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

For the quarterly period ended September 30, 2006

or

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission File Number 1-10709

PS BUSINESS PARKS, INC.

(Exact name of registrant as specified in its charter)

California (State or Other Jurisdiction of Incorporation)		95-4300881 (I.R.S. Employer Identification Number)

701 Western Avenue, Glendale, California 91201-2397
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (818) 244-8080

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer þ      Accelerated Filer o      Non-accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o        No þ

As of October 31, 2006, the number of shares of the registrant’s common stock, $0.01 par value per share, outstanding was 21,297,131.

 

 

PS BUSINESS PARKS, INC.
INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2006 (Unaudited) and December 31, 2005			2
Consolidated Statements of Income (Unaudited) for the Three and Nine Months Ended September 30, 2006 and 2005			3
Consolidated Statement of Shareholders’ Equity (Unaudited) for the Nine Months Ended September 30, 2006			4
Consolidated Statements of Cash Flows for the Nine Months (Unaudited) Ended September 30, 2006 and 2005			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures about Market Risk			34
Item 4. Controls and Procedures			34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			34
Item 1A. Risk Factors			34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			40
Item 6. Exhibits			41
EXHIBIT 3.1
EXHIBIT 12
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PS BUSINESS PARKS, INC.

		September 30,				December 31,
		2006				2005
		(Unaudited)
ASSETS
Cash and cash equivalents		$	92,800			$	200,447
Real estate facilities, at cost:
Land			417,597				383,308
Buildings and equipment			1,307,686				1,189,815
			1,725,283				1,573,123
Accumulated depreciation			(418,948	)			(355,228	)
			1,306,335				1,217,895
Properties held for disposition, net			—				5,366
Land held for development			9,019				9,011
			1,315,354				1,232,272
Rent receivable			2,369				2,678
Deferred rent receivable			21,087				18,650
Other assets			10,978				9,631
Total assets		$	1,442,588			$	1,463,678
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accrued and other liabilities		$	45,357			$	39,126
Mortgage notes payable			43,267				25,893
Total liabilities			88,624				65,019
Minority interests:
Preferred units			82,750				135,750
Common units			165,694				169,451
Commitments and contingencies
Shareholders’ equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized, 24,900 and 23,734 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively			622,500				593,350
Common stock, $0.01 par value, 100,000,000 shares authorized, 21,296,054 and 21,560,593 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively			213				215
Paid-in capital			395,897				407,380
Cumulative net income			466,527				418,823
Cumulative distributions			(379,617	)			(326,310	)
Total shareholders’ equity			1,105,520				1,093,458
Total liabilities and shareholders’ equity		$	1,442,588			$	1,463,678

See accompanying notes.

PS BUSINESS PARKS, INC.

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
		2006				2005				2006				2005
Revenues:
Rental income		$	61,695			$	54,654			$	179,608			$	163,806
Facility management fees			147				145				442				434
Total operating revenues			61,842				54,799				180,050				164,240
Expenses:
Cost of operations			19,213				16,182				55,354				48,675
Depreciation and amortization			22,184				19,291				63,720				56,203
General and administrative			1,742				1,499				5,264				4,263
Total operating expenses			43,139				36,972				124,338				109,141
Other income and expenses:
Interest and other income			1,884				1,400				5,457				2,780
Interest expense			(628	)			(304	)			(1,658	)			(866	)
Total other income and expenses			1,256				1,096				3,799				1,914
Income from continuing operations before minority interests			19,959				18,923				59,511				57,013
Minority interests in continuing operations:
Minority interest in income — preferred units
Distributions to preferred unit holders			(2,672	)			(2,460	)			(8,234	)			(7,842	)
Redemption of preferred operating partnership units			(1,366	)			—				(1,366	)			(301	)
Minority interest in income — common units			(1,185	)			(1,321	)			(3,850	)			(4,302	)
Total minority interests in continuing operations			(5,223	)			(3,781	)			(13,450	)			(12,445	)
Income from continuing operations			14,736				15,142				46,061				44,568
Discontinued operations:
Income (loss) from discontinued operations			—				1,244				(125	)			2,880
Gain on disposition of real estate			—				12,599				2,328				16,529
Minority interest in income attributable to discontinued operations — common units			—				(3,466	)			(560	)			(4,860	)
Income from discontinued operations			—				10,377				1,643				14,549
Net income			14,736				25,519				47,704				59,117
Net income allocable to preferred shareholders:
Preferred distributions			11,258				11,255				33,111				31,757
Redemption of preferred stock			—				—				1,658				—
Total preferred distributions			11,258				11,255				34,769				31,757
Net income allocable to common shareholders		$	3,478			$	14,264			$	12,935			$	27,360
Net income per common share — basic:
Continuing operations		$	0.16			$	0.18			$	0.53			$	0.59
Discontinued operations		$	—			$	0.47			$	0.08			$	0.67
Net income		$	0.16			$	0.65			$	0.61			$	1.25
Net income per common share — diluted:
Continuing operations		$	0.16			$	0.18			$	0.52			$	0.58
Discontinued operations		$	—			$	0.47			$	0.08			$	0.66
Net income		$	0.16			$	0.65			$	0.60			$	1.24
Weighted average common shares outstanding:
Basic			21,290				21,858				21,345				21,867
Diluted			21,599				22,030				21,630				22,050

See accompanying notes.

PS BUSINESS PARKS, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

																														Total
		Preferred Stock								Common Stock								Paid-in				Cumulative				Cumulative				Shareholders’
		Shares				Amount				Shares				Amount				Capital				Net Income				Distributions				Equity
Balances at December 31, 2005			23,734			$	593,350				21,560,593			$	215			$	407,380			$	418,823			$	(326,310	)		$	1,093,458
Issuance of preferred stock			3,800				95,000				—				—				(2,689	)			—				—				92,311
Redemption of preferred stock			(2,634	)			(65,850	)			—				—				1,658				—				(1,658	)			(65,850	)
Repurchase of common stock			—				—				(309,100	)			(3	)			(16,114	)			—				—				(16,117	)
Exercise of stock options			—				—				24,500				1				842				—				—				843
Stock compensation			—				—				20,061				—				1,642				—				—				1,642
Net income			—				—				—				—				—				47,704				—				47,704
Distributions:
Preferred stock			—				—				—				—				—				—				(33,111	)			(33,111	)
Common stock			—				—				—				—				—				—				(18,538	)			(18,538	)
Adjustment to minority interests underlying ownership			—				—				—				—				3,178				—				—				3,178
Balances at September 30, 2006			24,900			$	622,500				21,296,054			$	213			$	395,897			$	466,527			$	(379,617	)		$	1,105,520

See accompanying notes.

PS BUSINESS PARKS, INC.

		For the Nine Months
		Ended September 30,
		2006				2005
Cash flows from operating activities:
Net income		$	47,704			$	59,117
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense			63,747				57,418
In-place lease adjustment			172				116
Lease incentives net of tenant improvement reimbursements			387				22
Minority interest in income			14,010				17,305
Gain on disposition of real estate			(2,328	)			(16,529	)
Stock compensation expense			2,007				749
Increase in receivables and other assets			(3,019	)			(4,796	)
Increase in accrued and other liabilities			4,123				2,017
Total adjustments			79,099				56,302
Net cash provided by operating activities			126,803				115,419
Cash flows from investing activities:
Capital improvements to real estate facilities			(25,459	)			(29,066	)
Acquisition of real estate facilities			(108,588	)			—
Proceeds from disposition of real estate facilities			7,714				80,856
Insurance proceeds from casualty loss			500				—
Net cash (used in) provided by investing activities			(125,833	)			51,790
Cash flows from financing activities:
Principal payments on mortgage notes payable			(565	)			(312	)
Net proceeds from the issuance of preferred stock			92,557				79,627
Exercise of stock options			843				1,715
Repurchase of common stock			(16,117	)			(5,425	)
Redemption of preferred stock			(65,850	)			—
Redemption of preferred units			(53,000	)			(12,000	)
Distributions paid to preferred shareholders			(33,357	)			(31,757	)
Distributions paid to minority interests — preferred units			(8,234	)			(7,842	)
Distributions paid to common shareholders			(18,538	)			(19,021	)
Distributions paid to minority interests — common units			(6,356	)			(6,356	)
Net cash used in financing activities			(108,617	)			(1,371	)
Net (decrease) increase in cash and cash equivalents			(107,647	)			165,838
Cash and cash equivalents at the beginning of the period			200,447				39,688
Cash and cash equivalents at the end of the period		$	92,800			$	205,526
Supplemental schedule of non cash investing and financing activities:
Adjustment to reflect minority interest to underlying ownership interest:
Minority interest — common units		$	1,812			$	823
Paid-in capital		$	(1,812	)		$	(823	)
Effect of EITF Topic D-42:
Cumulative distributions		$	1,658			$	—
Minority interest — common units		$	1,366			$	301
Paid-in capital		$	(3,024	)		$	(301	)
Mortgage note payable assumed in property acquisition:
Real estate facilities		$	17,939			$	—
Mortgage notes payable		$	(17,939	)		$	—

See accompanying notes.

