, contain acceleration clauses in the event of a material adverse change, which are at the lenders’ discretion. Additionally, on five of the aforementioned loans, the Partnership has partially guaranteed the monetary obligations under the loans limited to approximately $17.3 million as of June 30, 2004. Two of the loans previously outstanding with Ford, totaling approximately $26 million, were repaid during the second quarter of 2004, as further described in the Balance Sheet Restructuring and Debt Extinguishment footnote herein.
	(10)		Certain amounts of our mortgage debt are subject to prepayment penalties.
	(11)		The loan bears interest equal to the three-month LIBOR rate plus 250 basis points and requires monthly level payments of principal plus interest with a final payment at maturity of approximately $3.0 million.
	(12)		On April 15, 2004 we closed on a public offering of $125.0 million 6.75% senior unsecured monthly income notes at par. The notes were issued under our shelf registration statement filed with the SEC on June 25, 2003, which we refer to as the 2003 Shelf Registration Statement. Interest on the notes is payable monthly. The notes have a 15-year term and are redeemable at the Company’s option after five years at par. On March 18, 2004, which was the date the Company priced the notes, we entered into an interest rate swap arrangement with a third party to cause the interest rate on $100 million of the notes effectively to be at a floating rate of the three-month LIBOR plus 162.4 basis points. The unrealized loss on our fair value hedge was approximately $7.1 million as of June 30, 2004, as further described in the Interest Rate Swaps section herein. Total net proceeds to the Company, after deducting the discounts and commissions to the underwriters and other expenses of the offering, totaled approximately $121 million. The net proceeds were used to pay off a portion of the debt outstanding with Ford (see footnotes (8) and (9)).
	(13)		Although the principal balance of the $125.0 million 6.75% senior unsecured monthly income notes was $125.0 million as of June 30, 2004, in accordance with GAAP, the carrying value of the debt on our balance sheet has been reduced by $7.1 million, representing the change in the fair value of the swap described in footnote (12) and as more fully described in the Interest Rate Swaps section.
	(14)		On May 12, 2004, we closed on a public offering of $110.0 million 6% convertible notes. The notes were issued under our 2003 Shelf Registration Statement. The notes have a 20-year term and are convertible, at the option of the holder, into the Company’s common shares under certain circumstances, at an initial conversion price of $35.5679 per share, subject to certain adjustments. The initial price is equivalent to a conversion rate of 28.1152 shares per $1,000 principal amount of notes and equivalent to a premium of 30%. The conversion rate will be adjusted under certain circumstances, including common stock splits, common stock issuances as dividends and increases in the dividend rate. The Company may, at its option, redeem the notes for cash on or after May 15, 2009, at any time, in whole or, from time to time, in part, at a redemption price equal to 100% of the principal amount to be redeemed plus accrued and unpaid interest. The noteholders may require us to repurchase all or part of the notes on May 15, 2009, May 15, 2014 and May 15, 2019, or upon a change in control, at a price equal to 100% of the principal amount plus accrued and unpaid interest. The notes require semi-annual interest payments. In accordance with GAAP, the notes will be accounted for as debt, and interest expense recorded, until the conversion of the notes. In addition, the deferred loan fees associated with this debt are being amortized over a five-year period. Total net proceeds to the Company, after deducting the discounts and commissions to the underwriters and other expenses of the offering, totaled approximately $107 million. The net proceeds were used to pay off approximately $92 million of the debt outstanding with Ford and the related prepayment penalties totaling $2.2 million (see footnote (7)), to fund acquisitions and for general corporate purposes.
	(15)		Amounts borrowed under this facility bear interest at market rates determined at the time of each draw until such time as the Company and the lender set an interest rate for any future amounts borrowed under the facility. As of June 30, 2004, the borrowings under the facility bear interest equal to the 30-day LIBOR rate plus 300 to 315 basis points. Properties are eligible within the borrowing base for 150 days, unless extended by the Company and the lender. The facility has a one-year term, which matures on March 21, 2005, and is renewable annually.
	(16)		This construction credit facility provides for a one-year term. Amounts borrowed under this facility bear interest equal to a spread over LIBOR as determined at the time of each draw. As of June 30, 2004, the borrowings under the facility bear interest equal to the 30-day LIBOR rate plus 323 basis points. Properties are eligible within the borrowing base for 12 months, unless extended by the Company and the lender. The facility matures on June 22, 2005, and is renewable annually.

