FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

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 October 31, 2004 was 38,393,379.

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)

[Continued from above table, first column(s) repeated]

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 September 30, 2004, owned approximately 82.5% 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 entities 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 September 30, 2004, we had invested nearly $2.1 billion in 327 properties located in 31 states, consisting of approximately 2,532 acres of land and containing approximately 14.3 million square feet of buildings and improvements. Our tenants operate 489 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 September 30, 2004 of approximately 17.7 years), with our entire portfolio having a weighted average initial lease term of approximately 15.0 years. As of September 30, 2004, our portfolio had a weighted average remaining lease term of approximately 11.8 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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nine months ended September 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 September 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 $9.1 million and $7.8 million for the three months ended September 30, 2004 and 2003, respectively. Real estate depreciation expense, including depreciation expense related to discontinued operations, was approximately $26.8 million and $22.8 million for the nine months ended September 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 September 30, 2004 and 2003, respectively. Total depreciation expense related to our furniture, fixtures and equipment was approximately $50,000 and $58,000 for the nine months ended September 30, 2004 and 2003, respectively.

Improvement Fundings and Construction Financing

We may fund facility 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 or have a ground lease on the underlying land, which in both cases 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 $9.4 million and $5.0 million as of September 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 $13.3 million and $20.2 million as of September 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 $23.5 million and $18.1 million as of September 30, 2004 and December 31, 2003, respectively. Loan cost amortization expense was approximately $815,000 and $675,000 for the three months ended September 30, 2004 and 2003, respectively. Loan cost amortization expense was approximately $2.3 million and $1.9 million for the nine months ended September 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. During the three months and nine months ended September 30, 2004, we expensed approximately $697,000 and $3.2 million of unamortized deferred loan costs attributable to loans that were paid off. We did not have any such expenses during the nine months ended September 30, 2003.

Capitalized Leasing Costs

Certain direct costs initially incurred by us in negotiating and consummating a successful lease are

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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 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 $1.7 million and $1.4 million as of September 30, 2004 and December 31, 2003, respectively. Leasing cost amortization expense was approximately $47,000 and $44,000 for the three months ended September 30, 2004 and 2003, respectively. Leasing cost amortization expense was approximately $145,000 and $128,000 for the nine months ended September 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 September 30, 2004, approximately $406 million of our real estate portfolio, or 20%, was subject to variable rate leases. This compares to $413 million of our real estate portfolio, or 24%, that was subject to variable rate leases as of September 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 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 $19.2 million and $16.7 million as of September 30, 2004 and December 31, 2003, respectively. Straight-lined rental revenue was approximately $957,000 and $1.2 million for the three months ended September 30, 2004 and 2003, respectively. Straight-lined rental revenue was approximately $3.1 million and $3.7 million for the nine months ended September 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

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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 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 Second Amended and Restated 1998 Equity Incentive Plan, which we refer to as the Plan, provides equity compensation to our employees, officers, non-employee trustees and certain other service providers. At September 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 September 2004, the Emerging Issues Task Force, commonly referred to as the EITF, reached a final consensus affirming their June 2004 tentative conclusion (with modifications) 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 contingencies occur, and at least one of the contingencies is based on the market price of the issuer’s shares. The EITF 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 Financial Accounting Standards Board, commonly referred to as the FASB, plans to issue an amendment to SFAS No. 128 during the fourth quarter of 2004. The amendment is expected to be effective for periods ending after December 15, 2004, and the consensus must be applied by restating all periods during which the contingently convertible debt instrument was outstanding. We do not expect the amendment to SFAS No. 128 to have a significant impact on our results of operations and earnings per common share for the three months and nine months ended September 30, 2004 and 2003.

4. REAL ESTATE INVESTMENTS

During the third quarter of 2004, we completed approximately $46.6 million in real estate investments, including two auto retail properties totaling approximately $34.1 million, transacted with two existing tenants and approximately $12.5 million in construction and improvement fundings, transacted with four existing tenants. The third quarter real estate investments contain 15 automotive franchises located in six states (Georgia, New Jersey, Ohio, Pennsylvania, Rhode Island and Texas) and have a weighted average initial lease term of approximately 17.7 years, with multiple renewal options exercisable at the option of the tenants. The investments were funded with borrowings on our short-term credit facilities and with cash on hand.

