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 March 31, 2007

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

For the transition period from                      to                     

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 April 30, 2007, the number of shares of the registrant’s common stock, $0.01 par value per share, outstanding was 21,331,497.

 

 

PS BUSINESS PARKS, INC.
INDEX

			Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets as of March 31, 2007 (unaudited) and December 31, 2006			2
Consolidated statements of income (unaudited) for the three months ended March 31, 2007 and 2006			3
Consolidated statement of shareholders’ equity (unaudited) for the three months ended March 31, 2007			4
Consolidated statements of cash flows (unaudited) for the three months ended March 31, 2007 and 2006			5
Notes to consolidated financial statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3. Quantitative and Qualitative Disclosures about Market Risk			32
Item 4. Controls and Procedures			32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			32
Item 1A. Risk Factors			32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			38
Item 6. Exhibits			39

		March 31,				December 31,
		2007				2006
		(Unaudited)
ASSETS
Cash and cash equivalents		$	66,374			$	66,282
Real estate facilities, at cost:
Land			485,898				439,777
Buildings and equipment			1,432,128				1,353,442
			1,918,026				1,793,219
Accumulated depreciation			(462,976	)			(441,336	)
			1,455,050				1,351,883
Land held for development			7,869				9,011
			1,462,919				1,360,894
Rent receivable			3,675				2,080
Deferred rent receivable			21,662				21,454
Other assets			7,621				12,154
Total assets		$	1,562,251			$	1,462,864
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accrued and other liabilities		$	46,021			$	42,394
Preferred stock called for redemption			—				50,000
Mortgage notes payable			61,716				67,048
Total liabilities			107,737				159,442
Minority interests:
Preferred units			94,750				82,750
Common units			164,196				165,469
Commitments and Contingencies
Shareholders’ equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized, 28,650 and 22,900 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively			716,250				572,500
Common stock, $0.01 par value, 100,000,000 shares authorized, 21,325,669 and 21,311,005 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively			213				213
Paid-in capital			394,923				398,048
Cumulative net income			501,994				483,403
Cumulative distributions			(417,812	)			(398,961	)
Total shareholders’ equity			1,195,568				1,055,203
Total liabilities and shareholders’ equity		$	1,562,251			$	1,462,864

See accompanying notes.

PS BUSINESS PARKS, INC.

		For the Three Months
		Ended March 31,
		2007				2006
Revenues:
Rental income		$	65,124			$	58,754
Facility management fees			183				149
Total operating revenues			65,307				58,903
Expenses:
Cost of operations			20,439				17,946
Depreciation and amortization			21,640				20,586
General and administrative			1,702				1,650
Total operating expenses			43,781				40,182
Other income and expenses:
Interest and other income			1,801				2,000
Interest expense			(1,107	)			(513	)
Total other income and expenses			694				1,487
Income from continuing operations before minority interests			22,220				20,208
Minority interests in continuing operations:
Minority interest in income — preferred units			(1,599	)			(2,781	)
Minority interest in income — common units			(2,030	)			(1,568	)
Total minority interests in continuing operations			(3,629	)			(4,349	)
Income from continuing operations			18,591				15,859
Discontinued operations:
Loss from discontinued operations			—				(97	)
Gain on disposition of real estate			—				711
Minority interest in income attributable to discontinued operations — common units			—				(156	)
Income from discontinued operations			—				458
Net income			18,591				16,317
Net income allocable to preferred shareholders:
Preferred stock distributions			12,668				11,255
Net income allocable to common shareholders		$	5,923			$	5,062
Net income per common share — basic:
Continuing operations		$	0.28			$	0.21
Discontinued operations		$	—			$	0.02
Net income		$	0.28			$	0.24
Net income per common share — diluted:
Continuing operations		$	0.27			$	0.21
Discontinued operations		$	—			$	0.02
Net income		$	0.27			$	0.23
Weighted average common shares outstanding:
Basic			21,316				21,437
Diluted			21,690				21,708

See accompanying notes.

PS BUSINESS PARKS, INC.