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(17)

This facility was terminated on April 1, 2004 because it prohibited the issuance of senior unsecured debt. On April 15, 2004, we closed on the public offering of senior unsecured monthly income notes as further described in footnote (12) above.

The more significant debt covenants related to our mortgage debt, unsecured debt and credit facilities limit our debt to assets ratio and require us to comply with minimum debt service coverage ratios and maximum debt to adjusted net worth and unencumbered assets to unsecured debt ratios. Several of our loan agreements contain no financial covenants; however, there are negative covenants relating to customary items such as operation and maintenance of the properties securing the loans and limitations on issuing additional debt at those subsidiaries. As of June 30, 2004, we were in compliance with all of the debt covenants related to our mortgage debt, unsecured debt and credit facilities.

Aggregate annual repayments of our debt outstanding (excluding borrowings on our credit facilities) as of June 30, 2004 are as follows (in thousands):

For the Year Ended December 31,

Interest Rate Swaps

We have entered into interest rate swap arrangements with third parties to manage or hedge our risk related to the effect of interest rate fluctuations on our investment spreads. We do not use derivative instruments for speculative purposes. We will either hedge our variable rate debt to convert it to a fixed interest rate, designating such hedge as a cash flow hedge, or hedge our fixed rate debt to convert it to a variable interest rate, designating such hedge as a fair value hedge. The cash flow and fair value hedges were designed to mirror the underlying debt in terms of index, spread, reset, amortization, compounding and maturity. Due to the identical nature of the terms of the swap arrangements and the underlying terms of the debt, the swaps were designated as highly effective at the inception of the swap arrangements. We continue to evaluate the highly effective nature of those hedges and believe our hedges continue to be highly effective. For all swap arrangements, we are required to post collateral, generally in the amount of the swap valuations at any point in time, to protect the lenders in case of an early termination by us.

The collateral posted by us related to our hedges, totaling approximately $13.3 million and $12.8 million as of June 30, 2004 and December 31, 2003, respectively, is included in other assets on our consolidated balance sheets.

As of June 30, 2004, we have two interest rate swap arrangements with third parties to fix the interest rate on the underlying variable rate debt, with a notional balance totaling approximately $100 million, which we have designated as cash flow hedges. During the second quarter of 2004, we terminated two of the interest rate swap arrangements with notional balances totaling approximately $58 million as part of our debt restructuring, as further described in the Balance Sheet Restructuring and Debt Extinguishment footnote herein. In conjunction with the early termination of these swap arrangements, we incurred swap

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breakage fees totaling approximately $4.0 million.

For a derivative qualifying as a cash flow hedge, the change in the unrealized gain or loss is recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity on our consolidated balance sheets. The fair value of the swap is recorded as either an asset or liability on our consolidated balance sheets.

The unrealized loss on our cash flow hedges was approximately $5.4 million and $13.5 million as of June 30, 2004 and December 31, 2003, respectively. Total comprehensive income for the three months ended June 30, 2004 and 2003 was approximately $21.4 million and $9.8 million, respectively. Total comprehensive income for the six months ended June 30, 2004 and 2003 was approximately $36.3 million and $20.8 million, respectively.