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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 third quarter of 2004, we sold four auto retail locations for approximately $20.1 million in sales proceeds to three dealer groups, resulting in a combined gain of approximately $2.8 million before minority interest. In exchange for early termination of the leases, we also received approximately $937,000 in lease termination fees, which were recorded during the third quarter. The earnings generated from these real estate dispositions, including the combined gain recognized and lease termination fees, have been reported as discontinued operations.

The following table sets forth the components of discontinued operations related to the 18 auto retail locations sold subsequent to January 1, 2003 (in thousands):

6. DEBT OUTSTANDING

Balance Sheet Restructuring and Debt Extinguishment Charges

Second Quarter of 2004

As previously discussed in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004, we initiated a significant restructuring of our balance sheet by paying off approximately $306

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million of our outstanding debt with Ford Motor Credit Corporation (Ford) during the second quarter of 2004. In April 2004, we repaid approximately $214 million of mortgage debt outstanding with Ford with a weighted average remaining maturity of approximately 7.7 years. Of the total debt, 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 Debt Outstanding 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 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 these transactions, 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% with a remaining maturity of approximately 7.2 years, 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 Debt Outstanding section herein.

As a result of the above 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.

Third Quarter of 2004

In August 2004, we repaid approximately $211.7 million of variable rate debt (consisting of $113.4 million of secured debt, $4.3 million of unsecured debt and borrowings on our secured credit facilities totaling $94.0 million). The debt repaid (excluding the borrowings on our secured credit facilities) had a

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weighted average spread over LIBOR of 278 basis points with a weighted average remaining maturity of approximately 6.4 years. The borrowings on our secured credit facilities had spreads over LIBOR ranging from 285 to 323 basis points. We have not terminated our secured credit facilities, which are scheduled to mature in 2005. The debt was repaid with the net proceeds derived from the closing of our unsecured revolving credit and term loan facility during August 2004, as further described in the Debt Outstanding section herein, and the issuance of 1,700,000 common shares in an underwritten public offering in August 2004, as further described in the Equity Transactions footnote herein.

As a result of the debt repayment, we incurred debt extinguishment charges totaling approximately $697,000, or $0.02 per share to net income available to common shareholders. The debt extinguishment charges consisted of the write-off of deferred loan fees related to the loans that were paid off during the third quarter.

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Debt Outstanding

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

*		For the quarter ended September 30, 2004. Includes deferred loan fees amortized over the life of the loans.
(1)		This loan requires monthly payments of principal and interest with a final payment at maturity of approximately $24.2

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		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 level payments of principal and interest 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 $13.3 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 that was outstanding with Ford totaling approximately $145 million, which was repaid during the second quarter of 2004, as further described above in the Balance Sheet Restructuring and Debt Extinguishment Charges section herein.
(8)		This loan requires monthly interest and level principal payments with a final payment at maturity of approximately $5.7 million. This loan bears interest equal to the three-month LIBOR plus 225 basis points.
(9)		This represents debt that was outstanding with various lenders, of which approximately $161 million was repaid during the second quarter of 2004 and $113 million was repaid during the third quarter of 2004, as further described above in the Balance Sheet Restructuring and Debt Extinguishment Charges section herein.
(10)		Certain amounts of our mortgage debt are subject to prepayment penalties.
(11)		This loan, totaling approximately $4 million, was repaid during the third quarter of 2004, as further described above in the Balance Sheet Restructuring and Debt Extinguishment Charges section herein.
(12)		On August 20, 2004, we closed on a syndicated unsecured revolving credit and term loan facility to replace the credit

