UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

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

Commission File Number 1-31824

FIRST POTOMAC REALTY TRUST

(Exact name of registrant as specified in its charter)

MARYLAND		37-1470730
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

7600 Wisconsin Avenue, 11^th Floor, Bethesda, MD 20814
(Address of principal executive offices) (Zip Code)

(301) 986-9200
(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 þ NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Exchange Act)
YES o NO þ

As of November 6, 2009, there were 30,046,790 common shares, par value $0.001 per share, outstanding.

 

 

FIRST POTOMAC REALTY TRUST

FORM 10-Q

INDEX

		Page
Part I: Financial Information
Item 1. Financial Statements
Consolidated balance sheets as of September 30, 2009 (unaudited) and December 31, 2008 (as adjusted — see footnote 2 (q))			3
Consolidated statements of operations (unaudited) for the three and nine months ended September 30, 2009 and 2008 (as adjusted — see footnote 2 (q))			4
Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2009 and 2008 (as adjusted — see footnote 2 (q))			5
Notes to consolidated financial statements (unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 3. Quantitative and Qualitative Disclosures about Market Risk			41
Item 4. Controls and Procedures			42
Part II: Other Information
Item 1. Legal Proceedings			43
Item 1A. Risk Factors			43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			43
Item 3. Defaults Upon Senior Securities			43
Item 4. Submission of Matters to a Vote of Security Holders			43
Item 5. Other Information			43
Item 6. Exhibits			43
Signatures

FIRST POTOMAC REALTY TRUST
Consolidated Balance Sheets
(Amounts in thousands, except per share amounts)

		September 30, 2009				December 31, 2008
		(unaudited)				(as adjusted – see
						footnote 2 (q))
Assets:
Rental property, net		$	961,340			$	994,913
Cash and cash equivalents			11,968				16,352
Escrows and reserves			9,141				8,808
Accounts and other receivables, net of allowance for doubtful accounts of $2,050 and $935, respectively			6,257				6,872
Accrued straight-line rents, net of allowance for doubtful accounts of $1,034 and $575, respectively			10,424				8,727
Investment in affiliate			1,909				—
Deferred costs, net			17,619				17,165
Prepaid expenses and other assets			9,835				6,365
Intangible assets, net			15,089				21,047
Total assets		$	1,043,582			$	1,080,249
Liabilities:
Mortgage loans		$	291,747			$	322,846
Exchangeable senior notes, net			48,485				80,435
Senior notes			75,000				75,000
Secured term loans			100,000				100,000
Unsecured revolving credit facility			99,400				75,500
Financing obligation			4,157				11,491
Accounts payable and other liabilities			15,465				18,022
Accrued interest			3,780				2,491
Rents received in advance			5,924				4,812
Tenant security deposits			5,031				5,243
Deferred market rent, net			6,393				8,489
Total liabilities			655,382				704,329
Noncontrolling interests in the Operating Partnership (redemption value of $8,470 and $7,186, respectively)			9,800				10,627
Shareholders’ equity:
Common shares, $0.001 par value, 100,000 common shares authorized: 29,966 and 27,353 shares issued and outstanding, respectively			30				27
Additional paid-in capital			509,807				484,825
Accumulated other comprehensive loss			(2,394	)			(3,823	)
Dividends in excess of accumulated earnings			(129,043	)			(115,736	)
Total shareholders’ equity			378,400				365,293
Total liabilities, noncontrolling interests and shareholders’ equity		$	1,043,582			$	1,080,249

See accompanying notes to consolidated financial statements.

FIRST POTOMAC REALTY TRUST
Consolidated Statements of Operations
(unaudited)
(Amounts in thousands, except per share amounts)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
						(as adjusted – see								(as adjusted – see
						footnote 2 (q))								footnote 2 (q))
Revenues:
Rental		$	27,149			$	25,491			$	80,885			$	75,316
Tenant reimbursements and other			5,725				5,577				18,134				16,304
Total revenues			32,874				31,068				99,019				91,620
Operating expenses:
Property operating			8,149				7,160				24,518				20,091
Real estate taxes and insurance			3,183				3,173				9,709				9,122
General and administrative			3,609				2,797				9,487				8,336
Depreciation and amortization			10,132				9,113				30,183				27,373
Total operating expenses			25,073				22,243				73,897				64,922
Operating income			7,801				8,825				25,122				26,698
Other expenses (income):
Interest expense			7,929				8,635				24,368				27,302
Interest and other income			(150	)			(142	)			(406	)			(377	)
Equity in losses of affiliate			38				—				92				—
Gain on early retirement of debt			(640	)			—				(6,346	)			(3,006	)
Total other expenses			7,177				8,493				17,708				23,919
Income from continuing operations			624				332				7,414				2,779
Discontinued operations:
Income from operations of disposed property			—				—				—				1,335
Gain on sale of disposed property			—				—				—				14,274
Income from discontinued operations			—				—				—				15,609
Net income			624				332				7,414				18,388
Less: Net income attributable to noncontrolling interests in the Operating Partnership			(16	)			(10	)			(202	)			(567	)
Net income attributable to common shareholders		$	608			$	322			$	7,212			$	17,821
Net income attributable to common shareholders per share — basic and diluted:
Income from continuing operations		$	0.02			$	0.01			$	0.25			$	0.10
Income from discontinued operations			—				—				—				0.63
Net income		$	0.02			$	0.01			$	0.25			$	0.73
Weighted average common shares outstanding — basic			28,134				24,150				27,434				24,121
Weighted average common shares outstanding — diluted			28,231				24,204				27,502				24,172

See accompanying notes to consolidated financial statements.

FIRST POTOMAC REALTY TRUST
Consolidated Statements of Cash Flows
(unaudited)
(Amounts in thousands)

		Nine Months Ended September 30,
		2009				2008
						(as adjusted – see
						footnote 2 (q))
Cash flows from operating activities:
Net income		$	7,414			$	18,388
Adjustments to reconcile net income to net cash provided by operating activities:
Discontinued operations:
Gain on sale of property			—				(14,274	)
Depreciation and amortization			—				479
Depreciation and amortization			30,828				28,025
Stock based compensation			2,226				1,459
Bad debt expense			1,780				216
Amortization of deferred market rent			(1,107	)			(1,364	)
Amortization of deferred financing costs and bond discount			2,010				2,407
Amortization of rent abatement			1,329				1,120
Equity in losses of affiliate			92				—
Change in financing obligation			(320	)			—
Gain on early retirement of debt			(6,347	)			(3,006	)
Changes in assets and liabilities:
Escrows and reserves			(1,580	)			4,657
Accounts and other receivables			(905	)			(157	)
Accrued straight-line rents			(2,188	)			(1,635	)
Prepaid expenses and other assets			(1,661	)			(1,537	)
Tenant security deposits			(176	)			(24	)
Accounts payable and accrued expenses			1,797				1,096
Accrued interest			1,374				1,755
Rents received in advance			1,200				591
Deferred costs			(4,585	)			(6,290	)
Total adjustments			23,767				13,518
Net cash provided by operating activities			31,181				31,906
Cash flows from investing activities:
Proceeds from sale of real estate assets			—				50,573
Purchase deposit on future acquisitions			(2,500	)			—
Additions to rental property			(17,818	)			(18,090	)
Additions to construction in progress			(905	)			(9,533	)
Acquisition of rental property and associated intangible assets			—				(46,573	)
Net cash used in investing activities			(21,223	)			(23,623	)
Cash flows from financing activities:
Financing costs			(1	)			(1,090	)
Proceeds from debt			31,500				192,300
Proceeds from the issuance of stock, net			22,277				38,165
Repayments of debt			(47,026	)			(209,428	)
Dividends to shareholders			(20,520	)			(24,892	)
Distributions to noncontrolling interests			(572	)			(795	)
Redemption of partnership units			—				(80	)
Stock option exercises			—				38
Net cash used in financing activities			(14,342	)			(5,782	)
Net (decrease) increase in cash and cash equivalents			(4,384	)			2,501
Cash and cash equivalents, beginning of period			16,352				5,198
Cash and cash equivalents, end of period		$	11,968			$	7,699

See accompanying notes to consolidated financial statements.

FIRST POTOMAC REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Description of Business

     First Potomac Realty Trust (the “Company”) is a self-managed, self-administered real estate investment trust that focuses on owning, operating, developing and redeveloping business parks and industrial properties in the Washington, D.C. metropolitan area and other major markets in Maryland and Virginia, which it refers to as the Southern Mid-Atlantic region. The Company separates its properties into three distinct segments, which it refers to as the Maryland, Northern Virginia and Southern Virginia reporting segments. The Company strategically focuses on acquiring and redeveloping properties that it believes can benefit from its intensive property management and seeks to reposition these properties to increase their profitability and value. The Company’s portfolio of properties contains a mix of single-tenant and multi-tenant business parks and industrial properties. Business parks combine office building features with industrial property space, while industrial properties generally are used as warehouse, distribution or manufacturing facilities.

     The Company conducts its business through First Potomac Realty Investment Limited Partnership; the Company’s operating partnership (the “Operating Partnership”). At September 30, 2009, the Company was the sole general partner of, and owned a 97.6% interest in, the Operating Partnership. The remaining interests in the Operating Partnership, which are presented as noncontrolling interests in the accompanying unaudited consolidated financial statements, are limited partnership interests, which are owned by several of the Company’s executive officers and trustees who contributed properties and other assets to the Company upon its formation, and other unrelated parties.