On March 18, 2004, in conjunction with pricing of the $125 million 6.75% senior unsecured monthly income notes, we entered into an interest rate swap arrangement with a third party to cause the interest rate on $100 million of the fixed rate debt effectively to be at a floating rate of the three-month LIBOR plus 162.4 basis points. At the time we entered into the swap, we had a firm commitment to close the debt on April 15, 2004. Therefore, we hedged our firm commitment and the debt. The swap arrangement has been designated as a fair value hedge.

For a derivative qualifying as a fair value hedge, the change in the net unrealized gain or loss upon measuring the fair value hedge and the fair value of the debt instrument being hedged is recorded on our consolidated statements of operations. Generally, these amounts offset each other. The fair value of the swap is recorded as either an asset or liability, with a corresponding increase or decrease recorded to the carrying value of the debt instrument being hedged on our consolidated balance sheets.

The unrealized loss on our fair value hedge was approximately $7.1 million as of June 30, 2004. The net unrealized gain or loss on our fair value hedge and the debt being hedged had no impact on our net income for the three months and six months ended June 30, 2004, respectively.

8.      EQUITY TRANSACTIONS

Common Shares

On April 2, 2004, we issued 1,000,000 common shares in an underwritten public offering at an initial price to the public of $35.15 per share under our 2003 Shelf Registration Statement. Net proceeds to the Company, after deducting the discounts and commissions to the underwriters and other expenses of this offering, totaled approximately $35.0 million. The Company contributed the net proceeds of the offering to the Partnership in exchange for Common Units in the Partnership and used the net proceeds to repay $18.0 million of borrowings under our short-term credit facilities and to pay off a portion of the debt outstanding with Ford.

Preferred Shares

On April 27, 2004, we issued 2,500,000 8% Series B Cumulative Redeemable Preferred Shares at $25.00 per share. On May 4, 2004, upon exercise of the underwriter’s over-allotment option, we issued an additional 100,000 Series B preferred shares at $25.00 per share. The Series B preferred shares were issued under our 2003 Shelf Registration Statement. Net proceeds to the Company, after deducting the discounts and commissions to the underwriters and other expenses of this offering, totaled approximately $63.2 million. The Company contributed the net proceeds of the offering to the Partnership in exchange for Series B Preferred Units in the Partnership. Of the total net proceeds, approximately $53 million was used to pay off a portion of the debt outstanding with Ford and the remaining proceeds were used to fund

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acquisitions and for general corporate purposes.

The preferred shares are non-voting and redeemable for cash, at $25.00 per share plus any accrued and unpaid dividends, at our option on or after April 27, 2009, unless in limited circumstances in which early redemption is necessary to preserve our status as a real estate investment trust for federal income tax purposes. The preferred shares have no stated maturity and are not subject to any sinking fund provisions. Additionally, the shares are not convertible into or exchangeable for any other security unless conversion is necessary to maintain our status as a real estate investment trust. Holders of preferred shares are entitled to cumulative cash dividends at a rate of 8% of the $25.00 liquidation preference per year (equivalent to $2.00 per year per share), payable quarterly (when and as declared by the Board of Trustees). In the case of the preferred shares, there are Series B Preferred Units in the Partnership owned by us that carry substantially the same terms.

9.      MINORITY INTEREST

Assets and liabilities allocated to the limited partners (other than the Company), which we describe as the Minority Interest, are based on their ownership percentage of the Partnership at the end of the period. The ownership percentage is determined by dividing the number of Common Units held by the Minority Interest at the end of the period by the total Common Units outstanding at the end of the period, excluding derivative securities. The full redemption amount of the Preferred Units is deducted from the Partnership’s equity prior to applying the ownership percentage to calculate Minority Interest. The Minority Interest ownership percentage in assets and liabilities of the Partnership was 18.3% and 19.3% as of June 30, 2004 and December 31, 2003, respectively.