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		facility we terminated in April 2004 and to refinance certain of our existing secured debt. The revolving credit portion of the facility is $250 million with an initial three-year term and an option to extend the term for an additional one-year period. The term loan portion of the facility is a $150 million five-year unsecured term loan and requires interest-only payments until maturity, at which time the loan requires a final payment totaling $150 million. The facility bears interest at a spread, generally over LIBOR, and adjusts over time, based upon our leverage or our debt rating, if elected. As of September 30, 2004, the borrowings under the facility bear interest equal to 30-day LIBOR rate plus 145 basis points. At closing, net proceeds to the Company from the facility, after deducting expenses, totaled approximately $197.4 million (representing the $150 million term loan portion and borrowings on the revolving credit facility portion totaling $50 million). The net proceeds were used to repay approximately $94 million of borrowings under our short-term secured credit facilities, to pay off approximately $89.8 million of debt outstanding (see Balance Sheet Restructuring and Debt Extinguishment Charges section herein), to fund acquisitions and for general corporate purposes.
(13)		On April 15, 2004 we closed on a public offering of $125 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 $3.4 million as of September 30, 2004, as further described in the Interest Rate Swaps section herein. The 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 during the second quarter of 2004, as further described above in the Balance Sheet Restructuring and Debt Extinguishment Charges section herein.
(14)		Although the principal balance of the $125 million 6.75% senior unsecured monthly income notes was $125 million as of September 30, 2004, in accordance with GAAP, the carrying value of the debt on our balance sheet has been reduced by $3.4 million, representing the change in the fair value of the swap described in footnote (13) and as more fully described in the Interest Rate Swaps section.
(15)		On May 12, 2004, we closed on a public offering of $110 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. The deferred loan fees associated with this debt are being amortized over a five-year period. The net proceeds to the Company, after deducting the discounts and commission to the underwriters and other expenses of the offering, totaled approximately $107 million. The net proceeds were used to pay off a portion of the debt outstanding with Ford and the related prepayment penalties, as further described above in the Balance Sheet Restructuring and Debt Extinguishment Charges section herein, to fund acquisitions and for general corporate purposes. In September 2004, the EITF reached a final consensus affirming their June 2004 tentative conclusion on EITF Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share”, as further described in the New Accounting Pronouncements footnote herein.
(16)		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. 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.
(17)		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. 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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Our secured debt generally contains customary covenants, including, among others, provisions:

•		relating to the maintenance of the property securing the debt;
•		restricting our ability to sell, assign or further encumber the properties securing the debt;
•		restricting our ability to incur additional debt;
•		restricting our ability to amend or modify existing leases; and
•		certain prepayment restrictions.

Our unsecured debt generally contains various restrictive covenants. The covenants in our unsecured debt include, among others, provisions restricting our ability to:

•		incur or guarantee additional debt;
•		make certain distributions, investments and other restricted payments, including distribution payments on our outstanding common and preferred shares;
•		limit the ability of restricted subsidiaries to make payments to us;
•		enter into transactions with certain affiliates;
•		create certain liens; and
•		consolidate, merge or sell our assets.

The more significant financial covenants related to our debt include:

•		minimum debt service coverage ratios;
•		minimum fixed charge coverage ratios;
•		maximum debt to adjusted net worth ratios, including maximum unsecured debt to unencumbered asset ratios;
•		maintenance of a minimum combined equity value or consolidated net worth; and
•		maximum dividend payout ratios.

As of September 30, 2004, we were in compliance with all of the debt covenants related to our debt outstanding.

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

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 $11.9 million and $12.8 million as of September 30, 2004 and December 31, 2003, respectively, is included in other assets on our consolidated balance sheets.

As of September 30, 2004, we have two interest rate swap arrangements with third parties to fix the interest rate on the underlying variable rate debt, with an initial notional balance totaling approximately $100 million, which we have designated as cash flow hedges. During the second quarter of 2004, we terminated two 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 Charges section herein. In conjunction with the early termination of these swap arrangements, we incurred swap 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 $8.5 million and $13.5 million as of September 30, 2004 and December 31, 2003, respectively. Total comprehensive income for the three months ended September 30, 2004 and 2003 was approximately $19.3 million and $16.8 million, respectively. Total comprehensive income for the nine months ended September 30, 2004 and 2003 was approximately $55.6 million and $37.6 million, respectively.

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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 $3.4 million as of September 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 nine months ended September 30, 2004.

7. EQUITY TRANSACTIONS

Common Shares

On February 9, 2004, we sold 1,825,000 common shares in an underwritten public offering at an initial price to the public of $35.40 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 $61.6 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 fund acquisitions, to repay borrowings under our short-term credit facilities and for general corporate purposes.

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 underwriter 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.

On August 27, 2004, we issued 1,700,000 common shares in an underwritten public offering, including 100,000 common shares issued pursuant to the exercise of the underwriter’s over-allotment option, at an initial price to the public of $28.95 per share. The shares were issued under our shelf registration filed with the SEC on June 4, 2004, which we refer to as the 2004 Shelf Registration Statement. Net proceeds to the Company, after deducting the discounts and commissions to the underwriter and other expenses of this offering, totaled approximately $48.5 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 approximately $27.9 million of debt outstanding, to repay borrowings under our short-term credit facilities, to fund acquisitions and for general corporate purposes.