																														Total
		Preferred Stock								Common Stock								Paid-in				Cumulative				Cumulative				Shareholders’
		Shares				Amount				Shares				Amount				Capital				Net Income				Distributions				Equity
Balances at December 31, 2006			22,900			$	572,500				21,311,005			$	213			$	398,048			$	483,403			$	(398,961	)		$	1,055,203
Issuance of preferred stock, net of costs			5,750				143,750				—				—				(4,183	)			—				—				139,567
Exercise of stock options			—				—				4,000				—				125				—				—				125
Stock compensation			—				—				10,664				—				173				—				—				173
Shelf registration			—				—				—				—				(88	)			—				—				(88	)
Net income			—				—				—				—				—				18,591				—				18,591
Distributions:
Preferred stock			—				—				—				—				—				—				(12,668	)			(12,668	)
Common stock			—				—				—				—				—				—				(6,183	)			(6,183	)
Adjustment to minority interest underlying ownership			—				—				—				—				848				—				—				848
Balances at March 31, 2007			28,650			$	716,250				21,325,669			$	213			$	394,923			$	501,994			$	(417,812	)		$	1,195,568

See accompanying notes.

PS BUSINESS PARKS, INC.

		For the Three Months
		Ended March 31,
		2007				2006
Cash flows from operating activities:
Net income		$	18,591			$	16,317
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense			21,640				20,612
In-place lease adjustment			27				53
Lease incentives net of tenant improvement reimbursements			58				130
Amortization of mortgage premium			(60	)			—
Minority interest in income			3,629				4,505
Gain on disposition of properties			—				(711	)
Stock compensation expense			638				526
Decrease in receivables and other assets			2,643				575
Increase in accrued and other liabilities			732				737
Total adjustments			29,307				26,427
Net cash provided by operating activities			47,898				42,744
Cash flows from investing activities:
Capital improvements to real estate facilities			(7,422	)			(5,714	)
Acquisition of real estate facilities			(113,812	)			(68,482	)
Proceeds from disposition of real estate			—				2,790
Net cash used in investing activities			(121,234	)			(71,406	)
Cash flows from financing activities:
Principal payments on mortgage notes payable			(322	)			(167	)
Repayment of mortgage note payable			(4,950	)			—
Net proceeds from the issuance of preferred units			11,665				—
Net proceeds from the issuance of preferred stock			139,567				—
Exercise of stock options			125				50
Shelf registration costs			(88	)			—
Repurchase of preferred stock			(50,000	)			—
Repurchase of common stock			—				(11,693	)
Distributions paid to preferred shareholders			(12,668	)			(11,255	)
Distributions paid to minority interests — preferred units			(1,599	)			(2,781	)
Distributions paid to common shareholders			(6,183	)			(6,189	)
Distributions paid to minority interests — common units			(2,119	)			(2,119	)
Net cash provided by (used in) financing activities			73,428				(34,154	)
Net increase (decrease) in cash and cash equivalents			92				(62,816	)
Cash and cash equivalents at the beginning of the period			66,282				200,447
Cash and cash equivalents at the end of the period		$	66,374			$	137,631
Supplemental schedule of non cash investing and financing activities:
Adjustment to minority interest underlying ownership:
Minority interest — common units		$	1,183			$	1,589
Paid-in capital		$	(1,183	)		$	(1,589	)

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 March 31, 2007, PSB owned approximately 75% 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 March 31, 2007, the Company owned and operated approximately 19.4 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 months ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. 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, 2006.
		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 March 31, 2007 and December 31, 2006.

		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 balance sheet as properties held for disposition and the operating results of the asset are included in discontinued operations.
		Intangible assets/liabilities
		Intangible assets and liabilities include above-market and below-market in-place lease values of acquired properties 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-market and below-market lease values (included in other assets and accrued liabilities in the accompanying consolidated balance sheet) are amortized, net, to rental income over the remaining non-cancelable terms of the respective leases. The Company amortized $27,000 and $53,000 of intangible assets and liabilities resulting from the above and below market lease values during the three months ended March 31, 2007 and 2006, respectively. As of March 31, 2007, the value of in-place leases resulted in a net intangible asset of $598,000, net of $594,000 of accumulated amortization and a net intangible liability of $1.0 million, net of $32,000 of accumulated amortization. As of

		December 31, 2006, the value of in-place leases resulted in a net intangible asset of $656,000, net of $535,000 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 March 31, 2007, 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. 104 of the Securities and Exchange Commission, Revenue Recognition in Financial Statements (“SAB 104”). SAB 104 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 receivable represents 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.