     As of September 30, 2009, the Company’s consolidated portfolio totaled approximately 12 million square feet and the Company’s properties were 86.6% occupied by 591 tenants. As of September 30, 2009, the Company’s largest tenant was the U.S. Government, which along with government contractors, accounted for approximately 20% of the Company’s total annualized rental revenue. The Company also owned land that can accommodate approximately 1.4 million square feet of additional development. The Company derives substantially all of its revenue from leases of space within its properties. The Company operates so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes.

(2) Summary of Significant Accounting Policies

(a) Principles of Consolidation

     The unaudited consolidated financial statements of the Company include the accounts of the Company, the Operating Partnership, the subsidiaries of the Operating Partnership, a 25 percent owned joint venture that owns RiversPark I and First Potomac Management LLC, a wholly-owned subsidiary that manages the Company’s properties. All intercompany balances and transactions have been eliminated in consolidation.

     The Company has condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements presented in accordance with U.S. generally accepted accounting principles (“GAAP”) in the accompanying unaudited consolidated financial statements. The Company believes the disclosures made are adequate to prevent the information presented from being misleading. However, the unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2008 and as updated from time to time in other filings with the Securities and Exchange Commission (“SEC”).

     In the Company’s opinion, the accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments and accruals necessary to present fairly its financial position as of September 30, 2009, the results of its operations for the three and nine months ended September 30, 2009 and 2008 and its cash flows for the nine months ended September 30, 2009 and 2008. Interim results are not necessarily indicative of full-year performance due, in part, to the timing of transactions and the impact of acquisitions and dispositions throughout the year. We have evaluated all subsequent events through November 6, 2009, the filing date of these consolidated financial statements.

(b) Use of Estimates

     The preparation of consolidated financial statements in conformity with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of

contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Estimates include the amount of accounts receivable that may be uncollectible; future cash flows, discount and cap rate assumptions used to value acquired properties and to test impairment of certain long-lived assets and goodwill; market lease rates, lease-up periods and leasing and tenant improvement costs used to value intangible assets acquired. Actual results could differ from those estimates.

     The United States stock and credit markets have experienced significant price volatility, dislocations and liquidity disruptions, which have caused market prices of many stocks to fluctuate substantially and the spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the financial markets, making terms for certain financings less attractive, and in certain cases have resulted in the unavailability of certain types of financing. These disruptions in the financial markets may have a material adverse effect on the market value of our common shares and may have a material impact on the estimates discussed above.

(c) Revenue Recognition

     The Company generates substantially all of its revenue from leases on its business parks and industrial properties. The Company recognizes rental revenue on a straight-line basis over the life of its leases. Accrued straight-line rents represent the difference between rental revenue recognized on a straight-line basis over the term of the respective lease agreements and the rental payments contractually due for leases that contain abatement or fixed periodic increases. The Company considers current information, credit quality, historical trends, economic conditions and other events regarding the tenants’ ability to pay their obligations in determining if amounts due from tenants, including accrued straight-line rents, are ultimately collectible. The uncollectible portion of the amounts due from tenants, including accrued straight-line rents, is charged to property operating expense in the period in which the determination is made.

     Tenant leases generally contain provisions under which the tenants reimburse the Company for a portion of property operating expenses and real estate taxes incurred by the Company. Such reimbursements are recognized in the period that the expenses are incurred. The Company records a provision for losses on estimated uncollectible accounts receivable based on its analysis of risk of loss on specific accounts. Lease termination fees are recognized on the date of termination when the related lease or portion thereof is cancelled, collectability is reasonably assured and the Company has possession of the terminated space. The Company recognized lease termination fees included in other income of $5 thousand and $106 thousand for the three and nine months ended September 30, 2009, respectively, and $45 thousand and $863 thousand for the three and nine months ended September 30, 2008, respectively.

     Concurrent with the Company’s August and September 2008 acquisitions of Triangle Business Center and RiversPark I, respectively, the former owner entered into master lease agreements for vacant space that was not producing rent at the time of the acquisitions. Payments received under the master lease agreements are recorded as a reduction to rental property rather than as rental income as the payments were determined to be a reduction in the purchase consideration at the time of acquisition. Payments received under these master lease agreements totaled $0.1 million and $0.3 million for the three and nine months ended September 30, 2009, respectively. The Company did not receive any payments under these master lease agreements for the three months ended September 30, 2008.

(d) Cash and Cash Equivalents

     The Company considers all highly liquid investments with a maturity of 90 days or less at the date of purchase to be cash equivalents.

(e) Escrows and Reserves

     Escrows and reserves represent cash restricted for debt service, real estate taxes, insurance, capital items and tenant security deposits.

(f) Rental Property

     Rental property is carried at historical cost less accumulated depreciation and, when appropriate, impairment losses. Improvements and replacements are capitalized at historical cost when they extend the useful life, increase capacity or improve the efficiency of the asset. Repairs and maintenance are charged to expense when incurred. Depreciation and amortization are

recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives of the Company’s assets, by class, are as follows:

Buildings		39 years
Building improvements		5 to 15 years
Furniture, fixtures and equipment		5 to 15 years
Tenant improvements		Shorter of the useful lives of the assets or the terms of the related leases

     The Company regularly reviews market conditions for possible impairment of a property’s carrying value. When circumstances such as adverse market conditions or changes in management’s intended holding period indicate a possible impairment of the value of a property, an impairment analysis is performed. The Company assesses the recoverability based on an estimate of the future undiscounted cash flows (excluding interest charges) expected to result from the property’s use and eventual disposition. This estimate is based on projections of future revenues, expenses, capital improvement costs, expected holding periods and cap rates. These cash flows consider factors such as expected future operating income, market trends and prospects, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a real estate investment based on forecast undiscounted cash flows, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. The Company is required to make estimates as to whether there are impairments in the values of its investments in real estate. The Company did not record any impairment to its real estate assets during the nine months ended September 30, 2009 and 2008.

     The Company will classify a building as held-for-sale in the period in which it has made the decision to dispose of the building, a binding agreement to purchase the property has been signed under which the buyer has committed a significant amount of nonrefundable cash and no significant financing contingencies exist that could cause the transaction not to be completed in a timely manner. If these criteria are met, the Company will record an impairment loss if the fair value, less anticipated selling costs, is lower than the carrying amount of the property. The Company will classify any impairment loss, together with the building’s operating results, as discontinued operations in its statements of operations and classify the assets and related liabilities as held-for-sale on its consolidated balance sheets. Interest expense is reclassified to discontinued operations only to the extent the held-for-sale property is secured by specific mortgage debt and the mortgage debt will not be transferred to another property owned by the Company after the disposition.

     The Company recognizes the fair value, if sufficient information exists to reasonably estimate the fair value, of any liability for conditional asset retirement obligations when incurred, which is generally upon acquisition, construction, development or redevelopment and/or through the normal operation of the asset.

     The Company capitalizes interest costs incurred on qualifying expenditures for real estate assets under development or redevelopment while being readied for their intended use in accordance with accounting requirements regarding capitalization of interest cost. The Company will capitalize interest when qualifying expenditures for the asset have been made, activities necessary to get the asset ready for its intended use are in progress and interest costs are being incurred. Capitalized interest also includes interest associated with expenditures incurred to acquire developable land while development activities are in progress. Capitalization of interest will end when the asset is substantially complete and ready for its intended use, but no later than one year from cession of major construction activity, if the property is not occupied. Total interest expense capitalized to construction in progress was $0.1 million and $0.3 million for the three and nine months ended September 30, 2009, respectively, and $0.4 million and $1.2 million for the three and nine months ended September 30, 2008, respectively. Capitalized interest is depreciated over the useful life of the underlying assets, commencing when those assets are placed into service.

(g) Purchase Accounting

     Acquisitions of rental property from third parties are accounted for at fair value, which is allocated between land and building (on an as-if vacant basis) based on management’s estimate of the fair value of those components for each type of property and to tenant improvements based on the depreciated replacement cost of the tenant improvements, which approximates their fair value. The purchase price is also allocated as follows:

■

the value of leases in-place on the date of acquisition based on the leasing origination costs at the date of the acquisition, which approximates the market value of the lease origination costs had the in-place leases been originated on the date of acquisition; the value of in-place leases represents absorption costs for the estimated lease-up period in which vacancy and foregone revenue are incurred;

	■		the value of above and below market in-place leases based on the present value (using a discount rate that reflects the risks associated with the acquired leases) of the difference between the contractual rent amounts to be paid under the lease and the estimated fair market lease rates for the corresponding spaces over the remaining non-cancelable terms of the related leases, which range from one to fourteen years; and
	■		the intangible value of tenant or customer relationships.

     The Company’s determination of these values requires it to estimate market rents for each of the leases and make certain other assumptions. These estimates and assumptions affect the rental revenue, and depreciation and amortization expense recognized for these leases and associated intangible assets and liabilities.

(h) Investment in Affiliate

     The Company may continue to grow its portfolio by entering into joint venture agreements with third parties. The structure of the joint venture will affect the Company’s accounting treatment for the joint venture as the Company adheres to requirements regarding consolidation of variable interest entities. When the Company’s investment in a joint venture meets the requirements for the equity accounting method, it will record its initial investment on its consolidated balance sheets as “Investment in Affiliate.” The initial investment in the joint venture is adjusted to recognize the Company’s share of earnings, losses and distributions received from the joint venture. The Company’s respective share of all earnings or losses from the joint venture will be recorded on its consolidated statements of operations as “Equity in Earnings or Losses of Affiliate.”