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

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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 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.

8. 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 the Partnership’s equity was 17.5% and 19.3% as of September 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 18.0% and 20.6% for the three months ended September 30, 2004 and 2003, respectively. The Minority Interest ownership percentage in income of the Partnership was 18.1% and 21.6% for the nine months ended September 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 September 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.

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9. 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 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 nine months ended September 30, 2004 and 2003 is as follows (in thousands, except per share data):

* Three months ended September 30, 2004 and September 30, 2003 include the effect of adjusting minority interest using the weighted average shares outstanding for the nine months ended September 30, 2004 and September 30, 2003.

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10. DIVIDENDS DECLARED PER SHARE

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

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

11. 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 against us and related parties. The temporary restraining order has expired and is no longer in effect.

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, tortious 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 28 and new accounting pronouncements on page 29. In the next section, beginning on page 29, we discuss our results of operations for the periods presented. We then provide, beginning on page 34, 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 48, 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 entities 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 September 30, 2004, we had invested nearly $2.1 billion in 327 properties located in 31 states, consisting of approximately 2,532 acres of land and containing approximately 14.3 million square feet of buildings and improvements. Our tenants operate 489 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 September 30, 2004 of approximately 17.7 years), with our entire portfolio having a weighted average initial lease term of approximately 15.0 years. As of September 30, 2004, our portfolio had a weighted average remaining lease term of approximately 11.8 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 or construction advances 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

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trust, or a REIT, for federal income tax purposes. Our general and administrative expenses consist 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 third quarter, we increased our net real estate investments by approximately $26.9 million (consisting of $46.6 million in real estate investments and $19.7 million in property dispositions), bringing the total net increase in investments for the year to $171.2 million.

Real Estate Investments

During the third quarter, we completed approximately $46.6 million in real estate investments, including two auto retail properties totaling approximately $34.1 million, transacted with two existing tenants and approximately $12.5 million in construction and improvement fundings, transacted with four existing tenants. The third quarter real estate investments contain 15 automotive franchises located in six states (Georgia, New Jersey, Ohio, Pennsylvania, Rhode Island and Texas) and have a weighted average initial lease term of approximately 17.7 years, with multiple renewal options exercisable at the option of the tenants. The investments were funded with borrowings on our short-term credit facilities and with cash on hand.

Real Estate Dispositions

We sell properties from time to time, generally when a tenant has indicated that a particular location no longer meets their operational needs. During the third quarter, we sold four auto retail locations for approximately $20.1 million in sales proceeds to three dealer groups, resulting in a combined gain of approximately $2.8 million before minority interest. In exchange for early termination of the leases, we also received approximately $937,000 in lease termination fees, which were recorded during the third quarter. The earnings generated from these real estate dispositions, including the combined gain recognized and the lease termination fees, have been reported as discontinued operations.

Financing

As part of our strategy of improving our capital structure, in August 2004 we repaid approximately $211.7 million of variable rate debt (consisting of $113.4 million of secured debt, $4.3 million of unsecured debt and borrowings on our secured credit facilities totaling $94.0 million). The debt repaid (excluding the borrowings on our secured credit facilities) had a weighted average spread over LIBOR of 278 basis points with a weighted average remaining maturity of approximately 6.4 years. The borrowings on our secured credit facilities had spreads over LIBOR ranging from 285 to 323 basis points. We have not terminated our secured credit facilities, which are scheduled to mature in 2005. The debt was repaid with the net proceeds derived from the closing of our unsecured revolving credit and term loan facility during August 2004, as further described in the “Liquidity and Capital Resources — Debt Outstanding” section herein, and the issuance of 1,700,000 common shares in an underwritten public offering in August 2004, as further described in the “Liquidity and Capital Resources — Equity Offerings” section herein.

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As a result of the debt repayment, we incurred debt extinguishment charges totaling approximately $697,000, or $0.02 per share to net income available to common shareholders. The debt extinguishment charges consisted of the write-off of deferred loan fees related to the loans that were paid off during the third quarter.