		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 2006 and intends to continue to meet such requirements for 2007. Accordingly, no provision for income taxes has been made in the accompanying consolidated financial statements.
		In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 is an interpretation of FASB Statement No. 109, “Accounting for Income Taxes,” and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, and accounting in interim periods and requires expanded disclosure with respect to the uncertainty in income taxes. The cumulative effect, if any, of applying FIN 48 is to be reported as an adjustment to the opening balance of retained earnings in the year of adoption. Effective January 1, 2007, the adoption of FIN 48 did not have a material effect on the Company.
		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, with a corresponding reduction to income allocable to common shareholders, 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 include the dilutive effect of stock options and restricted stock under the treasury stock method. “Basic” weighted average common shares outstanding exclude such effect. Earnings per share have been calculated as follows (in thousands, except per share amounts):

		For the Three Months
		Ended March 31,
		2007				2006
Net income allocable to common shareholders		$	5,923			$	5,062
Weighted average common shares outstanding:
Basic weighted average common shares outstanding			21,316				21,437
Net effect of dilutive stock compensation — based on treasury stock method using average market price			374				271
Diluted weighted average common shares outstanding			21,690				21,708
Net income per common share — Basic		$	0.28			$	0.24
Net income per common share — Diluted		$	0.27			$	0.23

No options to purchase shares were considered anti-dilutive for the three months ended March 31, 2007 and 2006.

		Segment reporting
		The Company views its operations as one segment.
		Reclassifications
		Certain reclassifications have been made to the consolidated financial statements for 2006 in order to conform to the 2007 presentation.
3.		Real estate facilities
		The activity in real estate facilities for the three months ended March 31, 2007 is as follows (in thousands):

										Accumulated
		Land				Buildings				Depreciation				Total
Balances at December 31, 2006		$	439,777			$	1,353,442			$	(441,336	)		$	1,351,883
Acquisition of real estate			44,979				71,264				—				116,243
Capital improvements, net			—				7,422				—				7,422
Depreciation expense			—				—				(21,640	)			(21,640	)
Transfer from land held for development			1,142				—				—				1,142
Balances at March 31, 2007		$	485,898			$	1,432,128			$	(462,976	)		$	1,455,050

		On March 27, 2007, the Company acquired Commerce Campus, a 251,000 square foot multi-tenant office and flex business park located in Santa Clara, California, for $39.1 million, including transaction costs.
		On February 16, 2007, the Company acquired Overlake Business Center, a 493,000 square foot multi-tenant office and flex business park located in Redmond, Washington, for $76.0 million, including transaction costs.
		In accordance with SFAS No. 141, “Business Combinations,” the purchase price of acquired properties is allocated to land, buildings and equipment and identified tangible and intangible assets and liabilities associated with in-place leases (including tenant improvements, unamortized leasing commissions, value of above-market and below-market leases, acquired in-place lease values, and tenant relationships, if any) based on their respective estimated fair values.
		The fair value of the tangible assets of the acquired properties considers the value of the properties as if vacant as of the acquisition date. Management must make significant assumptions in determining the value of assets and liabilities acquired. Using different assumptions in the allocation of the purchase cost of the acquired properties would affect the timing of recognition of the related revenue and expenses. Amounts allocated to land are derived from comparable sales of land within the same region. Amounts allocated to buildings and improvements, tenant improvements and unamortized leasing commissions are based on current market replacement costs and other market rate information. The amount allocated to acquired in-place leases is determined based on management’s assessment of current market conditions and the estimated lease-up periods for the respective spaces.
		The following table summarizes the assets and liabilities acquired during the three months ended March 31, (in thousands):

		2007				2006
Land		$	44,979			$	19,379
Buildings			71,264				49,503
In-place leases			(1,075	)			433
Total purchase price			115,168				69,315
Net operating assets and liabilities acquired			(1,356	)			(833	)
Total cash paid		$	113,812			$	68,482