PS BUSINESS PARKS, INC.

1.		Organization and Description of Business
		PS Business Parks, Inc. (“PSB”) was incorporated in the state of California in 1990. As of September 30, 2006, PSB owned approximately 74.5% of the common partnership units of PS Business Parks, L.P. (the “Operating Partnership” or “OP”). The remaining common partnership units are owned by Public Storage, Inc. (“PSI”) and its affiliates. PSB, as the sole general partner of the Operating Partnership, has full, exclusive and complete responsibility and discretion in managing and controlling the Operating Partnership. PSB and the Operating Partnership are collectively referred to as the “Company.”
		The Company is a fully-integrated, self-advised and self-managed real estate investment trust (“REIT”) that acquires, develops, owns and operates commercial properties containing commercial and industrial rental space. As of September 30, 2006, the Company owned and operated approximately 18.2 million rentable square feet of commercial space located in eight states. The Company also manages approximately 1.4 million rentable square feet on behalf of PSI and its affiliated entities.
2.		Summary of Significant Accounting Policies
		Basis of presentation
		The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from estimates. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
		The accompanying consolidated financial statements include the accounts of PSB and the Operating Partnership. All significant inter-company balances and transactions have been eliminated in the consolidated financial statements.
		Use of estimates
		The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from estimates.
		Allowance for doubtful accounts
		We monitor the collectibility of our receivable balances, including the deferred rent receivable, on an on-going basis. Based on these reviews, we maintain an allowance for doubtful accounts for estimated losses resulting from the possible inability of our tenants to make required rent payments to us. A provision for doubtful accounts is recorded during each period. The allowance for doubtful accounts, which represents the cumulative allowances less write-offs of uncollectible rent, is netted against tenant and other receivables on our consolidated balance sheets. Tenant receivables are net of an allowance for uncollectible accounts totaling $300,000 at September 30, 2006 and December 31, 2005.

		Financial instruments
		The methods and assumptions used to estimate the fair value of financial instruments are described below. The Company has estimated the fair value of financial instruments using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop estimates of market value. Accordingly, estimated fair values are not necessarily indicative of the amounts that could be realized in current market exchanges.
		The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. Due to the short period to maturity of the Company’s cash and cash equivalents, accounts receivable, other assets and accrued and other liabilities, the carrying values as presented on the condensed consolidated balance sheets are reasonable estimates of fair value. Based on borrowing rates currently available to the Company, the carrying amount of debt approximates fair value.
		Financial assets that are exposed to credit risk consist primarily of cash and cash equivalents and receivables. Cash and cash equivalents, which consist primarily of short-term investments, including commercial paper, are only invested in entities with an investment grade rating. Receivables are comprised of balances due from a large number of tenants. Balances that the Company expects to become uncollectable are reserved for or written off.
		Real estate facilities
		Real estate facilities are recorded at cost. Costs related to the renovation or improvement of the properties are capitalized. Expenditures for repairs and maintenance are expensed as incurred. Expenditures that are expected to benefit a period greater than 24 months and exceed $2,000 are capitalized and depreciated over the estimated useful life. Buildings and equipment are depreciated using the straight-line method over the estimated useful lives, which are generally 30 and 5 years, respectively. Leasing costs in excess of $1,000 for leases with terms greater than two years are capitalized and depreciated/amortized over their estimated useful lives. Leasing costs for leases of less than two years or less than $1,000 are expensed as incurred. Interest cost and property taxes incurred during the period of construction of real estate facilities are capitalized.
		Properties held for disposition
		The Company accounts for properties held for disposition in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. An asset is classified as an asset held for disposition when it meets the requirements of SFAS No. 144, which include, among other criteria, the approval of the sale of the asset, the asset has been marketed for sale and the Company expects that the sale will likely occur within the next twelve months. Upon classification of an asset as held for disposition, the net book value of the asset, net of any impairment provision and estimated costs of disposition, is included on the consolidated balance sheet as properties held for disposition and the operating results of the asset are included in discontinued operations.
		Intangible assets
		Intangible assets include above-market and below-market in-place lease values of acquired properties recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above and below-market lease values are amortized, net, to rental income over the remaining non-cancelable terms of the respective leases. As a result, included in the Company’s consolidated statements of income for the three months ended September 30, 2006 and 2005, is $60,000 and $39,000, respectively, in amortization expense resulting from the above and below market lease values. Amortization was $172,000 and $116,000 for each of the nine months ended September 30,

		2006 and 2005, respectively. At September 30, 2006, the value of in-place leases was $716,000, net of $476,000 of accumulated amortization.
		Evaluation of asset impairment
		The Company evaluates its assets used in operations, by identifying indicators of impairment and by comparing the sum of the estimated undiscounted future cash flows for each asset to the asset’s carrying amount. When indicators of impairment are present and the sum of the undiscounted future cash flows is less than the carrying value of such asset, an impairment loss is recorded equal to the difference between the asset’s current carrying value and its value based on discounting its estimated future cash flows. In addition, the Company evaluates its assets held for disposition. Assets held for disposition are reported at the lower of their carrying amount or fair value, less cost of disposition. At September 30, 2006, the Company did not consider any assets to be impaired.
		Stock-based compensation
		On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Effective January 1, 2006, the Company adopted SFAS No. 123(R) using the modified prospective method. Due to the Company adopting the Fair Value Method of accounting for stock options effective January 1, 2002, the adoption of this standard did not have a material impact on the results of operations or the financial position of the Company. See Note 11.
		Revenue and expense recognition
		Revenue is recognized in accordance with Staff Accounting Bulletin No. 101 of the Securities and Exchange Commission, Revenue Recognition in Financial Statements (“SAB 101”), as amended. SAB 101 requires that four basic criteria must be met before revenue can be recognized: persuasive evidence of an arrangement exists; the delivery has occurred or services rendered; the fee is fixed and determinable; and collectibility is reasonably assured. All leases are classified as operating leases. Rental income is recognized on a straight-line basis over the terms of the leases. Straight-line rent is recognized for all tenants with contractual increases in rent that are not included on the Company’s credit watch list. Deferred rent receivables represent rental revenue recognized on a straight-line basis in excess of billed rents. Reimbursements from tenants for real estate taxes and other recoverable operating expenses are recognized as rental income in the period the applicable costs are incurred. Property management fees are recognized in the period earned.
		Costs incurred in connection with leasing (primarily tenant improvements and leasing commissions) are capitalized and amortized over the lease period.
		Gains/Losses from sales of real estate
		The Company recognizes gains from sales of real estate at the time of sale using the full accrual method, provided that various criteria related to the terms of the transactions and any subsequent involvement by the Company with the properties sold are met. If the criteria are not met, the Company defers the gains and recognizes them when the criteria are met or using the installment or cost recovery methods as appropriate under the circumstances.