New Accounting Pronouncements

In September 2004, the Emerging Issues Task Force, commonly referred to as the EITF, reached a final consensus affirming their June 2004 tentative conclusion (with modifications) 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 contingencies occur, and at least one of the contingencies is based on the market price of the issuer’s shares. The EITF 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 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 Financial Accounting Standards Board, commonly referred to as the FASB, plans to issue an amendment to SFAS No. 128 during the fourth quarter of 2004. The amendment is expected to be effective for periods ending after December 15, 2004, and the consensus must be applied by restating all periods during which the contingently convertible debt instrument was outstanding. We do not expect the amendment to SFAS No. 128 to have a significant impact on our results of operations and earnings per common share for the three months and nine months ended September 30, 2004 and 2003.

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 nine months ended September 30, 2003 to

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the three and nine months ended September 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 September 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.

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 nine months ended September 30, 2003 to the three and nine months ended September 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 approximately $16.0 million as of September 30, 2004. Included in interest income for the nine months ended September 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. Additionally, the increase was due to lease assignment fees earned during the three and nine months ended September 30, 2004. There were no lease assignment fees during the three and nine months ended September 30, 2003.

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 nine months ended September 30, 2003 to the three and nine months ended September 30, 2004 due primarily to:

•

an increase in professional fees resulting from higher legal and consultation services;

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•		an increase in auditing fees and fees associated with the implementation of and compliance with Section 404 of the Sarbanes-Oxley Act of 2002; and
•		an increase in costs related to acquisition and financing transactions that were not consummated by us.

In addition to the above, the increase in general and administrative expenses from the nine months ended September 30, 2003 to the nine months ended September 30, 2004 was due to:

•

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.

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.

The increase in interest expense for the three months ended September 30, 2003 to the three months ended September 30, 2004 was primarily due to the reclassification of approximately $497,000 of interest expense related to 2004 property dispositions to discontinued operations for the three months ended September 30, 2003 as compared to the reclassification of approximately $8,000 for the three months ended September 30, 2004, as further described in the “Discontinued Operations” section herein. Interest related to the associated debt instrument after the disposition of the property is classified as interest expense, a component of income from continuing operations. The remaining increase was due to higher borrowings during the third quarter of 2004 as compared to the same period in the prior year. This was partially offset by a decrease in our overall effective interest rate due to the restructuring of our balance sheet from secured to unsecured debt during the second and third quarters of 2004, as further described in the “Liquidity and Capital Resources – Balance Sheet Restructuring and Debt Extinguishment Charges” section herein. For fixed rate debt, the effective interest rate decreased due to a decrease in interest rates at the time of debt issuance as well as the contraction of our credit spreads on newly issued debt. For variable rate debt, the effective interest rate increased due to rising interest rates, as further described in the “Liquidity and Capital Resources – Variable Rate Lease Program” section herein, which was partially offset by the contraction of our credit spreads.

The increase in interest expense for the nine months ended September 30, 2003 to the nine months ended September 30, 2004 was primarily due to the reclassification of approximately $1.5 million of interest expense related to 2004 property dispositions to discontinued operations for the nine months ended September 30, 2003 as compared to the reclassification of approximately $426,000 for the nine months ended September 30, 2004, as discussed above. The remaining increase was due to higher borrowings during the nine months ended September 30, 2004 as compared to the same period in the prior year. This

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was partially offset by a decrease in our overall effective interest rate due to the restructuring of our balance sheet from secured to unsecured debt during the second and third quarters of 2004, as discussed above. For fixed rate debt, the effective interest rate decreased due to a decrease in interest rates at the time of debt issuance as well as the contraction of our credit spreads on newly issued debt. For variable rate debt, the effective interest rate decreased due to the contraction of our credit spreads, which was partially offset by rising interest rates, as further described in the “Liquidity and Capital Resources – Variable Rate Lease Program” section herein.

Debt Extinguishment Charges. Debt extinguishment expenses for the three and nine months ended September 30, 2004 totaled approximately $697,000 and $9.4 million, respectively. The expenses for the three months ended September 30, 2004 are attributable to the debt repayment during the third quarter of 2004, as further described in the “Liquidity and Capital Resources – Balance Sheet Restructuring and Debt Extinguishment Charges” section herein. The debt extinguishment charges consisted of the write-off of deferred loan fees related to the loans that were paid off.