		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 Miami International Commerce Center (“MICC”) for a gross sales price of approximately $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 an aggregate gross sales price of $1.7 million resulting in a gain of $378,000.
		Included in the consolidated statements of income are cost of operations and depreciation of $71,000 and $26,000, respectively, reported as discontinued operations for properties sold during the three months ended March 31, 2006.
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 March 31, 2007 under these leases are as follows (in thousands):

2007		$	159,423
2008			175,443
2009			125,903
2010			88,003
2011			59,613
Thereafter			80,916
		$	689,301

		In addition to minimum rental payments, tenants reimburse the Company for their pro rata share of specified operating expenses, which amounted to approximately $10.0 million and $7.0 million for the three months ended March 31, 2007 and 2006, respectively. These amounts are included as rental income and cost of operations in the accompanying consolidated statements of income.
		Leases aggregating approximately 5% of the total leased square footage are subject to termination options which include leases for approximately 1% of the total leased square footage having termination options exercisable through December 31, 2007. 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 March 31, 2007 or December 31, 2006. The Credit Facility requires the Company to meet certain covenants, and the Company was in compliance with all such covenants at March 31, 2007.

6.		Mortgage notes payable
		Mortgage notes consist of the following (in thousands):

		March 31,				December 31,
		2007				2006
7.29% mortgage note, principal and interest payable monthly, due February, 2009		$	5,449			$	5,490
5.73% mortgage note, principal and interest payable monthly, due March, 2013			14,684				14,743
6.15% mortgage note, principal and interest payable monthly, due November, 2031 (1)			17,654				17,759
5.52% mortgage note, principal and interest payable monthly, due May, 2013			10,432				10,483
5.68% mortgage note, principal and interest payable monthly, due May, 2013			10,436				10,486
5.61% mortgage note, principal and interest payable monthly, due January, 2011 (2)			3,061				3,085
8.19% mortgage note, principal and interest payable monthly, repaid March, 2007			—				5,002
		$	61,716			$	67,048

At March 31, 2007, principal maturities of mortgage notes payable are as follows (in thousands):

2007		$	990
2008			1,396
2009			6,442
2010			1,376
2011			19,428
Thereafter			32,084
		$	61,716

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 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 March 31, 2007, 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 March 31, 2007, 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 44.4% 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 March 31, 2007 and December 31, 2006 (in thousands):

						Earliest
						Potential								March 31, 2007								December 31, 2006
						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 Q		March, 2007				March, 2012					6.550	%			480				12,000				—				—
															3,790			$	94,750				3,310			$	82,750

		During the first quarter of 2007, the Company completed a private placement of $12.0 million of preferred units through its operating partnership. The 6.550% Series Q Cumulative Redeemable Preferred Units are non-callable for five years and have no mandatory redemption.
		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 March 31, 2007, the Company had approximately $2.7 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.		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 approximately $80,000 for the three months ended March 31, 2007 and 2006.

		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 approximately $183,000 and $149,000 for the three months ended March 31, 2007 and 2006, respectively.
		In December, 2006, PSI began providing property management services for the mini storage component of two assets owned by the Company. These mini storage facilities, located in Palm Beach County, Florida, operate under the “Public Storage” names.
		Under the property management contracts, PSI is compensated based on a percentage of the gross revenues of the facilities managed. Under the supervision of the Company, PSI 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, PSI assists and advises the Company in establishing policies for the hire, discharge and supervision of employees for the operation of these facilities, including on-site managers, assistant managers and associate managers.
		Both the Company and PSI can cancel the property management contract upon 60 days notice. Management fee expense under the contract was approximately $12,000 for the three months ended March 31, 2007.
		At March 31, 2007, the Company has amounts due from PSI of $210,000 ($871,000 at December 31, 2006), for these contracts, as well as for certain operating expenses paid by the Company on behalf of PSI.
9.		Shareholders’ equity
		Preferred stock
		As of March 31, 2007 and December 31, 2006, the Company had the following preferred stock outstanding (in thousands):