		General and administrative expense
		General and administrative expense includes executive and other compensation, office expense, professional fees, state income taxes, dues, listing fees and other administrative items.
		Related party transactions
		Pursuant to a cost sharing and administrative services agreement, the Company shares costs with PSI and affiliated entities for certain administrative services, which are allocated among PSI and its affiliates in accordance with a methodology intended to fairly allocate those costs. These costs totaled $80,000 and $85,000 for the three months ended September 30, 2006 and 2005, respectively and $240,000 and $255,000 for the nine months ended September 30, 2006 and 2005, respectively. In addition, the Company provides property management services for properties owned by PSI and its affiliates for a fee of 5% of the gross revenues of such properties in addition to reimbursement of direct costs. These management fee revenues recognized under management contracts with affiliated parties totaled $147,000 and $145,000 for each of the three months ended September 30, 2006 and 2005, respectively and $442,000 and $434,000 for the nine months ended September 30, 2006 and 2005, respectively. At September 30, 2006, the Company has amounts due from PSI of $282,000 ($551,000 at December 31, 2005), for these contracts, as well as for amounts paid by the Company on behalf of PSI, in other assets on the accompanying consolidated balance sheets.
		Income taxes
		The Company qualified and intends to continue to qualify as a REIT, as defined in Section 856 of the Internal Revenue Code. As a REIT, the Company is not subject to federal income tax to the extent that it distributes its taxable income to its shareholders. A REIT must distribute at least 90% of its taxable income each year. In addition, REITs are subject to a number of organizational and operating requirements. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income tax (including any applicable alternative minimum tax) based on its taxable income using corporate income tax rates. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property and to federal income and excise taxes on its undistributed taxable income. The Company believes it met all organizational and operating requirements to maintain its REIT status during 2005 and intends to continue to meet such requirements for 2006. Accordingly, no provision for income taxes has been made in the accompanying consolidated financial statements.
		Accounting for preferred equity issuance costs
		In accordance with Emerging Issues Task Force (“EITF”) Topic D-42, the Company records its issuance costs as a reduction to Paid-in Capital on its balance sheet at the time the preferred securities are issued and reflects the carrying value of the preferred stock at the stated value. The Company reduces the carrying value of preferred stock by the issuance costs at the time it notifies the holders of preferred stock or units of its intent to redeem such shares or units.
		Net income per common share
		Per share amounts are computed using the number of weighted average common shares outstanding. “Diluted” weighted average common shares outstanding includes the dilutive effect of stock options and restricted stock units under the treasury stock method. “Basic” weighted average common shares outstanding excludes such effect. Earnings per share have been calculated as follows (in thousands, except per share amounts):

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
		2006				2005				2006				2005
Net income allocable to common shareholders		$	3,478			$	14,264			$	12,935			$	27,360
Weighted average common shares outstanding:
Basic weighted average common shares outstanding			21,290				21,858				21,345				21,867
Net effect of dilutive stock compensation — based on treasury stock method using average market price			309				172				285				183
Diluted weighted average common shares outstanding			21,599				22,030				21,630				22,050
Basic earnings per common share		$	0.16			$	0.65			$	0.61			$	1.25
Diluted earnings per common share		$	0.16			$	0.65			$	0.60			$	1.24

		No options to purchase shares were considered anti-dilutive for the three months ended September 30, 2006. Options to purchase approximately 20,000 shares for the nine months ended September 30, 2006 were not included in the computation of diluted net income per share because such options were considered anti-dilutive. Options to purchase approximately 50,000 and 130,000 shares for the three and nine months ended September 30, 2005, respectively, were not included in the computation of diluted net income per share because such options were considered anti-dilutive.
		Segment reporting
		The Company views its operations as one segment.
		Reclassifications
		Certain reclassifications have been made to the consolidated financial statements for 2005 in order to conform to the 2006 presentation.
3.		Real Estate Facilities
		The activity in real estate facilities for the nine months ended September 30, 2006 is as follows (in thousands):

										Accumulated
		Land				Buildings				Depreciation				Total
Balances at December 31, 2005		$	383,308			$	1,189,815			$	(355,228	)		$	1,217,895
Acquisition of real estate			34,289				92,420				—				126,709
Capital improvements, net			—				25,451				—				25,451
Depreciation expense			—				—				(63,747	)			(63,747	)
Transfer to properties held for disposition			—				—				27				27
Balances at September 30, 2006		$	417,597			$	1,307,686			$	(418,948	)		$	1,306,335

		Subsequent to September 30, 2006, the Company acquired a 66,500 square foot multi-tenant industrial and flex park in San Jose, California, for $8.4 million. The park consists of three single-story buildings.
		On June 29, 2006, the Company acquired Meadows Corporate Park, a 165,000 square foot multi-tenant office park in Silver Spring, Maryland, for $29.9 million. In connection with the acquisition, the Company assumed a $16.8 million mortgage with a fixed interest rate of 7.2% through November, 2011 at which time it can be prepaid without penalty.

		On June 20, 2006, the Company acquired Beaumont at Lafayette, consisting of two single-story multi-tenant flex buildings aggregating 107,300 square feet in Chantilly, Virginia, for $15.8 million.
		On June 14, 2006, the Company acquired four multi-tenant flex buildings, aggregating 88,800 square feet, located in Signal Hill, California, for $10.7 million.
		On February 8, 2006, the Company acquired WesTech Business Park, a 366,000 square foot office and flex park in Silver Spring, Maryland, for $69.7 million. The park consists of nine single-story buildings.
		The following table summarizes the assets and liabilities acquired during the nine months ended September 30, 2006 (in thousands):

Land		$	34,289
Buildings			92,420
In-place leases			433
Total purchase price			127,142
Loan assumed			(17,939	)
Net operating assets and liabilities acquired			(615	)
Total cash paid		$	108,588

		During the quarter ended June 30, 2006, the Company sold two assets previously classified as properties held for disposition. In May, 2006, the Company sold a 30,500 square foot building located in Beaverton, Oregon, for a gross sales price of $4.4 million resulting in a gain of $1.5 million. Also, in May, 2006, the Company sold a 7,100 square foot unit at Miami International Commerce Center (“MICC”) for a gross sales price of $815,000, resulting in a gain of $154,000.
		In the first quarter of 2006, the Company sold three assets previously classified as properties held for disposition. In February, 2006, the Company sold 10,100 square feet located at MICC for a gross sales price of $1.2 million resulting in a gain of $333,000. In addition, in March, 2006, the Company sold two additional units aggregating 15,200 square feet at MICC for a gross sales price of $1.7 million, resulting in a gain of $378,000.
		On October 25, 2005, the Company acquired Rose Canyon Business Park, a 233,000 square foot multi-tenant flex park in San Diego, California, for $35.1 million. In connection with the acquisition, the Company assumed a $15.0 million mortgage, which bears an interest rate of 5.73% and matures March 1, 2013.
		On September 30, 2005, the Company completed the sale of Woodside Corporate Park located in Beaverton, Oregon. The park consists of 13 buildings comprising approximately 574,000 square feet and a 3.3 acre parcel of land. Net proceeds from the sale, after transaction costs, were $64.5 million. In connection with the sale, the Company recognized a gain of $12.5 million.
		On August 8, 2005, the Company closed on the sale of a 7,100 square foot unit at MICC in Miami, Florida for a gross sales price of $750,000, resulting in a gain of $137,000.
		During the second quarter of 2005, the Company realized a gain of $1.0 million from the November 2004 sale of Largo 95 in Largo, Maryland. The gain was previously deferred due to the Company’s obligation to complete certain leasing related items satisfied in 2005.
		In February, 2005, the Company sold the 56,000 square foot retail center located at MICC for a sales price of $12.2 million resulting in a gain of $967,000. Also, in January, 2005, the Company closed on the sale of a 7,100 square foot unit at MICC for a gross sales price of $740,000 resulting in a gain of $142,000. On January 31, 2005, the Company closed on the sale of 8.2 acres of land within the Cornell Oaks project in Beaverton, Oregon, for a sales price of $3.6 million, resulting in a gain of $1.8 million.