Income before minority interest is allocated to the limited partners based on their weighted average ownership during the period. The ownership percentage is determined by dividing the weighted average number of Common Units held by the Minority Interest by the total weighted average number of Common Units outstanding during the period, excluding derivative securities. Income before minority interest is reduced by Preferred Unit dividends prior to applying the ownership percentage. The Minority Interest ownership percentage in income of the Partnership was 17.7% and 21.3% for the three months ended June 30, 2004 and 2003, respectively. The Minority Interest ownership percentage in income of the Partnership was 18.1% and 22.2% for the six months ended June 30, 2004 and 2003, respectively.

Holders of Common Units, which we refer to as Unitholders, are entitled to quarterly distributions which are equivalent to the quarterly dividend distributions received by holders of common shares. There were 8.1 million and 7.9 million Common Units as of June 30, 2004 and December 31, 2003, respectively, not held by the Company, which were outstanding and could be exchanged for common shares of the Company on a one-for-one basis in specified circumstances. When a Unitholder converts Common Units to shares of common stock, an adjustment is recorded to equity to reflect the change in the Minority Interest ownership in the Partnership. When the Company issues common shares from an underwritten public offering, its share-based compensation plan and its Dividend Reinvestment and Share Purchase Plan, the net proceeds from these issuances are contributed to the Partnership in exchange for Common Units in the Partnership and an adjustment is recorded to equity to reflect the change in the Minority Interest ownership in the Partnership.

10.      EARNINGS PER COMMON SHARE

Basic earnings per common share is computed as net income available to common shareholders divided by the weighted average common shares, excluding restricted shares, outstanding for the period. Diluted earnings per common share is computed as net income available to common shareholders, adjusted to

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reflect the change in the income allocated to minority interest calculated as if the dilutive securities were outstanding, divided by the weighted average common shares outstanding for the period plus the effect of dilutive securities outstanding for the period, based on the treasury stock method. Dilutive securities include options, warrants, phantom shares and restricted shares.

A reconciliation of income and weighted average common shares used to calculate basic and diluted earnings per common share for the three months and six months ended June 30, 2004 and 2003 is as follows (in thousands, except per share data):

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11.      DIVIDENDS DECLARED PER SHARE

The following table summarizes any activity related to our dividends during the six months ended June 30, 2004:

(1)

Initial dividend payment was prorated from the original issuance date through the date indicated.

12.      LEGAL PROCEEDINGS

We are engaged in litigation relating to the activities of Michael Burkitt, a former employee who left to become President, Chief Executive Officer, and a member of the board of directors of Milestone Realty Trust, a Maryland corporation, which we refer to as Milestone. We filed a motion for judgment in the Circuit Court of Fairfax County, Virginia against Mr. Burkitt seeking injunctive relief, punitive damages and actual damages resulting from Mr. Burkitt’s alleged misappropriation of our trade secrets, breaches of his fiduciary duties to us, and his misstatements to third parties regarding his role and activities as an employee of ours.

Milestone, together with three of its sponsors and investors, then filed suit against us in the District Court in Dallas County, Texas, seeking injunctive relief, actual damages of at least $150,000,000 and treble damages resulting from our alleged attempt to interfere with Milestone’s business relationships with potential investors and tenants and its efforts to raise capital. On April 6, 2004, the Dallas District Court issued a temporary restraining order, prohibiting us, our officers, employees, agents, and all other persons acting with us from contacting or attempting to contact, verbally or in writing, any representative of any entity that may be an investor or seller of real property to Milestone, for the purpose of disparaging Milestone, its officers and affiliates by untruthful statements and innuendoes or accusations. The order has been extended by mutual agreement. We believe that the issuance of a temporary injunction to this effect has not and will not affect our operations adversely. In connection with this suit, we and the plaintiffs engaged in mediation in Dallas, Texas, on April 19, 2004, which did not result in a settlement.