     When the Company is deemed to have a controlling interest in a joint venture, it will consolidate all of the joint venture’s assets, liabilities and operating results within its consolidated financial statements. The cash contributed to the consolidated joint venture by the third party, if any, will be reflected in the liability section of the Company’s consolidated balance sheets under “Financing Obligation.” The amount will be recorded based on the third party’s initial investment in the consolidated joint venture and will be adjusted to reflect the third party’s share of earnings or losses in the consolidated joint venture and for any distributions received by the third party from the joint venture. The earnings or losses from the joint venture attributable to the third party are recorded as interest expense on the Financing Obligation within the Company’s consolidated statements of operations. All distributions received by the Company from the consolidated joint venture will be recorded as an increase in the Financing Obligation.

(i) Sales of Real Estate

     The Company accounts for sales of real estate in accordance with the requirements for full profit recognition, which occurs when the sale is consummated, the buyer has made adequate initial and continuing investments in the property, the Company’s receivable is not subject to future subordination, and the seller does not have a substantial continuing involvement with the property, the related assets and liabilities are removed from the balance sheet and the resultant gain or loss is recorded in the period the sale is consummated. For sales transactions that do not meet the criteria for full profit recognition, the Company accounts for the transactions as partial sales or financing arrangements required by GAAP. For sales transactions with continuing involvement after the sale, if the continuing involvement with the property is limited by the terms of the sales contract, profit is recognized at the time of sale and is reduced by the maximum exposure to loss related to the nature of the continuing involvement. Sales to entities in which the Company has or receives an interest are accounted for as partial sales.

     For sales transactions that do not meet sale criteria, the Company evaluates the nature of the continuing involvement, including put and call provisions, if present, and accounts for the transaction as a financing arrangement, profit-sharing arrangement, leasing arrangement or other alternate method of accounting rather than as a sale, based on the nature and extent of the continuing involvement. Some transactions may have numerous forms of continuing involvement. In those cases, the Company determines which method is most appropriate based on the substance of the transaction.

     If the Company has an obligation to repurchase the property at a higher price or at a future indeterminable value (such as fair market value), or it guarantees the return of the buyer’s investment or a return on that investment for an extended period, the Company accounts for such transaction as a financing transaction. If the Company has an option to repurchase the property at a higher price and it is likely it will exercise this option, the transaction is accounted for as a financing transaction. For transactions treated as financings, the Company records the amounts received from the buyer as a Financing Obligation and continues to consolidate the property and its operating results in its consolidated statements of operations. The results of operations of the property are allocated to the joint venture partner for their equity interest and reflected as “interest expense” on the Financing Obligation.

(j) Intangible Assets

     Intangible assets include the value of acquired tenant or customer relationships and the value of in-place leases at acquisition. Customer relationship values are determined based on the Company’s evaluation of the specific characteristics of each tenant’s lease and its overall relationship with the tenant. Characteristics the Company considers include the nature and extent of its existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals. The value of customer relationship intangible assets is amortized to expense over the lesser of the initial lease term and any expected renewal periods or the remaining useful life of the building. The Company determines the fair value of the in-place leases at acquisition by estimating the leasing commissions avoided by having in-place tenants and the operating income that would have been lost during the estimated time required to lease the space occupied by existing tenants at the acquisition date. The cost of acquiring existing tenants is amortized to expense over the initial term of the respective leases. Should a tenant terminate its lease, the unamortized portion of the in-place lease value is charged to expense by the date of termination.

     Deferred market rent liability consists of the acquired leases with below-market rents at the date of acquisition. The value attributed to deferred market rent assets, which consist of above-market rents at the date of acquisition, is recorded as a component of deferred costs. Above and below market lease values are determined on a lease-by-lease basis based on the present value (using a discounted rate that reflects the risks associated with the acquired leases) of the difference between the contractual rent amounts to be paid under the lease and the estimated fair market lease rates for the corresponding spaces over the remaining non-cancelable terms of the related leases including any below-market fixed rate renewal periods. The capitalized below-market lease values are amortized as an increase to rental revenue over the initial term and any below-market fixed-rate renewal periods of the related leases. Capitalized above-market lease values are amortized as a decrease to rental revenue over the initial term of the related leases. The total accumulated amortization of intangible assets was $30.5 million and $29.0 million at September 30, 2009 and December 31, 2008, respectively.

     In conjunction with the Company’s initial public offering and related formation transactions, First Potomac Management, Inc. contributed all of the capital interests in First Potomac Management LLC, the entity that manages the Company’s properties, to the Operating Partnership. The $2.1 million fair value of the in-place workforce acquired has been classified as goodwill and is included as a component of intangible assets on the consolidated balance sheets. In accordance with accounting requirements regarding goodwill and other intangibles, all acquired goodwill that relates to the operations of a reporting unit and is used in determining the fair value of a reporting unit is allocated to the Company’s appropriate reporting unit in a reasonable and consistent manner. The Company assesses goodwill for impairment annually at the end of its fiscal year and in interim periods if certain events occur indicating the carrying value may be impaired. The Company performs its analysis for potential impairment of goodwill in accordance with GAAP, which requires that a two-step impairment test be performed on goodwill. In the first step, the fair value of the reporting unit is compared with its carrying value. If the fair value exceeds its carrying value, goodwill is not impaired, and no further testing is required. If the carrying value of the reporting unit exceeds its fair value, then a second step must be performed in order to determine the implied fair value of the goodwill and compare it to the carrying value of the goodwill. If the carrying value of goodwill exceeds its implied fair value, an impairment loss is recorded equal to the difference. No impairment losses were recognized during the nine months ended September 30, 2009 and 2008.

(k) Derivatives and Hedging

     In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company may enter into derivative agreements to mitigate exposure to unexpected changes in interest rates and may use interest rate protection or cap agreements to reduce the impact of interest rate changes. The Company intends to enter into derivative agreements only with counterparties that it believes have a strong credit rating to mitigate the risk of counterparty default or insolvency.

     The Company may designate a derivative as either a hedge of the cash flows from a debt instrument or anticipated transaction (cash flow hedge) or a hedge of the fair value of a debt instrument (fair value hedge). All derivatives are recognized as assets or liabilities at fair value. For effective hedging relationships, the change in the fair value of the assets or liabilities is recorded in “Accumulated Other Comprehensive Income (Loss),” an element of shareholders’ equity (cash flow hedge), or through earnings, along with the change in fair value of the asset or liability being hedged (fair value hedge). Ineffective portions of derivative transactions will result in changes in fair value recognized in earnings. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual inputs and guarantees.

(l) Income Taxes

     The Company has elected to be taxed as a REIT. To maintain its status as a REIT, the Company is required to distribute at least 90% of its ordinary taxable income annually to its shareholders and meet other organizational and operational requirements. As a REIT, the Company will not be subject to federal income tax and any non-deductible excise tax if it distributes at least 100% of its REIT taxable income to its shareholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate tax rates. The Company had a taxable REIT subsidiary that was inactive for the nine months ended September 30, 2009 and 2008.

(m) Noncontrolling Interests

     Noncontrolling interests relate to the interests in the Operating Partnership not owned by the Company. Interests in the Operating Partnership are owned by limited partners who contributed buildings and other assets to the Operating Partnership in exchange for Operating Partnership units. Limited partners have the right to tender their units for redemption in exchange for, at the Company’s option, common shares of the Company on a one-for-one basis or cash based on the value of the Company’s common shares at the date of redemption. Unitholders receive a distribution per unit equivalent to the dividend per common share.

     Noncontrolling interests are recorded based on the greater of their fair value or their cost basis, which is comprised of their fair value at issuance, subsequently adjusted for the noncontrolling interests’ share of net income or loss and distributions received. Differences between amounts paid to redeem noncontrolling interests and their carrying values are charged or credited to shareholders’ equity. As a result of the redemption feature of the Operating Partnership units, the noncontrolling interests are recorded outside of permanent equity.

     At December 31, 2008, 2.7% of the total outstanding Operating Partnership units were not owned by the Company. For the nine months ended September 30, 2009, the Company issued 2.1 million common shares through its controlled equity offering agreement, which resulted in the issuance in an equivalent amount of Operating Partnership units. During the third quarter of 2009, 40,000 Operating Partnership units were redeemed for 40,000 common shares valued at $0.5 million. At September 30, 2009, 732,712 Operating Partnership units, or 2.4% of the total outstanding Operating Partnership units were not owned by the Company. There were no Operating Partnership units purchased with available cash during the nine months ended September 30, 2009. Based on the closing share price of the Company’s common stock at September 30, 2009, the cost to acquire, through cash purchase or issuance of the Company’s common shares, all of the outstanding Operating Partnership units not owned by the Company would be approximately $8.5 million.

(n) Earnings Per Share

     Basic earnings per share (“EPS”), is calculated by dividing net income available to common shareholders by the weighted average common shares outstanding for the period. Diluted EPS is computed after adjusting the basic EPS computation for the effect of dilutive common equivalent shares outstanding during the period. The effect of stock options, non-vested shares and Exchangeable Senior Notes, if dilutive, is computed using the treasury stock method. In September 2008, new accounting guidance was issued regarding whether instruments granted in share-based payment transactions are participating securities. As a result of the Company’s outstanding unvested shares with non-forfeitable dividend rights, which are considered participating securities, it has applied the two-class method of determining EPS. The Company’s excess of distributions over earnings related to participating securities are shown as a reduction in income available to common shareholders in the Company’s computation of EPS.