The following table summarizes the condensed results of operations of the properties sold during 2006 and 2005, which are included in the consolidated statements of income as discontinued operations (in thousands):

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
		2006				2005				2006				2005
Rental income		$	—			$	1,826			$	—			$	5,823
Cost of operations			—				(555	)			(98	)			(1,728	)
Depreciation expense			—				(27	)			(27	)			(1,215	)
Income (loss) from discontinued operations		$	—			$	1,244			$	(125	)		$	2,880

		In addition to minimum rental payments, tenants reimburse the Company for their pro rata share of specified operating expenses, which amounted to $222,000 and $755,000 for the three and nine months ended September 30, 2005, respectively, for discontinued operations. These amounts are included as rental income and cost of operations in the table presented above for those assets either sold or classified as held for disposition.
4.		Leasing Activity
		The Company leases space in its real estate facilities to tenants primarily under non-cancelable leases generally ranging from one to ten years. Future minimum rental income, excluding reimbursement of expenses, as of September 30, 2006 under these leases are as follows (in thousands):

2006		$	47,721
2007			192,701
2008			149,661
2009			103,449
2010			73,003
Thereafter			124,919
		$	691,454

		In addition to minimum rental payments, tenants reimburse the Company for their pro rata share of specified operating expenses, which amounted to $8.7 million and $6.6 million for the three months ended September 30, 2006 and 2005, respectively and $23.9 million and $19.5 million for the nine months ended September 30, 2006 and 2005, respectively, for continuing operations. These amounts are included as rental income and cost of operations in the accompanying consolidated statements of income.
		Leases aggregating approximately 7% of the total leased square footage as of September 30, 2006 are subject to termination options which include leases for approximately 3% of the total leased square footage having termination options exercisable through December 31, 2006. In general, these leases provide for termination payments should the termination options be exercised. The above table is prepared assuming such options are not exercised.
5.		Bank Loans
		In August of 2005, the Company modified the terms of its line of credit (the “Credit Facility”) with Wells Fargo Bank. The Credit Facility has a borrowing limit of $100.0 million and matures on August 1, 2008. Interest on outstanding borrowings is payable monthly. At the option of the Company, the rate of interest charged is equal to (i) the prime rate or (ii) a rate ranging from the London Interbank Offered Rate (“LIBOR”) plus 0.50% to LIBOR plus 1.20% depending on the Company’s credit ratings and coverage ratios, as defined (currently LIBOR plus 0.65%). In addition, the Company is required to pay an annual commitment fee ranging from 0.15% to 0.30% of the borrowing limit (currently 0.20%). In connection with the modification of the Credit Facility, the Company paid a fee of $450,000 which will be amortized over the life of the Credit Facility. The Company had no balance outstanding as of September 30, 2006 or December 31, 2005. The Credit Facility requires the

		Company to meet certain covenants, and the Company was in compliance with all such covenants at September 30, 2006.
6.		Mortgage Notes Payable
		Mortgage notes consist of the following (in thousands):

		September 30,				December 31,
		2006				2005
8.190% mortgage note, principal and interest payable monthly, due March, 2007		$	5,079			$	5,302
7.290% mortgage note, principal and interest payable monthly, due February, 2009			5,530				5,645
5.730% mortgage note, principal and interest payable monthly, due March, 2013			14,800				14,946
6.150% mortgage note, principal and interest payable monthly, due November, 2031 (1)			17,858				—
		$	43,267			$	25,893
(1) Mortgage note of $16.8 million has a stated interest rate of 7.200%. Based on the fair market value at the time of assumption, a loan premium of $1.1 million was computed based on an effective interest rate of 6.150%. This loan is repayable without penalty beginning November, 2011. At September 30, 2006, principal maturities of mortgage notes payable are as follows (in thousands):
2006						$	273
2007							5,813
2008							858
2009							5,871
2010							773
Thereafter							29,679
						$	43,267

7.		Minority Interests
		Common partnership units
		The Company presents the accounts of PSB and the Operating Partnership on a consolidated basis. Ownership interests in the Operating Partnership that can be redeemed for common stock, other than PSB’s interest, are classified as minority interest – common units in the consolidated financial statements. Minority interest in income consists of the minority interests’ share of the consolidated operating results after allocation to preferred units and shares. Beginning one year from the date of admission as a limited partner (common units) and subject to certain limitations described below, each limited partner other than PSB has the right to require the redemption of its partnership interest.
		A limited partner (common units) that exercises its redemption right will receive cash from the Operating Partnership in an amount equal to the market value (as defined in the Operating Partnership Agreement) of the partnership interests redeemed. In lieu of the Operating Partnership redeeming the partner for cash, PSB, as general partner, has the right to elect to acquire the partnership interest directly from a limited partner exercising its redemption right, in exchange for cash in the amount specified above or by issuance of one share of PSB common stock for each unit of limited partnership interest redeemed.
		A limited partner (common units) cannot exercise its redemption right if delivery of shares of PSB common stock would be prohibited under the applicable articles of incorporation, if the general partner believes that there is a risk that delivery of shares of common stock would cause the general partner to no longer qualify as a REIT, would cause a violation of the applicable securities laws, or would result in the Operating Partnership no longer being treated as a partnership for federal income tax purposes.

		At September 30, 2006, there were 7,305,355 common units owned by PSI and its affiliates, which are accounted for as minority interests. On a fully converted basis, assuming all 7,305,355 minority interest common units were converted into shares of common stock of PSB at September 30, 2006, the minority interest units would convert into approximately 25.5% of the common shares outstanding. Combined with PSI’s common stock ownership, on a fully converted basis, PSI has a combined ownership of approximately 44.5% of the Company’s common equity. At the end of each reporting period, the Company determines the amount of equity (book value of net assets) which is allocable to the minority interest based upon the ownership interest and an adjustment is made to the minority interest, with a corresponding adjustment to paid-in capital, to reflect the minority interests’ equity in the Company.
		Preferred partnership units
		Through the Operating Partnership, the Company has the following preferred units outstanding as of September 30, 2006 and December 31, 2005 (in thousands):

						Earliest
						Potential							September 30, 2006								December 31, 2005
						Redemption			Dividend				Units								Units
Series			Issuance Date			Date			Rate				Outstanding				Amount				Outstanding				Amount
Series G			October, 2002			October, 2007			7.950%					800			$	20,000				800			$	20,000
Series J			May & June, 2004			May, 2009			7.500%					1,710				42,750				1,710				42,750
Series N			December, 2005			December, 2010			7.125%					800				20,000				800				20,000
Series E			September, 2001			September, 2006			9.250%					—				—				2,120				53,000
														3,310			$	82,750				5,430			$	135,750

		On September 21, 2006 the Company redeemed 2.1 million units of its 9.250% Series E Cumulative Redeemable Preferred Units for $53.0 million. The Company reported the excess of the redemption amount over the carrying amount, $1.4 million, as an additional allocation of net income to preferred unit holders and a corresponding reduction of net income allocable to common shareholders and common unit holders for the nine months ended September 30, 2006.
		During the second quarter of 2005, the Company notified the holders of its 8.875% Series Y Cumulative Redeemable Preferred Units of its intent to redeem such units in July 2005. The Company reported the excess of the redemption amount over the carrying amount, $301,000, as an additional allocation of net income to preferred unit holders and a corresponding reduction of net income allocable to common shareholders and common unit holders for the nine months ended September 30, 2005.
		The Operating Partnership has the right to redeem preferred units on or after the fifth anniversary of the applicable issuance date at the original capital contribution plus the cumulative priority return, as defined, to the redemption date to the extent not previously distributed. The preferred units are exchangeable for Cumulative Redeemable Preferred Stock of the respective series of PSB on or after the tenth anniversary of the date of issuance at the option of the Operating Partnership or a majority of the holders of the respective preferred units. The Cumulative Redeemable Preferred Stock will have the same distribution rate and par value as the corresponding preferred units and will otherwise have equivalent terms to the other series of preferred stock described in Note 9. As of September 30, 2006, the Company had $2.3 million of deferred costs in connection with the issuance of preferred units, which the Company will report as additional distributions upon notice of redemption.
8.		Property Management Contracts
		The Operating Partnership manages industrial, office and retail facilities for PSI and its affiliated entities. These facilities, all located in the United States, operate under the “Public Storage” or “PS Business Parks” names.
		Under the property management contracts, the Operating Partnership is compensated based on a percentage of the gross revenues of the facilities managed. Under the supervision of the property owners, the Operating