On June 25, 2004, the Circuit Court of Fairfax County granted us permission to amend our motion for judgment and add new parties. We have added Milestone, The Staubach Company, Staubach Retail Services, Inc., Cypress Equities, L.L.C., Presidio Financial Partners, L.L.C., and John Geller (who resigned from his position at Ernst & Young LLP, where he served as our audit partner, to become the Chief Financial Officer of Milestone) as defendants and Capital Automotive L.P. as co-plaintiff to our Fairfax, Virginia suit for misappropriation of trade secrets, breaches of fiduciary duty, tortuous interference with CARS’ business relationships, and conspiracies to injure CARS in its reputation, trade, business, and profession. We are seeking $250,000,000 in compensatory and punitive damages, and three-fold damages pursuant to Virginia’s conspiracy statute, and injunctive relief pursuant to the Virginia Uniform Trade Secrets Act.

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Although no assurance can be provided with respect to any litigation, we believe that the allegations against us in the Texas petition are without merit and that we have meritorious defenses to the claims made in the petition. We intend to prosecute our case and defend ourselves vigorously, and management does not anticipate that the litigation will have a material adverse effect on our financial position or results of operations.

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

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with our primary business strategy to give the reader an overview of the goals of our business. This is followed by a discussion of our recent developments beginning on page 26. In the next section, beginning on page 28, we discuss our results of operations for the periods presented. We then provide, beginning on page 32, an analysis of our liquidity and capital resources, including discussions of our cash flows, financing strategy, debt arrangements, sources of capital and financial commitments. Finally, on page 43, we discuss funds from operations, or FFO, which is a relative non-GAAP financial measure of performance of an equity REIT used by the REIT industry.

The MD&A should be read in conjunction with the other sections of this Quarterly Report on Form 10-Q, including the consolidated financial statements and notes thereto appearing in Item 1 of this report, disclosures about our market risk appearing in Item 3 of this report and the subsection captioned “Forward-Looking Statements” herein.

OVERVIEW

Our primary business strategy is to purchase real estate (land, buildings and other improvements), which we simultaneously lease to operators of franchised automobile dealerships and motor vehicle service, repair or parts businesses, used vehicle businesses and other related businesses under long-term, triple-net leases. We use (i) the term dealerships to refer to these types of businesses that are operated on our properties and (ii) the term dealer group, tenant or operators of dealerships to refer to the persons and companies that lease our properties. We focus on leasing properties to dealer groups that have a long history of operating multi-site, multi-franchised dealerships, generally targeting the largest dealer groups in terms of revenues in the largest major metropolitan areas in the U.S. in terms of population. In addition, we provide facility improvement and expansion funding, construction financing and takeout commitments in certain circumstances. As of June 30, 2004, we had invested more than $2.0 billion in 330 properties located in 31 states, consisting of approximately 2,480 acres of land and containing approximately 14.2 million square feet of buildings and improvements. Our tenants operate 473 motor vehicle franchises on our properties, representing 44 brands of motor vehicles, which include all of the top selling brands in the U.S.

Substantially all of our properties are leased pursuant to long-term, triple-net leases, under which the tenants typically pay all operating expenses of a property, including, but not limited to, all real estate taxes, assessments and other government charges, insurance, utilities, repairs and maintenance. The initial lease terms generally range from 10 to 20 years (with a weighted average initial lease term for leases entered into during the quarter ended June 30, 2004 of approximately 17.0 years), with our entire portfolio having a weighted average initial lease term of approximately 14.9 years. As of June 30, 2004, our portfolio had a weighted average remaining lease term of approximately 11.7 years. The leases typically have options to renew upon generally the same terms and conditions for one or more additional periods of five to 10 years each, exercisable at the option of the tenants (with renewal options typically ranging from a total of five to 40 years).

Substantially all of our revenues are derived from (1) rents received or accrued under long-term, triple-net leases; (2) interest earned on notes secured by real estate; (3) interest earned from the temporary investment of funds in short-term investments; and (4) other fee income.