     The following table sets forth the computation of the Company’s basic and diluted earnings per share (amounts in thousands, except per share amounts):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Numerator for basic and diluted earnings per share calculations:
Income from continuing operations		$	624			$	332			$	7,414			$	2,779
Income from discontinued operations			—				—				—				15,609
Net income			624				332				7,414				18,388
Less: Net income attributable to noncontrolling interests in the Operating Partnership			(16	)			(10	)			(202	)			(567	)
Net income attributable to common shareholders			608				322				7,212				17,821
Less: Allocation to participating securities			(153	)			(120	)			(362	)			(297	)
Income available to common shareholders		$	455			$	202			$	6,850			$	17,524
Denominator for basic and diluted earnings per share calculations:
Weighted average shares outstanding — basic			28,134				24,150				27,434				24,121
Effect of dilutive shares:
Employee stock options and non-vested shares			97				54				68				51
Weighted average shares outstanding — diluted			28,231				24,204				27,502				24,172
Amounts attributable to common shareholders per share —basic and diluted:
Income from continuing operations		$	0.02			$	0.01			$	0.25			$	0.10
Income from discontinued operations			—				—				—				0.63
Net income		$	0.02			$	0.01			$	0.25			$	0.73
Amounts attributable to common shareholders:
Income from continuing operations		$	608			$	322			$	7,212			$	2,693
Income from discontinued operations			—				—				—				15,128
Net income		$	608			$	322			$	7,212			$	17,821
In accordance with accounting requirements regarding earnings per share, the Company did not include the following anti-dilutive shares in its calculation of diluted earnings per share (amounts in thousands).
		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Stock option awards			763				667				771				684
Non-vested share awards			212				77				252				89
			975				744				1,023				773

     Approximately 1.4 million anti-dilutive shares from the assumed conversion of the Company’s Exchangeable Senior Notes were excluded from its calculation of earnings per share for the three and nine months ended September 30, 2009 and 2.5 million anti-dilutive shares were excluded for the three and nine months ended September 30, 2008.

(o) Share-Based Compensation

     Stock Options Summary

     During the first quarter of 2009, the Company issued 103,250 options to non-executive officers. The stock options vest 25% on the first anniversary of the date of grant and 6.25% in each subsequent calendar quarter thereafter until fully vested. The maximum term of the options granted is ten years. The Company recognized compensation expense related to stock options of $48 thousand and $50 thousand for the three months ended September 30, 2009 and 2008, respectively, and $140 thousand and $157 thousand for the nine months ended September 30, 2009 and 2008, respectively.

     Non-vested share awards

     On February 24, 2009, the Company granted 102,714 restricted common shares to its officers. The awards will vest ratably over a four year award term and were valued based on the outstanding share price at the date of issuance. On May 21, 2009, the Company granted 308,142 restricted common shares in two separate awards to its officers. The first award of 102,714 common shares will vest ratably over a four year award term and was valued based on the outstanding share price at the date of issuance. The second award of 205,428 common shares will vest in four separate tranches based upon the Company’s achievement of specified performance conditions.

     On May 21, 2009, the Company issued a total of 27,120 common shares to its non-employee trustees, all of which will vest on the anniversary of the award date. The trustee shares were valued based on the outstanding share price at the date of issuance. The Company recognized compensation expense associated with all restricted share based awards of $0.9 million and $0.5 million for the three months ended September 30, 2009 and 2008, respectively, and $2.1 million and $1.3 million for the nine months ended September 30, 2009 and 2008, respectively.

(p) Reclassifications

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

(q) Application of New Accounting Standards

     Effective January 1, 2009, the Company retrospectively adopted new accounting requirements regarding accounting for convertible debt instruments that may be settled in cash upon conversion, including partial cash settlement. These new requirements specify that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when the interest costs are recognized in subsequent periods. The Company compared the present value of its Exchangeable Senior Notes, which were issued in December 2006, to the present value of hypothetical senior notes, without a conversion feature, issued at the same time. The difference attributed to the conversion feature was retrospectively recorded as part of shareholders’ equity with a corresponding discount recorded to the Company’s Exchangeable Senior Notes. The discount is amortized over the estimated life of the Exchangeable Senior Notes as interest expense. During 2008 and through the first nine months of 2009, the Company repurchased $74.5 million of principal of its Exchangeable Senior Notes at a discount. In accordance with the new accounting requirements, at the time of repurchase, the Company allocated a portion of the settlement consideration to the extinguishment of the liability component equal to the fair value of that component immediately prior to extinguishment. Any difference between the consideration attributed to the liability component and the sum of (a) the net carrying amount of the liability component and (b) any unamortized debt issuance costs is recognized in the statement of operations as a gain or loss on debt extinguishment. The Company will allocate any remaining settlement consideration to the reacquisition of the equity component and recognize that amount as a reduction of shareholders’ equity. In all of the Company’s 2008 and 2009 repurchases of its Exchangeable Senior Notes, the consideration paid was below the fair value of the liability immediately prior to extinguishment, therefore, the Company did not allocate any consideration to the repurchase of the equity component. The Company’s cash interest payments are unaffected by this implementation. The overall impact on the Company’s consolidated financial statements is summarized as follows:

•

Contractual cash interest expense includes $0.6 million and $0.9 million for the three months ended September 30, 2009 and 2008, respectively, and $2.0 million and $3.1 million for the nine months ended September 30, 2009 and 2008, respectively. Non-cash interest expense related to the amortization of the discount on the liability component includes $0.2 million and $0.3 million for the three months ended September 30, 2009 and 2008, respectively, and $0.7 million and $1.1 million for the nine months ended September 30, 2009 and 2008, respectively;

•

Additional paid in capital increased by the total discount recorded of $8.7 million, with a shareholders’ equity increase of $3.4 million at December 31, 2008;

•

The gain on the early retirement of debt previously reported was reduced by $1.7 million for the nine months ended September 30, 2008, respectively;

•

The unamortized discount was $1.5 million and $3.4 million at September 30, 2009 and December 31, 2008, respectively; and

•

The total impact of adoption of these new requirements was a reduction in net income attributable to common shareholders of $0.5 million, or $0.02 per diluted share, and $1.9 million, or $0.06 per diluted share, for the three and nine months ended September 30, 2009, respectively, and $0.3 million, or $0.01 per diluted share, and $2.8 million, or $0.12 per diluted share, for the three and nine months ended September 30, 2008, respectively.

     The Company adopted new accounting requirements regarding subsequent events. Companies are required to evaluate events that occurred subsequent to the balance sheet date through the date the consolidated financial statements are issued. The new requirements enhance the accounting and disclosures regarding recognized subsequent events that occurred at the balance sheet date (Type I) and non-recognized subsequent events that occurred after the balance sheet date (Type II). The Company applied the new requirements prospectively, effective for the quarter ended June 30, 2009. See footnote 2(a), Summary of Significant Account Policies. The Company’s adoption of this new accounting requirement did not have a material impact on its consolidated financial statements.

     In June 2009, new accounting requirements were issued regarding amendments to previous guidance regarding consolidation of variable interest entities in the determination of whether a reporting entity is required to consolidate another entity based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. The new requirements also involve ongoing assessments as to whether an enterprise is the primary beneficiary of a Variable Interest Entity (“VIE”), modifies the presentation of consolidated VIE assets and liabilities, and requires additional disclosures about a company’s involvement in VIEs. Also, a reporting entity will be required to disclose how its involvement with a VIE affects the reporting entity’s consolidated financial statements. These new requirements will be effective for fiscal years beginning after November 15, 2009. The Company is currently determining the effect that adoption of these requirements will have on its consolidated financial statements.

     In July 2009, new guidance was issued regarding the codification of accounting standards. This new guidance requires companies to update their existing references and disclosures of GAAP in consolidated financial statements to a format categorized by topic, subtopic, section and/or paragraph. The codification of such financial information is the sole authoritative reference for nongovernmental GAAP for use in consolidated financial statements and was effective for fiscal periods ending after September 15, 2009. The Company’s adoption of this new requirement did not have a material impact on its consolidated financial statements.

(3) Rental Property

     Rental property represents the property, net of accumulated depreciation, and developable land that are wholly owned by the Company or owned by the Company through a consolidated joint venture. All of the Company’s rental properties are located in the Southern Mid-Atlantic region. Rental property is comprised of the following (amounts in thousands):

		September 30, 2009				December 31, 2008
Land		$	225,333			$	235,911
Buildings and improvements			772,812				786,401
Construction in process			13,234				12,687
Tenant improvements			73,731				61,674
Furniture, fixtures and equipment			9,898				9,898
			1,095,008				1,106,571
Less: accumulated depreciation			(133,668	)			(111,658	)
		$	961,340			$	994,913

(a) Development and Redevelopment Activity

     The Company constructs business parks and/or industrial buildings on a build-to-suit basis or with the intent to lease upon completion of construction. At September 30, 2009, the Company had a total of approximately 0.1 million square feet under development, which consisted of 57 thousand square feet in Northern Virginia and 48 thousand square feet in Southern Virginia. At September 30, 2009, the Company had a total of approximately 0.1 million square feet under redevelopment, which consisted of 42 thousand square feet in Maryland and 71 thousand square feet in Southern Virginia. The Company anticipates that development and redevelopment efforts on the majority of these projects will be completed in 2010.

     At September 30, 2009, the Company owned land that can accommodate approximately 1.4 million square feet of building space, which includes 0.1 million square feet in Maryland, 0.6 million square feet in Northern Virginia and 0.7 million square feet in Southern Virginia.