						Earliest
						Potential								March 31, 2007								December 31, 2006
						Redemption				Dividend				Shares								Shares
Series		Issuance Date				Date				Rate				Outstanding				Amount				Outstanding				Amount
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 & August, 2006				June, 2011					7.375	%			3,800				95,000				3,800				95,000
Series P		January, 2007				January, 2012					6.700	%			5,750				143,750				—				—
Series F		January, 2002				January, 2007					8.750	%			—				—				2,000				50,000
															28,650			$	716,250				24,900			$	622,500

During the fourth quarter of 2006, the Company notified the holders of its 8.750% Series F Cumulative Preferred Stock of its intent to redeem such shares in January, 2007. As a result, the Company classified the aggregate redemption amount of $50.0 million as a liability at December 31, 2006. In accordance with EITF Topic D-42,

		the Company reported the excess of the redemption amount over the carrying amount of $1.7 million as a reduction of net income allocable to common shareholders for the year ended December 31, 2006. The Company redeemed the Series F units on January 29, 2007.
		On January 17, 2007, the Company issued 5,750,000 depositary shares, each representing 1/1,000 of a share of the 6.700% Cumulative Preferred Stock, Series P, at $25.00 per depositary share for gross proceeds of $143.8 million.
		The Company recorded approximately $12.7 million and $11.3 million in distributions to its preferred shareholders for the three months ended March 31, 2007 and 2006, respectively.
		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 March 31, 2007, the Company had approximately $23.7 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 March 31, 2007, the Company has repurchased an aggregate of 3.3 million shares of common stock at an aggregate cost of approximately $102.6 million (average cost of $31.18 per share). During the three months ended March 31, 2006, the Company repurchased 225,000 shares of common stock at a cost of approximately $11.7 million. No shares were repurchased during the three months ended March 31, 2007.
		The Company paid approximately $6.2 million ($0.29 per common share) for the three months ended March 31, 2007 and 2006 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.

		Additionally, under the 1997 Plan and 2003 Plan, PSB has granted restricted stock units to officers and key employees.
		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.
		No options were granted during the three months ended March 31, 2007 and 2006.
		The weighted average grant date fair value of restricted stock units granted during the three months ended March 31, 2007 and 2006, were $71.25 and $54.60, respectively. The Company has calculated the fair value of each restricted stock unit grant using the market value on the date of grant.
		At March 31, 2007, 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, 2006			588,971			$	35.89
Granted			—			$	—
Exercised			(4,000	)		$	31.39
Forfeited			(5,000	)		$	39.18
Outstanding at March 31, 2007			579,971			$	35.89			5.89 Years				$	18,832
Exercisable at March 31, 2007			383,771			$	32.07			5.01 Years				$	14,755

						Weighted
		Number of				Average Grant
Restricted Stock Units:		Units				Date Fair Value
Nonvested at December 31, 2006			227,200			$	48.88
Granted			28,650			$	71.25
Vested			(16,773	)		$	41.28
Forfeited			(14,900	)		$	48.96
Nonvested at March 31, 2007			224,177			$	52.30

		Included in the Company’s consolidated income statement for the three months ended March 31, 2007 and 2006, is approximately $70,000 and $102,000, respectively, in net stock option compensation expense related to stock options granted. Net compensation expense of $542,000 and $414,000 related to restricted stock units was recognized during the three months ended March 31, 2007 and 2006, respectively.
		As of March 31, 2007, there was $1.1 million of unamortized compensation expense related to stock options expected to be recognized over a weighted average period of 3.0 years. As of March 31, 2007, there was $8.9 million of unamortized compensation expense related to restricted stock units expected to be recognized over a weighted average period of 3.5 years.
		Cash received from stock option exercises was $125,000 and $50,000 for the three months ended March 31, 2007 and 2006, respectively. The aggregate intrinsic value of the stock options exercised during the three months ended March 31, 2007 and 2006 was $181,000 and $59,000, respectively.
		During the three months ended March 31, 2007, 16,773 restricted stock units vested; of this amount, 10,664 shares were issued, net of shares applied to payroll taxes. The aggregate fair value of restricted stock granted

during the three months ended March 31, 2007 was $1.2 million. During the three months ended March 31, 2006, 9,450 restricted stock units vested; of this amount, 6,364 shares were issued, net of shares applied to payroll taxes. The aggregate fair value of the shares vested for the three months ended March 31, 2006 was $505,000.