We are a self-administered and self-managed real estate company operating as a real estate investment trust, or a REIT, for federal income tax purposes. Our general and administrative expenses consist

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primarily of compensation expense for our executive officers and other employees, professional fees, office administration expenses (including rent), business taxes and insurance and various other expenses incurred in managing our business. Our primary non-cash expense is the depreciation of our properties. We depreciate buildings and improvements on our properties over a nine-year to 40-year period for tax purposes and a 20-year to 45-year period for financial reporting purposes. We do not own or lease any significant personal property, furniture or equipment at any property we currently own.

RECENT DEVELOPMENTS

Real Estate Investments

During the second quarter, we increased our real estate investments by approximately $120.4 million, bringing the total increase in investments for the year to $144.2 million.

Property Investments

During the second quarter, we completed approximately $126 million in real estate investments, including sale-leaseback financing on 14 auto retail properties to six dealer groups, including two new tenants. These dealer groups consist primarily of Top 100 dealer groups, both private and publicly-traded. Also included in the second quarter investments was approximately $18 million in construction improvements, transacted with six existing tenants. Several of the properties acquired this quarter will undergo major renovations by the tenants over the next 12 to 24 months, which we have committed up to $75 million to fund. The second quarter real estate investments contain 28 automotive franchises located in 13 states (California, Florida, Georgia, Illinois, Louisiana, Maryland, Michigan, New Jersey, North Carolina, Ohio, South Carolina, Texas and Virginia) and have a weighted average initial lease term of approximately 17 years, with multiple renewal options exercisable at the option of the tenants. The investments were funded with approximately $70.0 million from borrowings on our short-term credit facilities, with the issuance of $10.1 million in operating partnership units at an average price of $28.61 per unit, and with cash on hand. During the second quarter, a tenant completed the construction of a new facility, totaling $10 million, on land owned by us. The construction was funded through our construction financing program. We acquired this facility upon completion of construction.

Property Dispositions

During the second quarter, we sold two auto retail locations, for approximately $3.5 million, to one dealer group, resulting in a combined gain of approximately $315,000 before minority interest. In exchange for early termination of the leases related to these properties, we received approximately $175,000 in lease termination fees, which was recorded during the second quarter. In addition, we sold five auto retail locations back to a tenant for $6.7 million in net proceeds, consisting of $700,000 in cash and a $6 million secured first mortgage note, with additional collateral as well as personal guarantees. The secured mortgage is a three-year, interest-only note. The gain related to this sale, totaling approximately $700,000 before minority interest, has been deferred. The earnings generated from these real estate dispositions, including the combined recognized gain and the lease termination fees, have been reported as discontinued operations.

Financing

Balance Sheet Restructuring and Extinguishment of Debt

As previously discussed in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004, we completed a significant restructuring of our

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balance sheet by paying off a portion of our outstanding debt with Ford Motor Credit Corporation (Ford). We repaid approximately $214 million of mortgage debt outstanding with Ford, of which approximately $161 million was variable rate debt, with a weighted average spread over LIBOR of 226 basis points, and approximately $53 million was variable rate debt swapped to fixed rate debt, bearing interest at approximately 7.6%. The net proceeds used to repay the debt were derived from the following sources:

•		On April 2, 2004, we issued 1,000,000 common shares in an underwritten public offering at an initial price to the public of $35.15 per share, as further described in the “Liquidity and Capital Resources — Equity Offerings” section herein;
•		On April 15, 2004, we closed on a public offering of $125 million 6.75% senior unsecured monthly income notes at par, as further described in the “Liquidity and Capital Resources — Mortgages and Notes Payable” section herein;
•		On April 27, 2004, we issued 2,500,000 8% Series B Cumulative Redeemable Preferred Shares at $25.00 per share, as further described in the “Liquidity and Capital Resources — Equity Offerings” section herein; and
•		Approximately $23 million from borrowings on our short-term credit facilities, which were subsequently repaid during the second quarter of 2004, and cash on hand due to the timing of the equity and debt transactions noted above.