(b) Acquisitions

     On October 8, 2009, the Company acquired Cloverleaf Center, a four-building, 174,000 square foot business park in Germantown, Maryland, for $25.5 million. The property is currently 97% leased to seven tenants. The acquisition was financed with a $17.5 million mortgage loan and available cash that was funded with proceeds from shares issued through the Company’s controlled equity offering agreement.

     The Company acquired the following buildings at an aggregate purchase cost of $46.4 million during 2008: four buildings at Triangle Business Center; and six buildings at RiversPark I and II. On December 12, 2008, the Company entered into a consolidated joint venture with a third party to own RiversPark I and II. The Company deconsolidated RiversPark II on March 17, 2009 as discussed below in footnote 4, Investment in Affiliate.

(4) Investment in Affiliate

     On December 12, 2008, the Company entered into joint venture arrangements with a third party to own RiversPark I and II. As a condition of the joint venture arrangements, the Company provided a guarantee to the joint venture for several lease agreements entered into by the former owner for certain vacancy at RiversPark I and rental payments in the event a specified tenant did not renew its lease at RiversPark II. On March 17, 2009, the specified tenant renewed its lease at RiversPark II, which effectively terminated the Company’s lease guarantee related to RiversPark II. As a result, the Company was no longer required to consolidate the joint venture and applied the equity accounting method to its investment in RiversPark II. The assets, liabilities and operating results of RiversPark II are no longer consolidated on the Company’s consolidated financial statements effective March 17, 2009. There was no significant gain or loss recognized upon the deconsolidation. The Company’s net investment in RiversPark II is recorded as “Investment in Affiliate” on the Company’s consolidated balance sheets. Since the Company is still guaranteeing the leases at RiversPark I, it consolidates all of RiversPark I’s assets, liabilities and operations within its consolidated financial statements. The Company will continue to consolidate RiversPark I until the lease guarantees expire or the underlying space is re-leased, at which time, the Company will no longer consolidate the assets, liabilities and operating results of RiversPark I on its consolidated financial statements and will account for its share of the investment using the equity accounting method.

     As of September 30, 2009, the balance sheet of RiversPark II was as follows (amounts in thousands):

		September 30, 2009
Assets:
Rental property, net		$	25,208
Cash and cash equivalents			560
Other assets			2,087
Total assets		$	27,855
Liabilities:
Mortgage loan		$	18,144
Other liabilities			1,663
Total liabilities			19,807
Equity:			8,048
Total liabilities and equity		$	27,855

     The following table summarizes the results of operations of RiversPark II for the period subsequent to its deconsolidation. The Company’s share of RiversPark II losses is recorded in its consolidated statements of operations as Equity in Losses of Affiliate (amounts in thousands):

						The period March 17,
		Three Months Ended				2009 through
		September 30, 2009				September 30, 2009
Total revenues		$	703			$	1,426
Total operating expenses			(185	)			(326	)
Net operating income			518				1,100
Depreciation and amortization			(365	)			(814	)
Interest expense			(303	)			(653	)
Net loss		$	(150	)		$	(367	)

(5) Discontinued Operations

     Income from discontinued operations represents revenues and expenses associated with Alexandria Corporate Park, which was sold during the second quarter of 2008. The property was located in the Company’s Northern Virginia reporting segment. The Company reported a gain on the sale of $14.3 million in the third quarter of 2008. The Company has had no continuing involvement with this property subsequent to its disposal. The Company did not dispose of any other properties during the nine months ended September 30, 2009 and 2008.

     The following table summarizes the components of income from discontinued operations (amounts in thousands):

		Nine Months Ended
		September 30, 2008
Revenue		$	2,473
Income from operations of disposed property			1,335
Gain on sale of disposed property			14,274

(6) Debt

     The Company’s borrowings consisted of the following (amounts in thousands):

		September 30,				December 31,
		2009				2008
						(as adjusted –
						see footnote
						2 (q))
Mortgage loans, effective interest rates ranging from 5.19% to 8.53%, maturing at various dates through September 2021(1)		$	291,747			$	322,846
Exchangeable senior notes, net of discounts, effective interest rate of 5.84%, maturing December 2011(2)			48,485				80,435
Series A senior notes, effective interest rate of 6.41%, maturing September 2013			37,500				37,500
Series B senior notes, effective interest rate of 6.55%, maturing September 2016			37,500				37,500
Secured term loan, effective interest rate of 3.81%, maturing August 2011(3)(4)			50,000				50,000
Secured term loan, effective interest rate of 5.83%, maturing August 2011(4)(5)			35,000				35,000
Secured term loan, effective interest rate of LIBOR plus 2.50%, maturing August 2011(4)(5)			15,000				15,000
Unsecured revolving credit facility, effective interest rate of LIBOR plus 1.20%, maturing April 2011(4)(6)			99,400				75,500
		$	614,632			$	653,781

(a) Mortgage Loans

     At September 30, 2009 and December 31, 2008, the Company’s mortgage debt was as follows (dollars in thousands):

		Contractual				Effective				Maturity				September 30,				December 31,
Property		Interest Rate				Interest Rate				Date				2009				2008
Glenn Dale Business Center (1)			7.83	%			5.13	%				—		$	—			$	8,152
4200 Tech Court (2)(4)			8.07	%			8.07	%		October 2009					1,705				1,726
Park Central I (3)			8.00	%			5.66	%		November 2009					4,565				4,754
4212 Tech Court			8.53	%			8.53	%		June 2010					1,671				1,689
Park Central II			8.32	%			5.66	%		November 2010					5,670				5,902
Enterprise Center (4)			8.03	%			5.20	%		December 2010					17,576				18,102
Indian Creek Court (4)			7.80	%			5.90	%		January 2011					12,518				12,818
403/405 Glenn Drive			7.60	%			5.50	%		July 2011					8,324				8,529
4612 Navistar Drive (4)			7.48	%			5.20	%		July 2011					12,791				13,130
RiversPark I and II (5)		LIBOR+2.50%					5.97	%		September 2011					9,856				28,000
Campus at Metro Park (4)			7.11	%			5.25	%		February 2012					23,579				24,154
1434 Crossways Blvd Building II			7.05	%			5.38	%		August 2012					9,940				10,202
Crossways Commerce Center			6.70	%			6.70	%		October 2012					24,711				25,008
Newington Business Park Center			6.70	%			6.70	%		October 2012					15,588				15,775
Prosperity Business Center			6.25	%			5.75	%		January 2013					3,665				3,752
Aquia Commerce Center I			7.28	%			7.28	%		February 2013					518				610
1434 Crossways Blvd Building I			6.25	%			5.38	%		March 2013					8,557				8,749
Linden Business Center			6.01	%			5.58	%		October 2013					7,271				7,379
Owings Mills Business Center			5.85	%			5.75	%		March 2014					5,577				5,650
Annapolis Commerce Park East			5.74	%			6.25	%		June 2014					8,643				8,728
Plaza 500, Van Buren Business Park, Rumsey Center, Snowden Center, Greenbrier Technology Center II, Norfolk Business Center, Northridge I & II and 15395 John Marshall Highway			5.19	%			5.19	%		August 2015					99,625				100,000
Hanover Business Center:
Building D			8.88	%			6.63	%		August 2015					783				862
Building C			7.88	%			6.63	%		December 2017					1,181				1,260
Chesterfield Business Center:
Buildings C,D,G and H			8.50	%			6.63	%		August 2015					2,042				2,245
Buildings A,B,E and F			7.45	%			6.63	%		June 2021					2,588				2,695
Gateway Centre Building I			7.35	%			5.88	%		November 2016					1,391				1,505
Airpark Business Center			7.45	%			6.63	%		June 2021					1,412				1,470
Total Mortgage Debt							5.63	%(6)						$	291,747			$	322,846

     During the fourth quarter of 2009, the Company repaid a $1.7 million mortgage loan encumbering 4200 Tech Court and a $4.5 million mortgage loan encumbering Park Central I with available cash.

     On October 8, 2009, the Company acquired Cloverleaf Center, which was financed with a $17.5 million mortgage loan and available cash that was funded with proceeds from shares issued through the Company’s controlled equity offering agreement. The mortgage loan has a fixed interest rate of 6.75% and matures in October 2014, with two one-year extension options. The

Company has the right to exercise the two one-year options, which provide for a fixed interest rate to be calculated at the beginning of each extension period and not to be lower than 6.50%.

(b) Exchangeable Senior Notes

     During the third quarter of 2009, the Company used available cash and proceeds from the sale of common stock issued through its controlled equity offering agreement to repurchase $8.5 million of its Exchangeable Senior Notes, at a weighted average discount of 12%. The transactions resulted in a gain of $0.6 million, net of deferred financing costs and discounts. The Company evaluated the fair value of the repurchased debt based on the cash flows at the date of repurchase, which were discounted at risk-adjusted rates. Based on this calculation, the fair value of repurchased debt was greater than the repurchase price; therefore, the Company did not allocate any of the repurchase price to the equity components of the Exchangeable Senior Notes. At September 30, 2009, the Exchangeable Senior Notes were convertible into 28.039 shares for each $1,000 of principal amount for a total of approximately 1.4 million shares. The Company was in compliance with all the terms of its Exchangeable Senior Notes at September 30, 2009.