		Partnership coordinates rental policies, rent collections, marketing activities, the purchase of equipment and supplies, maintenance activities, and the selection and engagement of vendors, suppliers and independent contractors. In addition, the Operating Partnership assists and advises the property owners in establishing policies for the hire, discharge and supervision of employees for the operation of these facilities, including property managers and leasing, billing and maintenance personnel.
		The property management contract with PSI is for a seven year term with the term being automatically extended one year on each anniversary. At any time, either party may notify the other that the contract is not to be extended, in which case the contract will expire on the first anniversary of its then scheduled expiration date. For PSI affiliate owned properties, PSI can cancel the property management contract upon 60 days notice while the Operating Partnership can cancel upon seven years notice. Management fee revenues under these contracts were $147,000 and $145,000 for the three months ended September 30, 2006 and 2005, respectively and $442,000 and $434,000 for the nine months ended September 30, 2006 and 2005, respectively.
9.		Shareholders’ Equity
		Preferred stock
		As of September 30, 2006 and December 31, 2005, the Company had the following preferred stock outstanding (in thousands, except shares outstanding):

						Earliest
						Potential							September 30, 2006								December 31, 2005
						Redemption			Dividend				Shares								Shares
Series			Issuance Date			Date			Rate				Outstanding				Amount				Outstanding				Amount
Series F			January, 2002			January, 2007				8.750	%			2,000			$	50,000				2,000			$	50,000
Series H			January & October, 2004			January, 2009				7.000	%			8,200				205,000				8,200				205,000
Series I			April, 2004			April, 2009				6.875	%			3,000				75,000				3,000				75,000
Series K			June, 2004			June, 2009				7.950	%			2,300				57,500				2,300				57,500
Series L			August, 2004			August, 2009				7.600	%			2,300				57,500				2,300				57,500
Series M			May, 2005			May, 2010				7.200	%			3,300				82,500				3,300				82,500
Series O			June, 2006			June, 2011				7.375	%			3,800				95,000				—				—
Series D			May, 2001			May, 2006				9.500	%			—				—				2,634				65,850
														24,900			$	622,500				23,734			$	593,350

		On June 16, 2006, the Company issued 3.0 million depositary shares, each representing 1/1,000 of a share of the 7.375% Cumulative Preferred Stock, Series O, at $25.00 per depositary share. On August 16, 2006 the Company issued an additional 800,000 depositary shares each representing 1/1000 of a share of the 7.375% Cumulative Preferred Stock, Series O, at $25.00 per depository share. The Company intends to use the proceeds from the offering to fund future property acquisitions, preferred equity redemptions and general corporate purposes.
		On May 10, 2006, the Company redeemed 2.6 million depositary shares of its 9.500% Cumulative Preferred Stock, Series D for $65.9 million. In accordance with EITF Topic D-42, the redemption resulted in a reduction of net income allocable to common shareholders of $1.7 million for the nine months ended September 30, 2006 equal to the excess of the redemption amount over the carrying amount of the redeemed securities.
		In May of 2005, the Company issued 3.3 million depositary shares each representing 1/1,000 of a share of the 7.200% Cumulative Preferred Stock, Series M, at $25.00 per depositary share.
		The Company recorded $11.3 million in distributions to its preferred shareholders for the three months ended September 30, 2006 and 2005. The Company recorded $34.8 million and $31.8 million in distributions to its preferred shareholders for the nine months ended September 30, 2006 and 2005, respectively. The distributions for the nine months ended September 30, 2006 include $1.7 million of non-cash distributions related to EITF Topic D-42.
		Holders of the Company’s preferred stock are not entitled to vote on most matters, except under certain conditions. In the event of a cumulative arrearage equal to six quarterly dividends, the holders of the preferred

		stock will have the right to elect two additional members to serve on the Company’s Board of Directors until all events of default have been cured.
		Except under certain conditions relating to the Company’s qualification as a REIT, the preferred stock is not redeemable prior to the previously noted redemption dates. On or after the respective redemption dates, the respective series of preferred stock will be redeemable, at the option of the Company, in whole or in part, at $25 per depositary share, plus any accrued and unpaid dividends. As of September 30, 2006, the Company had $21.2 million of deferred costs in connection with the issuance of preferred stock, which the Company will report as additional non-cash distributions upon notice of its intent to redeem such shares.
		Common stock
		The Company’s Board of Directors has authorized the repurchase, from time to time, of up to 4.5 million shares of the Company’s common stock on the open market or in privately negotiated transactions. Since inception of the program through September 30, 2006, the Company has repurchased an aggregate of 3.3 million shares of common stock at an aggregate cost of $102.6 million (average cost of $31.18 per share). During the nine months ended September 30, 2006, the Company repurchased 309,100 shares of common stock at a cost of $16.1 million. During the nine months ended September 30, 2005, the Company repurchased 123,100 shares of common stock at a cost of $5.4 million.
		The Company paid $6.2 million ($0.29 per common share) and $6.3 million ($0.29 per common share) for the three months ended September 30, 2006 and 2005, respectively and $18.5 million ($0.87 per common share) and $19.0 million ($0.87 per common share) for the nine months ended September 30, 2006 and 2005, respectively, in distributions to its common shareholders. Pursuant to restrictions imposed by the Credit Facility, distributions may not exceed 95% of funds from operations, as defined.
		Equity Stock
		In addition to common and preferred stock, the Company is authorized to issue 100.0 million shares of Equity Stock. The Articles of Incorporation provide that the Equity Stock may be issued from time to time in one or more series and give the Board of Directors broad authority to fix the dividend and distribution rights, conversion and voting rights, redemption provisions and liquidation rights of each series of Equity Stock.
10.		Commitments and Contingencies
		The Company currently is neither subject to any material litigation nor, to management’s knowledge, is any material litigation currently threatened against the Company other than routine litigation and administrative proceedings arising in the ordinary course of business.
11.		Stock-Based Compensation
		PSB has a 1997 Stock Option and Incentive Plan (the “1997 Plan”) and a 2003 Stock Option and Incentive Plan (the “2003 Plan”), each covering 1.5 million shares of PSB’s common stock. Under the 1997 Plan and 2003 Plan, PSB has granted non-qualified options to certain directors, officers and key employees to purchase shares of PSB’s common stock at a price no less than the fair market value of the common stock at the date of grant.
		On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Effective January 1, 2006, the Company adopted SFAS No. 123(R) using the modified prospective method.

		The weighted average grant date fair value of the options granted in the nine months ended September 30, 2006 and 2005 was $11.24 per share and $6.96 per share, respectively. The Company has calculated the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants during the nine months ended September 30, 2006 and 2005, respectively; a dividend yield of 2.1% and 2.6%; expected volatility of 17.9% and 17.6%; expected life of five years; and risk-free interest rates of 4.9% and 4.2%.
		The weighted average grant date fair value of restricted stock units granted during the nine months ended September 30, 2006 and 2005 was $55.15 and $41.43, respectively. The Company has calculated the fair value of each restricted stock unit grant using the market value on the date of grant.
		At September 30, 2006, there were a combined total of 1.3 million options and restricted stock units authorized to grant. Information with respect to the 1997 Plan and 2003 Plan is as follows:

										Weighted				Aggregate
						Weighted				Average				Intrinsic
		Number of				Average				Remaining				Value
Options:		Options				Exercise Price				Contract Life				(in thousands)
Outstanding at December 31, 2005			599,871			$	34.86
Granted			32,000			$	56.73
Exercised			(24,500	)		$	34.38
Forfeited			(5,000	)		$	44.20
Outstanding at September 30, 2006			602,371			$	35.96			6.40 Years				$	13,920
Exercisable at September 30, 2006			356,171			$	31.48			5.35 Years				$	10,265
						Weighted
		Number of				Average Grant
Restricted Stock Units:		Units				Date Fair Value
Nonvested at December 31, 2005			128,000			$	39.27
Granted			127,700			$	55.15
Vested			(21,500	)		$	36.18
Forfeited			(10,750	)		$	40.91
Nonvested at September 30, 2006			223,450			$	48.56