As a result of this restructuring, on April 1, 2004, we terminated our $60 million unsecured credit facility, which prohibited the issuance of senior unsecured debt. As of March 31, 2004, the facility had no amounts outstanding and was expected to remain principally unused until its expiration in March 2005.

In May 2004, we repaid the remainder of our outstanding Ford debt totaling approximately $92 million, which had an effective interest rate of approximately 7.84%, and incurred related prepayment penalties totaling approximately $2.2 million. The debt and prepayment penalties were paid with a portion of the net proceeds derived from our May 12, 2004 public offering of $110 million of 6% Convertible Notes, as further described in the “Liquidity and Capital Resources — Mortgages and Notes Payable” section herein.

As a result of these transactions, we incurred a debt extinguishment charge totaling approximately $8.7 million, or $0.20 per share to net income available to common shareholders. The debt extinguishment charge consisted of: (i) swap breakage fees totaling approximately $4.0 million related to the repayment of variable rate debt with Ford that had been swapped to a fixed rate; (ii) the write-off of deferred loan fees related to the loans that were paid off and the termination of our $60 million unsecured credit facility totaling approximately $2.5 million; and (iii) prepayment penalties totaling approximately $2.2 million related to the repayment of the fixed rate debt with Ford.

By completing the restructuring during the second quarter of 2004, we significantly improved our balance sheet flexibility while continuing our strategy of match-funding our debt with our leases. Specifically, we accomplished the following:

•		Replaced $306 million of secured financing with unsecured financing and equity capital;
•		Reduced our long-term variable rate debt by approximately $60 million;
•		Increased our unencumbered assets. As of June 30, 2004, our encumbered assets totaled nearly $800 million;
•		Reduced future amortization requirements by approximately $81 million over the remaining terms

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		of the repaid debt, including approximately $12 million in amortization previously scheduled within the next twelve months. This also improved our overall leverage and debt service and fixed charge coverage ratios; and
•		Extended the weighted average remaining term of our long-term debt.

Shelf Registration

On June 4, 2004, we filed a shelf registration statement, which we refer to as the 2004 Shelf Registration Statement, with the SEC relating to the future offering of up to an aggregate of $600 million of common shares, preferred shares, depositary shares, debt securities and warrants exercisable for common or preferred shares. The 2004 Shelf Registration includes approximately $64.2 million available under our shelf registration statement filed with the SEC on March 2, 1999 as well as approximately $1.5 million available under our shelf registration statement filed with the SEC on June 25, 2003, which we refer to as the 2003 Shelf Registration Statement, for the issuance of securities. We believe the 2004 Shelf Registration Statement will provide us with more efficient and immediate access to capital markets when considered appropriate. As of June 30, 2004, we had not issued any securities pursuant to the 2004 Shelf Registration Statement and, thus, $600 million was available under the 2004 Shelf Registration Statement for the issuance of securities.

RESULTS OF OPERATIONS

Revenue

This section should be read in conjunction with the section captioned “Variable Rate Lease Program” herein.

Rental. The increase in rental revenue from the three and six months ended June 30, 2003 to the three and six months ended June 30, 2004 was primarily attributable to the growth of our real estate portfolio from property acquisitions from which we generate our rental income. The following table demonstrates the growth of our real estate portfolio for the periods indicated. Excluded in the periods presented are property dispositions that have occurred through June 30, 2004. The results of operations related to these properties were reclassified from rental revenue to discontinued operations for all periods presented as further described under the “Discontinued Operations” section herein.

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The increase in rental income was also attributable to an increase from rent adjustments above the fixed minimum escalators, which are recorded as revenue in the period they are due from the tenants.