(c) Unsecured Revolving Credit Facility

     During the third quarter of 2009, the Company borrowed $6.0 million on its unsecured revolving credit facility, which it repaid during the quarter. As of September 30, 2009, the effective underlying interest rate on the Company’s unsecured revolving credit facility was 1.5% At September 30, 2009, the Company had available borrowings of $25.5 million under its unsecured revolving credit facility and the Company was in compliance with all of the terms of its unsecured revolving credit facility.

(7) Derivative Instruments and Comprehensive Income

     The Company is exposed to certain risks arising from business operations and economic factors. The Company uses derivative financial instruments to manage exposures that arise from business activities in which its future exposure to interest rate fluctuations is unknown. The objective in the use of an interest rate derivative is to add stability to interest expenses and manage exposure to interest rate changes. No hedging activity can completely insulate the Company from the risks associated with changes in interest rates. Moreover, interest rate hedging could fail to protect the Company or adversely affect it because, among other things:

•

available interest rate hedging may not correspond directly with the interest rate risk for which the Company seeks protection;

•

the duration of the hedge may not match the duration of the related liability;

•

the party owing money in the hedging transaction may default on its obligation to pay; and

•

the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs the Company’s ability to sell or assign its side of the hedging transaction.

     During 2008, the Company entered into three separate interest rate swap agreements to hedge its exposure on its variable rate debt against fluctuations in prevailing interest rates. The interest rate swap agreements are effective over the life of the debt instrument that is being hedged. The table below summarizes the Company’s three interest rate swap agreements as of September 30, 2009 (dollars in thousands):

Transaction Date		Instrument		Amount				Contractual Interest Rate		Effective Interest Rate
January 2008		Term Loan		$	50,000			LIBOR plus variable spread (1)		2.71% plus a variable spread(1)
August 2008		Term Loan			35,000			LIBOR plus 250 basis points		5.83%
September 2008		Mortgage Loan(2)			9,856			LIBOR plus 250 basis points		5.97%
				$	94,856

     The Company’s interest rate swap agreements qualify as effective cash flow hedges and the Company records any unrealized gains associated with the change in fair value of the swap agreements within shareholders’ equity and prepaid expenses and other assets and any unrealized losses within shareholders’ equity and other liabilities.

     Total comprehensive income is summarized as follows (amounts in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2009				2008				2009				2008
Net income		$	624			$	332			$	7,414			$	18,388
Unrealized gain (loss) on derivative instruments			154				(289	)			785				393
Total comprehensive income			778				43				8,199				18,781
Comprehensive income attributable to noncontrolling interests in the Operating Partnership			(20	)			(1	)			(223	)			(580	)
Comprehensive income attributable to common shareholders		$	758			$	42			$	7,976			$	18,201

(8) Fair Value of Financial Instruments

     The Company adopted accounting provisions which outline a valuation framework and create a fair value hierarchy that distinguishes between market assumptions based on market data (observable inputs) and a reporting entity’s own assumptions about market data (unobservable inputs). The standard increases the consistency and comparability of fair value measurements and the related disclosures. Fair value is identified, under the standard, as the price that would be received to sell an asset or paid to transfer a liability at the measurement date (an exit price). In accordance with GAAP, certain assets and liabilities must be measured at fair value, and the Company provides the necessary disclosures that are required for items measured at fair value as outlined in the accounting requirements regarding fair value.

     The Company has three interest rate swap derivative instruments that are measured under the accounting provisions regarding fair value. The derivatives are valued based on the prevailing market yield curve on the measurement date. Financial assets and liabilities are measured using inputs from three levels of the fair value hierarchy.

     The three levels are as follows:

     Level 1 — Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

     Level 2 — Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).

     Level 3 — Unobservable inputs, only used to the extent that observable inputs are not available, reflect the Company’s assumptions about the pricing of an asset or liability.

     In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value as of September 30, 2009. The derivative instruments in the table below are recorded on the Company’s consolidated balance sheets under “Accounts payable and other liabilities” (amounts in thousands):

		Balance at
		September 30, 2009				Level 1				Level 2				Level 3
Liabilities:
Derivative instrument-swap agreements		$	2,252			$	—			$	2,252			$	—

     For the nine months ended September 30, 2009, the Company did not re-measure or complete any transactions involving non-financial assets or non-financial liabilities that are measured on a recurring basis.

     The carrying amounts of cash, accounts and other receivables and accounts payable approximate their fair values due to their short-term maturities. The Company calculates fair value of its financial instruments by discounting future contractual principal and interest payments using prevailing market rates for securities with similar terms and characteristics at the balance sheet date.

     The carrying amount and estimated fair value of the Company’s financial instruments at September 30, 2009 and December 31, 2008 are as follows (amounts in thousands):

		September 30, 2009								December 31, 2008
		Carrying				Fair				Carrying				Fair
		Value				Value				Value				Value
Mortgage debt		$	291,747			$	268,150			$	322,846			$	307,247
Exchangeable senior notes(1)			48,485				46,460				80,435				60,350
Series A senior notes			37,500				37,467				37,500				28,199
Series B senior notes			37,500				36,781				37,500				24,239
Secured term loans			100,000				96,851				100,000				101,691
Unsecured revolving credit facility			99,400				94,512				75,500				76,739
Total		$	614,632			$	580,221			$	653,781			$	598,465

(9) Shareholders’ Equity

     During the third quarter of 2009, the Company issued 1.6 million common shares through its controlled equity offering agreement at a weighted average price of $10.68 per share. In October 2009, the Company issued an additional 0.1 million common shares through its controlled equity offering agreement at a weighted average price of $11.75 per share. The offerings generated net proceeds of $17.9 million, which were used to repurchase a portion of the Company’s Exchangeable Senior Notes at a discount, to reduce a portion of its unsecured revolving credit facility and to fund the cash portion of the Cloverleaf Center acquisition, which closed in October 2009.

     As a result of the redemption feature of the Operating Partnership units, the noncontrolling interests are recorded outside of permanent equity, and therefore, the Company does not allocate its equity to any noncontrolling interests. The Company’s equity and redeemable noncontrolling interests are as follows (amounts in thousands):

						Redeemable
		First Potomac				noncontrolling
		Realty Trust				interests
Balance, December 31, 2008		$	365,293			$	10,627
Net income			7,212				202
Changes in ownership			25,651				(478	)
Distributions to owners			(20,520	)			(572	)
Other comprehensive income			764				21
Balance, September 30, 2009		$	378,400			$	9,800

(10) Segment Information

     The Company’s reportable segments consist of three distinct reporting and operational segments within the broader Southern Mid-Atlantic geographic area in which it operates: Maryland, Northern Virginia and Southern Virginia.

     The Company evaluates the performance of its segments based on the operating results of the properties located within each segment, which excludes large non-recurring gains and losses, gains from sale of assets, interest expense, general and administrative costs or any other indirect corporate expense to the segments. In addition, the segments do not have significant non-cash items other than straight-line and deferred market amortization reported in their operating results. There are no inter-segment sales or transfers recorded between segments.

     The results of operations for the Company’s three reportable segments are as follows (dollars in thousands):

		Three Months Ended September 30, 2009
		Maryland(1)				Northern Virginia				Southern Virginia				Consolidated
Number of buildings			72				48				54				174
Square feet			3,610,072				2,820,535				5,262,230				11,692,837
Total revenues		$	10,706			$	10,010			$	12,158			$	32,874
Property operating expense			(2,866	)			(2,281	)			(3,002	)			(8,149	)
Real estate taxes and insurance			(1,142	)			(971	)			(1,070	)			(3,183	)
Total property operating income		$	6,698			$	6,758			$	8,086				21,542
Depreciation and amortization expense															(10,132	)
General and administrative															(3,609	)
Other expenses, net															(7,177	)
Net income														$	624
Total assets(2)		$	383,701			$	294,577			$	318,954			$	1,043,582
Capital expenditures(3)		$	4,068			$	7,605			$	6,988			$	18,723

		Three Months Ended September 30, 2008
		Maryland				Northern Virginia				Southern Virginia				Consolidated
Number of buildings			74				47				54				175
Square feet			3,749,989				2,816,409				5,254,201				11,820,599
Total revenues		$	10,263			$	9,335			$	11,470			$	31,068
Property operating expense			(2,137	)			(2,041	)			(2,982	)			(7,160	)
Real estate taxes and insurance			(1,040	)			(1,090	)			(1,043	)			(3,173	)
Total property operating income		$	7,086			$	6,204			$	7,445				20,735
Depreciation and amortization expense															(9,113	)
General and administrative															(2,797	)
Other expenses, net															(8,493	)
Net income														$	332
Total assets(2)		$	431,507			$	281,872			$	308,236			$	1,069,972
Capital expenditures(3)		$	8,178			$	9,647			$	9,582			$	27,623

		Nine Months Ended September 30, 2009
		Maryland(1)				Northern Virginia				Southern Virginia				Consolidated
Total revenues		$	33,302			$	29,636			$	36,081			$	99,019
Property operating expense			(8,969	)			(6,822	)			(8,727	)			(24,518	)
Real estate taxes and insurance			(3,319	)			(3,204	)			(3,186	)			(9,709	)
Total property operating income		$	21,014			$	19,610			$	24,168				64,792
Depreciation and amortization expense															(30,183	)
General and administrative															(9,487	)
Other expenses, net															(17,708	)
Net income														$	7,414

		Nine Months Ended September 30, 2008
		Maryland				Northern Virginia				Southern Virginia				Consolidated
Total revenues		$	30,928			$	27,203			$	33,489			$	91,620
Property operating expense			(6,314	)			(5,830	)			(7,947	)			(20,091	)
Real estate taxes and insurance			(2,926	)			(3,093	)			(3,103	)			(9,122	)
Total property operating income		$	21,688			$	18,280			$	22,439				62,407
Depreciation and amortization expense															(27,373	)
General and administrative															(8,336	)
Other expenses, net															(23,919	)
Income from discontinued operations															15,609
Net income														$	18,388

(11) Supplemental Disclosure of Cash Flow Information

     Supplemental disclosures of cash flow information for the nine months ended September 30 are as follows (amounts in thousands):

		2009				2008
Cash paid for interest, net		$	22,882			$	24,389
Non-cash investing and financing activities:
Conversion of Operating Partnership units into common shares			507				358

     Cash paid for interest on indebtedness is net of capitalized interest of $0.3 million and $1.2 million for the nine months ended September 30, 2009 and 2008, respectively.