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 income statement for the three months ended March 31, 2007 and 2006, was $25,000 and $10,000, respectively, in compensation expense. As of March 31, 2007 and 2006, there was $388,000 and $169,000, respectively, of unamortized compensation expense related to these shares.

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 19.4 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.

In 2006 and the first quarter of 2007, the Company generally experienced solid and improving commercial real estate conditions throughout its portfolio. Markets experienced steady to improving demand with the Company having a greater ability throughout its portfolio to maintain or improve occupancy while raising rents in certain markets.

The Company successfully leased or re-leased 1.2 million square feet of space in the first quarter of 2007. The Company also continued to experience a trend of decreasing transaction costs from the high levels incurred in 2003 and 2004. Total net operating income increased from the three months ended March 31, 2006 to 2007 by $3.9 million or 9.5%. 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. 104 of the Securities and Exchange Commission, Revenue Recognition in Financial Statements (“SAB 104”), as amended. SAB 104 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 receivable represents 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 Acquisitions: In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” we allocate the purchase price of acquired properties to land, buildings and equipment and identified tangible and intangible assets and liabilities associated with in-place leases (including tenant improvements, unamortized leasing commissions, value of above-market and below-market leases, acquired in-place lease values, and tenant relationships, if any) based on their respective estimated fair values.
		The fair value of the tangible assets of the acquired properties considers the value of the properties as if vacant as of the acquisition date. Management must make significant assumptions in determining the value of assets and liabilities acquired. Using different assumptions in the allocation of the purchase cost of the acquired properties would affect the timing of recognition of the related revenue and expenses. Amounts allocated to land are derived from comparable sales of land within the same region. Amounts allocated to buildings and improvements, tenant improvements and unamortized leasing commissions are based on current market replacement costs and other market rate information.
		The amount allocated to acquired in-place leases is determined based on management’s assessment of current market conditions and the estimated lease-up periods for the respective spaces. The amount allocated to acquired in-place leases is included in deferred leasing costs and other related intangible assets in the balance sheet and amortized as an increase to amortization expense over the remaining non-cancelable term of the respective leases.
		The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of the rents that would be paid using fair market rental rates over the remaining term of the lease. The amounts allocated to above or below market leases are included in other assets or other liabilities in the balance sheet and are amortized on a straight-line basis as an increase or reduction of rental income over the remaining non-cancelable term of the respective leases.
		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 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, respectively. 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 overstated 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:

Over the course of 2006 and through the first quarter of 2007, improving economic conditions in the United States were reflected in commercial real estate as market conditions allowed for higher rents throughout the Company’s portfolio along with a continued reduction in rent concessions and tenant improvement allowances.

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 previously disclosed, a tenant occupying approximately 134,000 square feet defaulted on its lease during the first quarter. Subsequent to March 31, 2007, the tenant cured their default. The Company will continue to monitor the tenant closely and reserve all related receivables. As of March 31, 2007, the Company had approximately 32,000 square feet occupied by a tenant that is protected by the U.S. Bankruptcy Code. In addition, subsequent to March 31, 2007, a tenant occupying approximately 5,000 square feet filed for bankruptcy protection. 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 other 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’s operations are concentrated in 10 markets. Current market conditions for each specific market are summarized below. Overall, during the three months ended March 31, 2007, rental rates on new and renewed leases within the Company’s portfolio increased an average of 4.1%. This change is based on comparisons to the most recent in-place rents prior to renewal or replacement. The Company has compiled the market occupancy information set forth below using third party reports for each respective market. 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. This is one of the healthiest markets in our portfolio. In 2006 and through the first quarter of 2007, this market has continued to experience low levels of vacancy and rising rental rates. Market vacancy rates have decreased throughout Southern California for flex, industrial and office space, and range from 1.5% to 9.9%, depending on submarkets and product type. The Company’s vacancy rate in this market at March 31, 2007 was 4.8%.