		Included in the Company’s consolidated statements of income for the three months ended September 30, 2006 and 2005, is $127,000 and $107,000, respectively, in net stock option compensation expense related to stock options granted. Net stock option compensation expense for the nine months ended September 30, 2006 and 2005 was $400,000 and $296,000, respectively. Net compensation expense of $614,000 and $191,000 related to restricted stock units was recognized during the three months ended September 30, 2006 and 2005, respectively. Net compensation expense of $1.6 million and $436,000 related to restricted stock units was recognized during the nine months ended September 30, 2006 and 2005, respectively.
		As of September 30, 2006, there was $1.4 million of unamortized compensation expense related to stock options expected to be recognized over a weighted average period of 3.4 years. As of September 30, 2006, there was $8.5 million of unamortized compensation expense related to restricted stock units expected to be recognized over a weighted average period of 3.4 years.
		Cash received from stock option exercises was $843,000 and $1.7 million for the nine months ended September 30, 2006 and 2005, respectively. The aggregate intrinsic value of the stock options exercised during the nine months ended September 30, 2006 and 2005 was $502,000 and $882,000, respectively.
		During the nine months ended September 30, 2006, 21,500 restricted stock units vested; of this amount, 15,061 shares were issued, net of shares applied to payroll taxes. The aggregate fair value of the shares vested for the nine months ended September 30, 2006 was $1.2 million. During the nine months ended September 30, 2005, 19,250 restricted stock units vested; of this amount, 11,962 shares were issued, net of shares applied to payroll

		taxes. The aggregate fair value of the shares vested for the nine months ended September 30, 2005 was $841,000.
		In May of 2004, the shareholders of the Company approved the issuance of up to 70,000 shares of common stock under the Retirement Plan for Non-Employee Directors (the “Director Plan”). Under the Director Plan, the Company grants 1,000 shares of common stock for each year served as a director up to a maximum of 5,000 shares issued upon retirement. The Company recognizes compensation expense with regards to grants to be issued in the future under the Director Plan. As a result, included in the Company’s consolidated statements of income for the three and nine months ended September 30, 2006, is $20,000 and $41,000, respectively, in compensation expense. As of September 30, 2006, there was $439,000 of unamortized compensation expense related to these shares. In May of 2006, the Company issued 5,000 shares to a director upon retirement with an aggregate fair value of $256,000.

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

Forward-Looking Statements: Forward-looking statements are made throughout this Quarterly Report on Form 10-Q. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “may,” “believes,” “anticipates,” “plans,” expects,” “seeks,” “estimates,” “intends,” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the results of the Company to differ materially from those indicated by such forward-looking statements, including those detailed under the heading “Item 1A. Risk Factors” in Part II of this quarterly report on Form 10-Q. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Moreover, we assume no obligation to update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.

Overview

The Company owns and operates approximately 18.2 million rentable square feet of flex, industrial and office properties located in eight states.

The Company focuses on increasing profitability and cash flow aimed at maximizing shareholder value. The Company strives to maintain high occupancy levels while increasing rental rates when market conditions allow. The Company also acquires properties which it believes will create long-term value. Operating results are driven by income from rental operations and are therefore substantially influenced by rental demand for space within our properties.

Throughout 2006, the Company has experienced improving market conditions in generally all of its markets. In the Company’s markets such as Southern California, Washington D.C. and Miami, market conditions showed solid signs of an owner’s market. During the nine months ended September 30, 2006, weighted average occupancies in these markets have improved to rates in the range of 94% to 97%. Rental rates have shown signs of improvement while capital costs and concessions have been less onerous. While conditions in these markets are relatively good from an owner’s perspective, the Company has experienced some rental rate roll downs in Washington D.C. as it renews or replaces leases originally signed prior to 2002 at the highpoint of the market. The Company’s markets such as Portland, Northern California and three markets in Texas, have all shown varying signs of recovery. Each of these markets have seen flat to positive net absorption over the past three calendar quarters, increased deal activity and improved occupancies. See further discussion of operating results below.

Critical Accounting Policies and Estimates:

Our significant accounting policies are described in Note 2 to the consolidated financial statements included in this Form 10-Q. We believe our most critical accounting policies relate to revenue recognition, allowance for doubtful accounts, impairment of long-lived assets, depreciation, accruals of operating expenses and accruals for contingencies, each of which we discuss below.

Revenue Recognition: We recognize revenue in accordance with Staff Accounting Bulletin No. 101 of the Securities and Exchange Commission, Revenue Recognition in Financial Statements (“SAB 101”), as amended. SAB 101 requires that the following four basic criteria must be met before revenue can be recognized: persuasive evidence of an arrangement exists; the delivery has occurred or services rendered; the fee is fixed and determinable; and collectibility is reasonably assured. All leases are classified as operating leases. Rental income is recognized on a straight-line basis over the terms of the leases. Straight-line rent is recognized for all tenants with contractual increases in rent that are not included on the Company’s credit watch list. Deferred rent receivables represent rental revenue recognized on a straight-line basis in excess of billed rents. Reimbursements from tenants for real estate taxes and other recoverable operating expenses are recognized as rental income in the period the applicable costs are incurred.

Allowance for Doubtful Accounts: Rental revenue from our tenants is our principal source of revenue. We monitor the collectibility of our receivable balances including the deferred rent receivable on an on-going basis. Based on these reviews, we maintain an allowance for doubtful accounts for estimated losses resulting from the possible inability of our tenants to make required rent payments to us. Tenant receivables and deferred rent receivables are carried net of the allowances for uncollectible tenant receivables and deferred rent. As discussed below, determination of the adequacy of these allowances requires significant judgments and estimates. Estimate of the required allowance is subject to revision as the factors discussed below change and is sensitive to the effect of economic and market conditions on our tenants.

Tenant receivables consist primarily of amounts due for contractual lease payments, reimbursements of common area maintenance expenses, property taxes and other expenses recoverable from tenants. Determination of the adequacy of the allowance for uncollectible current tenant receivables is performed using a methodology that incorporates specific identification, aging analysis, an overall evaluation of the historical loss trends and the current economic and business environment. The specific identification methodology relies on factors such as the age and nature of the receivables, the payment history and financial condition of the tenant, the assessment of the tenant’s ability to meet its lease obligations, and the status of negotiations of any disputes with the tenant. The allowance also includes a reserve based on historical loss trends not associated with any specific tenant. This reserve as well as the specific identification reserve is reevaluated quarterly based on economic conditions and the current business environment.

Deferred rent receivable represents the amount that the cumulative straight-line rental income recorded to date exceeds cash rents billed to date under the lease agreement. Given the long-term nature of these types of receivables, determination of the adequacy of the allowance for unbilled deferred rent receivables is based primarily on historical loss experience. Management evaluates the allowance for unbilled deferred rent receivables using a specific identification methodology for significant tenants designed to assess their financial condition and ability to meet their lease obligations.

Impairment of Long-Lived Assets: The Company evaluates a property for potential impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. On a quarterly basis, the Company evaluates the whole portfolio for impairment based on current operating information. In the event that these periodic assessments reflect that the carrying amount of a property exceeds the sum of the undiscounted cash flows (excluding interest) that are expected to result from the use and eventual disposition of the property, the Company would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value of the property. The estimation of expected future net cash flows is inherently uncertain and relies on subjective assumptions dependent upon future and current market conditions and events that affect the ultimate value of the property. It requires management to make assumptions related to the property such as future rental rates, tenant allowances, operating expenditures, property taxes, capital improvements, occupancy levels, and the estimated proceeds generated from the future sale of the property. These assumptions could differ materially from actual results in future periods. Since Statement of Financial Accounting Standards (“SFAS”) No. 144 provides that the future cash flows used in this analysis be considered on an undiscounted basis, our intent to hold properties over the long term directly decreases the likelihood of recording an impairment loss. If our strategy changes or if market conditions otherwise dictate an earlier sale date, an impairment loss could be recognized and such loss could be material.