Interest and Other. The increase in interest and other income from the three and six months ended June 30, 2003 to the three and six months ended June 30, 2004 was primarily due to interest earned on notes or construction advances secured by real estate funded during the previous twelve months. Notes and construction advances totaled $13.4 million as of June 30, 2004. Included in interest income for the six months ended June 30, 2004 is interest earned on a $25.5 million note secured by real estate issued in the fourth quarter of 2003 that was repaid at the end of the first quarter of 2004.

Expenses

Depreciation and Amortization. Depreciation and amortization consisted primarily of depreciation on buildings and improvements owned during the periods indicated above. The increases are primarily attributable to the growth of our real estate portfolio described under “Revenue — Rental” above, resulting in an increase in our depreciable assets.

General and Administrative. General and administrative expenses increased from the three and six months ended June 30, 2003 to the three and six months ended June 30, 2004 due primarily to:

•		an increase in professional services resulting in higher legal and accounting fees;
•		an increase in payroll and related expenses primarily attributable to an increase in overall compensation and an increase in the number of employees; and
•		an increase in state and local taxes and registration fees due to the growth in our real estate portfolio as well as changes in state tax laws.

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Interest. The following table sets forth certain information regarding our debt as of the periods indicated.

*

Includes deferred loan fees amortized over the life of the loans.

Interest expense for the three months ended June 30, 2003 was slightly higher than the three months ended June 30, 2004. Although our overall debt increased from new debt issuances and borrowings on our credit facilities, which was primarily obtained to fund real estate investments, our effective interest rate decreased to 6.27% for the second quarter of 2004 from 6.45% for the same quarter in the prior year, primarily due to our balance sheet restructuring, as further described in the “Recent Developments” section herein. In addition, the borrowings on our short-term revolving credit facilities, totaling $77 million, which were primarily used to fund acquisitions, occurred at the end of the quarter thereby having a minimal impact on interest expense.

The increase in interest expense from the six months ended June 30, 2003 to the six months ended June 30, 2004 is primarily due to an increase in our overall debt during the past 18 months, which was primarily obtained to fund our investments in real estate during that time period, as well as the conversion of approximately $200 million of variable rate debt to fixed rate debt at the end of the first quarter of 2003. During 2003, we completed a $228 million debt securitization, at an effective rate of 5.86%, in order to lock in rates during the low interest rate environment. The net proceeds from the debt securitization were primarily used to pay down borrowings on our short-term revolving credit facilities and to pay off short-term variable rate mortgage debt. As the debt was issued at the end of the first quarter of 2003, the conversion from variable to fixed rate debt had little impact on interest expense for that period, but resulted in an increase in interest expense in subsequent periods. The increase in interest expense was partially offset by a decrease in our effective rate for the six months ended June 30, 2004, as compared to the same period in prior year as noted above.

Debt Extinguishment Charge. Debt extinguishment expenses for the three and six months ended June 30, 2004 totaled approximately $8.7 million. The expenses are attributable to the balance sheet restructuring that was completed during the second quarter of 2004, as further described in the “Recent Developments” section herein. The debt extinguishment charge consisted of (i) swap breakage fees totaling approximately $4.0 million related to the repayment of variable rate debt with Ford that had been swapped to a fixed rate; (ii) the write-off of deferred loan fees related to the loans that were paid off and the termination of our $60 million unsecured credit facility totaling approximately $2.5 million; and (iii) prepayment penalties totaling approximately $2.2 million related to the repayment of the fixed rate debt with Ford.

Discontinued Operations

Beginning in 2002, SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that gains and losses from dispositions of properties and all operating earnings from these properties be reported as “discontinued operations.” This also requires that all past earnings applicable to a property disposed of subsequent to January 1, 2002 be reported as “discontinued operations.” As a

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result, previously reported “income from continuing operations” will be updated each time a property is sold. This requirement is for presentation only and has no impact on net income.

Since January 1, 2003, we have sold 14 auto retail locations with net proceeds totaling approximately $44.1 million.

The following table sets forth the components of discontinued operations related to properties sold subsequent to January 1, 2003 (in thousands):