     During the nine months ended September 30, 2009 and 2008, 40,000 and 26,181 Operating Partnership units, respectively, were redeemed for the Company’s common shares.

     On March 17, 2009, the Company deconsolidated a joint venture that owned RiversPark II and removed all its related assets and liabilities from its consolidated balance sheet as of the date of deconsolidation. For more information, see footnote 4 — Investment in Affiliate.

ITEM 2:		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q. The discussion and analysis is derived from the consolidated operating results and activities of First Potomac Realty Trust.

     First Potomac Realty Trust (the “Company”) is a self-managed, self-administered real estate investment trust (“REIT”). The Company focuses on owning, operating, developing and redeveloping business parks and industrial properties in the Washington, D.C. metropolitan area and other major markets in Maryland and Virginia, which it refers to as the Southern Mid-Atlantic region. The Company separates its properties into three distinct segments, which it refers to as the Maryland, Northern Virginia and Southern Virginia reporting segments. The Company strategically focuses on acquiring and redeveloping properties that it believes can benefit from its intensive property management and seeks to reposition these properties to increase their profitability and value. The Company’s portfolio of properties contains a mix of single-tenant and multi-tenant business parks and industrial properties. Business parks combine office building features with industrial property space, while industrial properties generally are used as warehouse, distribution or manufacturing facilities.

     The Company conducts its business through First Potomac Realty Investment Limited Partnership; the Company’s operating partnership (the “Operating Partnership”). At September 30, 2009, the Company was the sole general partner of, and owned a 97.6% interest in, the Operating Partnership. The remaining interests in the Operating Partnership, which are presented as noncontrolling interests in the accompanying unaudited consolidated financial statements, are limited partnership interests, which are owned by several of the Company’s executive officers and trustees who contributed properties and other assets to the Company upon its formation, and other unrelated parties.

     The primary source of the Company’s revenue and earnings is rent received from customers under long-term (generally three to ten years) operating leases at its properties, including reimbursements from customers for certain operating costs. Additionally, the Company may generate earnings from the sale of assets either outright or contributed into joint ventures.

     The Company’s long-term growth will be driven by its ability to:

	•		maintain and increase occupancy rates and/or increase rental rates at its properties;
	•		sell assets to third parties or contribute properties to joint ventures; and
	•		continue to grow its portfolio through acquisition of new properties, potentially through joint ventures.

     As of September 30, 2009, the Company’s consolidated portfolio totaled approximately 12 million square feet and the Company’s properties were 86.6% occupied by 591 tenants. As of September 30, 2009, the Company’s largest tenant was the U.S. Government, which along with government contractors, accounted for approximately 20% of the Company’s total annualized rental revenue. The Company derives substantially all of its revenue from leases of space within its properties. The Company operates so as to qualify as a REIT for federal income tax purposes.

Executive Summary

     The Company’s funds from operations (“FFO”) for the third quarter of 2009 were $10.7 million, or $0.37 per diluted share ($0.35 per diluted share, excluding gains on the retirement of debt), compared with $9.4 million, or $0.38 per diluted share, during the third quarter of 2008. The Company’s net income attributable to common shareholders for the third quarter of 2009 increased to $0.6 million, or $0.02 per diluted share, compared with net income attributable to common shareholders of $0.3 million, or $0.01 per diluted share, for the third quarter of 2008.

     The Company’s FFO for the first nine months of 2009 increased to $37.1 million, or $1.31 per diluted share ($1.09 per diluted share, excluding gains on the retirement of debt), compared with $32.0 million, or $1.28 per diluted share ($1.16 per diluted share, excluding gains on the retirement of debt), for the first nine months of 2008. The Company reported net income attributable to common shareholders for the first nine months of 2009 of $7.2 million, or $0.25 per diluted share, compared with net income attributable to common shareholders of $17.8 million, or $0.73 per diluted share, for the first nine months of 2008, which included a gain from the sale of a property of $14.3 million, or $0.57 per diluted share after noncontrolling interests.

Significant Third Quarter and Subsequent Event Transactions

	•		During the third quarter of 2009, the Company issued 1.6 million common shares through its controlled equity offering agreement at a weighted average price of $10.68 per share. In October 2009, the Company issued an additional 0.1 million common shares through its controlled equity offering agreement at a weighted average price of $11.75 per share. The offerings generated net proceeds of $17.9 million, which were used to repurchase a portion of the Company’s Exchangeable Senior Notes at a discount, to reduce a portion of its unsecured revolving credit facility and to fund the cash portion of the Cloverleaf Center acquisition. Since the beginning of 2009 and through the filing date of these consolidated financial statements, the Company has issued 2.2 million common shares through its controlled equity offering agreement, generating net proceeds of $23.3 million;
	•		The Company repurchased $8.5 million of its Exchangeable Senior Notes, at a 12% discount, resulting in a gain of $0.6 million, or $0.02 per diluted share. For the nine months ended September 30, 2009, the Company repurchased $34.5 million of its Exchange Senior Notes, at a 23% discount, resulting in a gain of $6.3 million, or $0.23 per diluted share;
	•		The Company executed 80,000 square feet of new leases, including 24,000 square feet at 1400 Cavalier Boulevard, which is located in the Company’s Southern Virginia reporting segment, and 18,000 square feet at Annapolis Commerce Park East, which is located in the Company’s Maryland reporting segment. Rent is expected to commence for the majority of these new leases by the end of the first quarter of 2010; and
	•		The Company executed 370,000 square feet of renewal leases, which reflects a 90% retention rate. Renewal leases in the quarter include 79,000 square feet at Annapolis Commerce Park East, 66,000 square feet at Crossways Commerce Center and 59,000 square feet at Frederick Industrial Park.
	•		On October 8, 2009, the Company acquired Cloverleaf Center, a four-building, 174,000 square foot business park in Germantown, Maryland, for $25.5 million. The property is currently 97% leased to seven tenants. The acquisition was financed with a $17.5 million mortgage loan and available cash that was funded with proceeds from shares issued through the Company’s controlled equity offering agreement.

Development and Redevelopment Activity

     As of September 30, 2009, the Company continued development of several parcels of land, including land adjacent to previously acquired properties and land acquired with the intent to develop. The Company intends to construct business parks and/or industrial buildings on a build-to-suit basis or with the intent to lease upon completion of construction. The Company also continued to redevelop several of its assets to attract new tenants.

     During the third quarter of 2009, the Company completed redevelopment efforts on approximately 57,000 square feet of space at Interstate Plaza in its Northern Virginia reporting segment and 8,000 square feet of space at Park Central in its Southern Virginia reporting segment.

     As of September 30, 2009, the Company had incurred development and redevelopment expenditures for several buildings, of which the more significant projects are noted below:

Development

	•		Greenbrier Technology Center III — a 48,000 square foot three-story office building has been designed, all permits have been received and construction is set to commence. Costs to date include civil, architectural, mechanical, electrical and plumbing design as well as permit fees; and
	•		Sterling Park Business Center, Lot 7 — a 57,000 square foot office building, adjacent to a recently completed building, has been designed, all permits have been received and construction is pending further leasing activity. Costs to date include civil site preparation work, architectural, mechanical, electrical and plumbing design as well as permit fees.

Redevelopment

•

Enterprise Parkway — a 71,000 square foot multi-tenanted office redevelopment. Costs incurred to date include building, lobby and common corridor renovations, design documents and permit fees for major common area bathroom renovations as well as schematic architectural and engineering design for future tenant layouts; and

•

Gateway 270 — a 42,000 square foot business park redevelopment has been designed, all permits have been processed and construction is set to commence. The majority of the costs incurred to date include architectural and engineering design work.

     The Company anticipates development and redevelopment efforts on these projects will continue into 2010. The Company will commence redevelopment efforts on unfinished vacant space through the investment of capital in electrical, plumbing and other capital improvements in order to expedite the leasing of the space. At September 30, 2009, the Company owned developable land that can accommodate approximately 1.4 million square feet of building space, which includes 0.1 million square feet in Maryland, 0.6 million square feet in Northern Virginia and 0.7 million square feet in Southern Virginia.

Critical Accounting Policies and Estimates

     The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) that require the Company to make certain estimates and assumptions. Critical accounting policies and estimates are those that require subjective or complex judgments and are the policies and estimates that the Company deems most important to the portrayal of its financial condition and results of operations. It is possible that the use of different reasonable estimates or assumptions in making these judgments could result in materially different amounts being reported in its consolidated financial statements. The Company’s critical accounting policies relate to revenue recognition, including evaluation of the collectability of accounts receivable, impairment of long-lived assets, purchase accounting for acquisitions of real estate and share-based compensation.

     The following is a summary of certain aspects of these critical accounting policies.