Depreciation: We compute depreciation on our buildings and equipment using the straight-line method based on estimated useful lives of generally 30 and 5 years. A significant portion of the acquisition cost of each property is allocated to building and building components. The allocation of the acquisition cost to building and building components, as well as, the determination of their useful lives are based on estimates. If we do not appropriately allocate to these components or we incorrectly estimate the useful lives of these components, our computation of depreciation expense may not appropriately reflect the actual impact of these costs over future periods, which will affect net income. In addition, the net book value of real estate assets could be over or understated. The statement of cash flows, however, would not be affected.

Accruals of Operating Expenses: The Company accrues for property tax expenses, performance bonuses and other operating expenses each quarter based on historical trends and anticipated disbursements. If these estimates are incorrect, the timing of expense recognition will be affected.

Accruals for Contingencies: The Company is exposed to business and legal liability risks with respect to events that may have occurred, but in accordance with U.S. generally accepted accounting principles (“GAAP”) has not accrued for such potential liabilities because the loss is either not probable or not estimable. Future events and the result of pending litigation could result in such potential losses becoming probable and estimable, which could have a material adverse impact on our financial condition or results of operations.

Effect of Economic Conditions on the Company’s Operations:

Throughout 2006, strong economic conditions in the United States have begun to be reflected in the commercial real estate market. While comparative rental rates have slowly improved, with average rental rate roll downs diminishing steadily over the last two years, lease concessions have clearly improved from an owner’s perspective. Rent abatements and tenant improvements required to execute a transaction have eased.

While the Company historically has experienced a low level of write-offs due to bankruptcy, there is inherent uncertainty in a tenant’s ability to continue paying rent if they are in bankruptcy. As of September 30, 2006, the Company had approximately 18,000 square feet occupied by a tenant protected by Chapter 11 of the U.S. Bankruptcy Code. Given the historical uncertainty of such a tenant’s ability to meet its lease obligations, we will continue to reserve any income that would have been realized on a straight line basis. Several tenants have contacted us, requesting early termination of their lease, reduction in space under lease, rent deferment or abatement. At this time, the Company cannot anticipate what impact, if any, the ultimate outcome of these discussions will have on our operating results.

Effect of Economic Conditions on the Company’s Primary Markets:

The Company has concentrated its operations in nine markets. The Company’s overall view of these markets as of September 30, 2006, is summarized below. Overall, during the nine months ended September 30, 2006, the Company has seen rental rates on new leases and renewed leases within its portfolio increase by an average of 1.9% over expiring rents. The Company’s overall vacancy rate at September 30, 2006 was 6.0%. The Company has compiled the market occupancy information set forth below using third party reports for these respective markets. The Company considers these sources to be reliable, but there can be no assurance that the information in these reports is accurate.

The Company owns approximately 4.0 million square feet in Southern California, which consists of the Los Angeles, Orange County, and San Diego markets. These markets represent the most stable and best performing markets in the country with decreasing vacancy rates, increasing rental rates and lower lease concessions. Vacancy rates have decreased throughout Southern California for flex, industrial and office space, and range from 1.9% to 7.8%, depending on markets and product type. The Company’s combined vacancy rate in these markets at September 30, 2006 was 3.0%.

The Company owns approximately 1.5 million square feet in Northern California with a concentration in Sacramento, the East Bay (Hayward and San Ramon) and the Silicon Valley (San Jose). The vacancy rates in these submarkets are at 8.6%, 4.7% and 8.7%, respectively. The greater Northern California market has a vacancy rate of 16.1% compared to the Company’s vacancy rate in this market at September 30, 2006 of 4.7%. While these submarkets continue to have high vacancy rates, the Company has been able to maintain lower levels of vacancy.

The Company owns approximately 1.2 million square feet in Southern Texas, which consists of the Austin and Houston markets. The vacancy rate was 10.2% in the Austin market and 13.2% in the Houston market. Although the Austin market has experienced challenging economic conditions, due primarily to the reductions in the technology industry, market activity, rental rates and vacancy rates appear to have begun to improve. However, a high level of competition for tenants still exists. The Houston market has been slower to stabilize. The Company’s vacancy rate in these markets at September 30, 2006 was 11.5%.

The Company owns approximately 1.7 million square feet in the Dallas Metroplex market. The vacancy rate in Las Colinas, where most of the Company’s properties are located, is 12.0%. This submarket continues to be challenged by new development, which may limit growth in rental rates and may make it more difficult to reduce vacancy levels. The Company’s vacancy rate in this submarket at September 30, 2006 was 16.9%.

The Company owns approximately 3.2 million square feet in the Airport West submarket of Miami-Dade County in Florida. The vacancy rate was 3.3% for the entire submarket, compared with a vacancy rate at Miami International Commerce Center (“MICC”) of 2.6% at September 30, 2006. The property is located less than one mile from the cargo entrance of the Miami International Airport, which is considered one of the most active ports in the Southeast. Leasing activity is strong, resulting in better than market occupancy.

The Company owns approximately 2.9 million square feet in Northern Virginia, where the overall market vacancy rate was 8.2% as of September 30, 2006. The Northern Virginia market continues to be positively impacted by increased federal government spending on defense, national security and life sciences. This effect is expected to continue throughout 2006 and may result in increased rental rates and reduced vacancy. The Company’s vacancy rate in this market at September 30, 2006 was 6.5%.

The Company owns approximately 1.8 million square feet in Maryland. The portfolio is primarily located in the Montgomery County submarket, which remains stable. Similar to Northern Virginia, the Maryland market benefits from increased federal government spending on defense, national security and life sciences, which has enabled the Company to maintain high occupancy levels. The Company’s vacancy rate in this market at September 30, 2006 was 4.1% compared to 8.8% for the market as a whole.

The Company owns approximately 1.3 million square feet in the Beaverton submarket of Portland, Oregon. Market conditions continue to be affected by weak demand and high vacancy rates. The Company has experienced some improvement within the submarket in 2006, with increased leasing activity, stabilizing rental terms and vacancy rates, and reduced leasing costs. The vacancy rate in this submarket was 17.8% compared to the Company’s vacancy rate in this submarket of 8.6% at September 30, 2006.

The Company owns approximately 679,000 square feet in Phoenix and Tempe, Arizona. Overall, the Arizona market has been characterized by steady growth. The vacancy rate in this market is 7.3%. The Company’s vacancy rate in this market at September 30, 2006 was 4.7%.

Growth of the Company’s Operations and Acquisitions and Dispositions of Properties:

The Company is focused on maximizing cash flow from its existing portfolio of properties and through acquisitions and dispositions of properties, expanding its presence in existing and new markets through strategic acquisitions and strengthening its balance sheet, primarily through the issuance of preferred equity. The Company has historically maintained low debt and overall leverage levels through the issuance of preferred equity; this approach is intended to provide the Company with the flexibility for future growth without the need to issue additional common stock.

Subsequent to September 30, 2006, the Company acquired a 66,500 square foot multi-tenant industrial and flex park in San Jose, California, for $8.4 million. The park, which consists of three single-story buildings, was 87.9% leased with 28 tenants at the time of acquisition.

On June 29, 2006, the Company acquired Meadows Corporate Park, a 165,000 square foot multi-tenant office park in Silver Spring, Maryland, for $29.9 million. The park, which consists of two three-story buildings and one four-story building, was 92.1% leased to 40 tenants at the time of acquisition. In connection with the purchase, the Company assumed a $16.8 million mortgage with a fixed interest rate of 7.2% through November, 2011 at which time it can be prepaid without penalty. The buildings are adjacent to the 366,000 square foot WesTech Business Park (“WesTech”) that the Company acquired in February of this year.

On June 20, 2006, the Company acquired Beaumont at Lafayette, consisting of two single-story multi-tenant flex buildings aggregating 107,300 square feet in Chantilly, Virginia, for $15.8 million. At the time of acquisition, the buildings were 84.0% leased to 16 tenants. The buildings are adjacent to a 197,000 square foot complex that the Company acquired and developed between 1999 and 2001.