Revenue Recognition

     Rental revenue under leases with scheduled rent increases or rent abatements is recognized using the straight-line method over the term of the leases. Accrued straight-line rents included in the Company’s consolidated balance sheets represent the aggregate excess of rental revenue recognized on a straight-line basis over contractual rent under applicable lease provisions. The Company’s leases generally contain provisions under which the tenants reimburse the Company for a portion of the Company’s property operating expenses and real estate taxes. Such reimbursements are recognized in the period that the expenses are incurred. Lease termination fees are recognized on the date of termination when the related leases are canceled and the Company has no continuing obligation to provide services to such former tenants.

     The Company must make estimates of the collectability of its accounts receivable related to minimum rent, deferred rent, tenant reimbursements, lease termination fees and other income. The Company specifically analyzes accounts receivable and historical bad debt experience, tenant concentrations, tenant creditworthiness and current economic trends when evaluating the adequacy of its allowance for doubtful accounts receivable. These estimates have a direct impact on the Company’s net income as a higher required allowance for doubtful accounts receivable will result in lower net income. The uncollectible portion of the amounts due from tenants, including straight-line rents, is charged to property operating expense in the period in which the determination is made.

Investments in Real Estate and Real Estate Entities

     Investments in real estate are recorded at cost. Improvements and replacements are capitalized at historical cost when they extend the useful life, increase capacity, or improve the efficiency of the asset. Repairs and maintenance are charged to expense when incurred.

     Depreciation and amortization are recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives of the Company’s assets, by class, are as follows:

Buildings		39 years
Building improvements		5 to 15 years
Furniture, fixtures and equipment		5 to 15 years
Tenant improvements		Shorter of the useful lives of the assets or the terms of the related leases
Lease related intangible assets		Term of related lease

     The Company regularly reviews market conditions for possible impairment of a property’s carrying value. When circumstances such as adverse market conditions or changes in management’s intended holding period indicate a possible

impairment of the value of a property, an impairment analysis is performed. The Company assesses the recoverability based on an estimate of the future undiscounted cash flows (excluding interest charges) expected to result from the property’s use and eventual disposition. This estimate is based on projections of future revenues, expenses, capital improvement costs, expected holding periods and cap rates. These cash flows consider factors such as expected future operating income, market trends and prospects, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a real estate investment based on forecast undiscounted cash flows, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. The Company is required to make estimates as to whether there are impairments in the values of its investments in real estate. The Company did not record any impairment to its real estate assets during the nine months ended September 30, 2009 and 2008.

     The Company will classify a building as held-for-sale in the period in which it has made the decision to dispose of the building, a binding agreement to purchase the property has been signed under which the buyer has committed a significant amount of nonrefundable cash and no significant financing contingencies exist that could cause the transaction not to be completed in a timely manner. If these criteria are met, the Company will record an impairment loss if the fair value, less anticipated selling costs, is lower than the carrying amount of the property. The Company will classify any impairment loss, together with the building’s operating results, as discontinued operations in its statements of operations and classify the assets and related liabilities as held-for-sale on its consolidated balance sheets. Interest expense is reclassified to discontinued operations only to the extent the held-for-sale property is secured by specific mortgage debt and the mortgage debt will not be transferred to another property owned by the Company after the disposition.

Purchase Accounting

     Acquisitions of rental property from third parties are accounted for at fair value, which is allocated between land and building (on an as-if vacant basis) based on management’s estimate of the fair value of those components for each type of property and to tenant improvements based on the depreciated replacement cost of the tenant improvements, which approximates their fair value. The purchase price is also allocated as follows:

■

the value of leases in-place on the date of acquisition based on the leasing origination costs at the date of the acquisition, which approximates the market value of the lease origination costs had the in-place leases been originated on the date of acquisition; the value of in-place leases represents absorption costs for the estimated lease-up period in which vacancy and foregone revenue are incurred;

■

the value of above and below market in-place leases based on the present value (using a discount rate that reflects the risks associated with the acquired leases) of the difference between the contractual rent amounts to be paid under the lease and the estimated fair market lease rates for the corresponding spaces over the remaining non-cancelable terms of the related leases, which range from one to fourteen years; and

■

the intangible value of tenant or customer relationships.

     The Company’s determination of these values requires it to estimate market rents for each of the leases and make certain other assumptions. These estimates and assumptions affect the rental revenue, and depreciation and amortization expense recognized for these leases and associated intangible assets and liabilities.

Goodwill and Impairment Analysis

     In conjunction with the Company’s initial public offering and related formation transactions, First Potomac Management, Inc. contributed all of the capital interests in First Potomac Management LLC, the entity that manages the Company’s properties, to the Operating Partnership. The $2.1 million fair value of the in-place workforce acquired has been classified as goodwill and is included as a component of intangible assets on the consolidated balance sheets. All acquired goodwill that relates to the operations of a reporting unit and is used in determining the fair value of a reporting unit is allocated to the Company’s appropriate reporting unit in a reasonable and consistent manner. The Company assesses goodwill for impairment annually at the end of its fiscal year and in interim periods if certain events occur indicating the carrying value may be impaired. The Company performs its analysis for potential impairment of goodwill, which requires that a two-step impairment test be performed on goodwill. In the first step, the fair value of the reporting unit is compared with its carrying value. If the fair value exceeds its carrying value, goodwill is not impaired, and no further testing is required. If the carrying value of the reporting unit exceeds its fair value, then a second step must be performed in order to determine the implied fair value of the goodwill and compare it to the carrying value of the goodwill. If the carrying value of goodwill exceeds its implied fair value then an impairment loss is recorded equal to the difference. No impairment losses were recognized during the nine months ended September 30, 2009 and 2008.

Investment in Affiliate

     The Company may continue to grow its portfolio by entering into joint venture agreements with third parties. The structure of the joint venture will affect the Company’s accounting treatment for the joint venture as the Company adheres to requirements regarding consolidation of variable interest entities. When the Company’s investment in a joint venture meets the requirements for the equity accounting method, it will record its initial investment on its consolidated balance sheets as “Investment in Affiliate.” The initial investment in the joint venture is adjusted to recognize the Company’s share of earnings, losses and distributions received from the joint venture. The Company’s respective share of all earnings or losses from the joint venture will be recorded on its consolidated statements of operations as “Equity in Earnings or Losses of Affiliate.”

     When the Company is deemed to have a controlling interest in a joint venture, it will consolidate all of the joint venture’s assets, liabilities and operating results within its consolidated financial statements. The cash contributed to the consolidated joint venture by the third party, if any, will be reflected in the liability section of the Company’s consolidated balance sheets under “Financing Obligation.” The amount will be recorded based on the third party’s initial investment in the consolidated joint venture and will be adjusted to reflect the third party’s share of earnings or losses in the consolidated joint venture and for any distributions received by the third party from the joint venture. The earnings or losses from the joint venture attributable to the third party are recorded as interest expense on the Financing Obligation within the Company’s consolidated statements of operations. All distributions received by the Company from the consolidated joint venture will be recorded as an increase in the Financing Obligation.

Derivative Instruments

     In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company may enter into derivative agreements to mitigate exposure to unexpected changes in interest rates and may use interest rate protection or cap agreements to reduce the impact of interest rate changes. The Company intends to enter into derivative agreements only with counterparties that it believes have a strong credit rating to mitigate the risk of counterparty default or insolvency.

     The Company may designate a derivative as either a hedge of the cash flows from a debt instrument or anticipated transaction (cash flow hedge) or a hedge of the fair value of a debt instrument (fair value hedge). All derivatives are recognized as assets or liabilities at fair value. For effective hedging relationships, the change in the fair value of the assets or liabilities is recorded in “Accumulated Other Comprehensive Income (Loss),” an element of shareholders’ equity (cash flow hedge), or through earnings, along with the change in fair value of the asset or liability being hedged (fair value hedge). Ineffective portions of derivative transactions will result in changes in fair value recognized in earnings. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual inputs and guarantees.

Share-Based Compensation

     The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide services in exchange for the award — the requisite service period (usually the vesting period). The value for all share-based payment transactions are recognized as a component of income from continuing operations.

Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2009 to the Three and Nine Months Ended September 30, 2008

     2008 Acquisitions

     The Company acquired the following buildings at an aggregate purchase cost of $46.4 million during 2008: four buildings at Triangle Business Center; three buildings at RiversPark I; and three buildings at RiversPark II. In December 2008, the Company contributed the RiversPark I and II buildings to a newly formed joint venture, which it consolidated in its consolidated financial statements as a result of certain lease guarantees. On March 17, 2009, a tenant at RiversPark II renewed its lease, which effectively terminated the Company’s lease guarantee related to RiversPark II. As a result, the Company deconsolidated the assets, liabilities and operating results for RiversPark II effective March 17, 2009. Collectively, the properties are referred to as the “2008 Acquisitions.”

     The balance of the portfolio is referred to as the “Remaining Portfolio.” The operating results of the Company’s Cloverleaf Center acquisition are not included in the below results as the property was acquired in the fourth quarter of 2009.

Total Revenues

     Total revenues are summarized as follows:

		Three Months Ended								Nine Months Ended								Three Months								Nine Months
		September 30,								September 30,												Percent								Percent
(amounts in thousands)		2009				2008				2009				2008				Increase				Change				Increase				Change
Rental		$	27,149			$	25,491			$	80,885			$	75,316			$	1,658				7	%		$	5,569				7	%
Tenant reimbursements & other		$	5,725			$	5,577			$	18,134			$	16,304			$	148				3	%		$	1,830				11	%