On June 14, 2006, the Company acquired four multi-tenant flex buildings, aggregating 88,800 square feet, located in Signal Hill, California, for $10.7 million. At the time of acquisition, the buildings were 97.7% leased to 52 tenants. The Company owns an additional 178,000 square feet of multi-tenant flex assets in the Signal Hill submarket.

During the quarter ended June 30, 2006, the Company sold two assets previously classified as properties held for disposition. In May, 2006, the Company sold a 30,500 square foot building located in Beaverton, Oregon, for a gross sales price of $4.4 million resulting in a gain of $1.5 million. Also, in May, 2006, the Company sold 7,100 square feet at MICC for a gross sales price of $815,000 resulting in a gain of $154,000.

On February 8, 2006, the Company acquired WesTech, a 366,000 square foot office and flex park in Silver Spring, Maryland, for $69.7 million. The park, which was 95.0% occupied at the time of acquisition, consists of nine single-story buildings.

In the first quarter of 2006, the Company sold three assets aggregating 25,300 square feet located at MICC for a gross sales price of $2.9 million resulting in a gain of $711,000.

On October 25, 2005, the Company acquired Rose Canyon Business Park, a 233,000 square foot multi-tenant flex and office park in San Diego, California, for $35.1 million. In connection with the acquisition, the Company assumed a $15.0 million mortgage, which bears an interest rate of 5.73% and matures March 1, 2013.

During the year ended December 31, 2005, the Company sold Woodside Corporate Park located in Beaverton, Oregon. Net proceeds from the sale, after transactions costs, were $64.5 million and the Company reported a gain of $12.5 million. The sale consisted of 13 buildings comprising approximately 574,000 square feet and approximately 3.3 acres of adjacent land. The park was 76.8% leased at the time of the sale. In addition, the Company sold 8.2 acres of land in the Beaverton area for $3.6 million resulting in a gain of $1.8 million. Six units totaling approximately 44,000 square feet and a small parcel of land at MICC were sold for a combined sale price of $5.8 million resulting in a gain of $1.8 million. The Company sold a retail center located at MICC consisting of 56,000 square feet for a sales price of $12.2 million resulting in a gain of $967,000.

Impact of Inflation:

Although inflation has slowed in recent years, it is still a factor in our economy and the Company continues to seek ways to mitigate its impact. A substantial portion of the Company’s leases require tenants to pay operating expenses, including real estate taxes, utilities, and insurance, as well as increases in common area expenses. Management believes these provisions reduce the Company’s exposure to the impact of inflation.

Concentration of Portfolio by Region:

Rental income, cost of operations and rental income less cost of operations, excluding depreciation and amortization or net operating income prior to depreciation and amortization (defined as “NOI” for purposes of the following tables) from continuing operations are summarized for the three and nine months ended September 30, 2006 by major geographic region below. The Company uses NOI and its components as a measurement of the performance of its commercial real estate. Management believes that these financial measures provide them as well as the investor the most consistent measurement on a comparative basis of the performance of the commercial real estate and its contribution to the value of the Company. Depreciation and amortization have been excluded from these financial measures as they are generally not used in determining the value of commercial real estate by management or the investment community. Depreciation and amortization are generally not used in determining value as they consider the historical costs of an asset compared to its current value; therefore, to understand the effect of the assets’ historical cost on the Company’s results, investors should look at GAAP financial measures, such as total operating costs including depreciation and amortization. The Company’s calculation of NOI may not be comparable to those of other companies and should not be used as an alternative to measures of performance calculated in accordance with generally accepted accounting principles. The tables below reflect rental income, operating expenses and NOI from continuing operations for the three and nine months ended September 30, 2006 based on geographical concentration. The total of all regions is equal to the amount of rental income and cost of operations recorded by the Company in accordance with GAAP. As part of the tables below, we have shown the effect of depreciation and amortization on NOI. We have reconciled NOI to consolidated income from continuing operations before minority interests in the table under “Results of Operations” below. The percent of totals by region reflects the actual contribution to rental income, cost of operations and NOI during the period from properties included in continuing operations (in thousands):

Three Months Ended September 30, 2006:

		Weighted
		Square				Percent				Rental				Percent				Cost of				Percent								Percent
Region		Footage				of Total				Income				of Total				Operations				of Total				NOI				of Total
Southern California			3,985				21.9	%		$	15,698				25.4	%		$	4,784				24.9	%		$	10,914				25.7	%
Northern California			1,500				8.2	%			4,747				7.7	%			1,264				6.6	%			3,483				8.2	%
Southern Texas			1,161				6.4	%			2,653				4.3	%			1,183				6.2	%			1,470				3.4	%
Northern Texas			1,688				9.3	%			3,401				5.5	%			1,633				8.5	%			1,768				4.2	%
Florida			3,199				17.5	%			6,297				10.2	%			2,001				10.4	%			4,296				10.1	%
Virginia			2,894				15.9	%			12,796				20.7	%			3,501				18.2	%			9,295				21.9	%
Maryland			1,771				9.7	%			9,476				15.4	%			2,537				13.2	%			6,939				16.3	%
Oregon			1,341				7.4	%			4,801				7.8	%			1,532				8.0	%			3,269				7.7	%
Arizona			679				3.7	%			1,826				3.0	%			778				4.0	%			1,048				2.5	%
Total before depreciation and amortization			18,218				100.0	%			61,695				100.0	%			19,213				100.0	%			42,482				100.0	%
Depreciation and amortization											—								22,184								(22,184	)
Total										$	61,695							$	41,397							$	20,298

Nine Months Ended September 30, 2006:

		Weighted
		Square				Percent				Rental				Percent				Cost of				Percent								Percent
Region		Footage				of Total				Income				of Total				Operations				of Total				NOI				of Total
Southern California			3,932				21.9	%		$	45,513				25.4	%		$	13,025				23.5	%		$	32,488				26.1	%
Northern California			1,500				8.4	%			14,040				7.8	%			3,656				6.6	%			10,384				8.4	%
Southern Texas			1,161				6.5	%			7,755				4.3	%			3,406				6.2	%			4,349				3.5	%
Northern Texas			1,688				9.4	%			11,256				6.3	%			4,565				8.2	%			6,691				5.4	%
Florida			3,199				17.8	%			17,965				10.0	%			6,199				11.2	%			11,766				9.5	%
Virginia			2,827				15.7	%			38,045				21.2	%			10,803				19.5	%			27,242				21.9	%
Maryland			1,611				9.0	%			25,712				14.3	%			6,842				12.4	%			18,870				15.2	%
Oregon			1,341				7.5	%			14,094				7.8	%			4,735				8.6	%			9,359				7.5	%
Arizona			679				3.8	%			5,228				2.9	%			2,123				3.8	%			3,105				2.5	%
Total before depreciation and amortization			17,938				100.0	%			179,608				100.0	%			55,354				100.0	%			124,254				100.0	%
Depreciation and amortization											—								63,720								(63,720	)
Total										$	179,608							$	119,074							$	60,534

Concentration of Credit Risk by Industry:

The information below depicts the industry concentration of our tenant base as of September 30, 2006. The Company analyzes this concentration to understand significant industry exposure risk.

Business services			11.5	%
Government			11.2	%
Financial services			10.3	%
Contractors			9.8	%
Computer hardware, software and related services			9.5	%
Warehouse, transportation and logistics			9.4	%
Retail			5.9	%
Communications			4.9	%
Home furnishings			4.1	%
Electronics			3.3	%
			79.9	%

The information below depicts the Company’s top ten customers by annual rents as of September 30, 2006 (in thousands):

										% of Total
Tenants		Square Footage				Annual Rents (1)				Annual Rents
U.S. Government			483			$	12,957				5.2	%
Kaiser Permanente			194				3,857				1.5	%
County of Santa Clara			97				3,175				1.3	%
Intel			214				2,814				1.1	%
Axcelis Technologies			89				1,802				0.7	%
Wells Fargo			102				1,651				0.7	%
Northrop Grumman			58				1,539				0.6	%
AARP			102				1,510				0.6	%
MCI			72				1,227				0.5	%
American Continental University			75				1,222				0.5	%
			1,486			$	31,754				12.7	%