The Company owns approximately 1.8 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 stand at 12.3%, 18.3% and 16.2%, respectively. The Company’s vacancy rate in its Northern California portfolio at March 31, 2007 was 10.7%. Rental rates dropped dramatically in 2005 and 2006 as a result of an oversupply of commercial space and weak demand. With slowly improving market conditions, rental rates increased 4.4% over in-place rental rates during the first quarter of 2007.

The Company owns approximately 1.2 million square feet in Southern Texas, which consists of the Austin and Houston markets. The market vacancy rates are 9.3% in the Austin market and 11.7% in the Houston market. The Austin market has continued to experience a steady level of lease demand during the first quarter of 2007, which has enabled the Company to increase rental rates on executed leases by 5.8% over in-place rents. The Houston market continues to stabilize occupancy and rental rates. With a more diverse tenant base, this market has not been as significantly impacted as other parts of Texas that were more reliant on the telecommunications and technology industries, which had contracted over the last several years. In addition, the strong oil and gas industry has helped stabilize and improve the Houston market. The Company’s vacancy rate in Southern Texas at March 31, 2007 was 8.4%.

The Company owns approximately 1.7 million square feet in the Dallas Metroplex market. The market vacancy rate in Las Colinas, where most of the Company’s properties are located, is 12.3%. During 2006 and in the first quarter of 2007, modest new construction continued, which included both speculative construction, as well as owner-user construction. The Company believes that new construction could cause vacancy rates to rise and limit opportunities to increase rental rates. Despite the new construction, during 2006 and the first quarter of 2007, the Company has experienced a higher level of leasing activity in the market than it had experienced over the past two years. The Company’s vacancy rate at March 31, 2007 was 17.1%.

The Company owns approximately 3.6 million square feet in South Florida. The Company acquired two assets in Palm Beach County at the end of 2006. Additionally, the Company owns Miami International Commerce Center (“MICC”) located in the Airport West submarket of Miami-Dade County. MICC 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 market vacancy rates for Palm Beach County and Miami-Dade County are 8.6% and 6.3%, respectively, compared with a vacancy rate for the Company of 1.8% at March 31, 2007.

The Company owns approximately 2.9 million square feet in the Northern Virginia submarket of Washington D.C., where the average market vacancy rate was 9.3% as of March 31, 2007. Washington D.C. submarkets have continued to be positively impacted by federal government spending and government contracting trends. The Company’s vacancy rate in this market at March 31, 2007 was 6.4%.

The Company owns approximately 1.8 million square feet in the Maryland submarket of Washington D.C. The portfolio is primarily located in Montgomery County and Silver Spring. As expected, the business of the federal government, defense contractors and the biotech industry has remained stable during the first quarter of 2007. The Company’s vacancy rate in this market at March 31, 2007 was 5.1% compared to 9.4% for the market as a whole.

The Company owns approximately 1.3 million square feet in the Beaverton submarket of Portland, Oregon. In 2006, the Company experienced improving lease terms as a result of increasing lease activity. Although rental rates are down 3.4% over in-place rents for the first quarter of 2007, leasing volume has increased measurably and the Company’s occupancy level in this market is up 5.1% over the first quarter of 2006. The market vacancy rate is 18.4%. The Company’s vacancy rate in this market was 7.6% at March 31, 2007.

The Company owns approximately 679,000 square feet in the Phoenix and Tempe submarkets of Arizona. Overall, the Arizona market has been characterized by modest growth. Although average market rental rates have declined over the past several years as demand for space subsided, rental rates are up 14.2% over in-place rental rates for the first quarter of 2007. The market vacancy rate is 7.4%. The Company’s vacancy rate in this market at March 31, 2007 was 8.9%.

On February 16, 2007, the Company acquired Overlake Business Center, a 493,000 square foot multi-tenant office and flex business park located in Redmond, Washington. The property’s vacancy rate at March 31, 2007 was 9.7% compared to 11.0% for the market as a whole.

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 by expanding its presence in existing and new markets through strategic acquisitions and through the disposition of non-strategic assets. The Company has historically maintained a low leverage level approach intended to provide the Company with the flexibility for future growth.

On March 27, 2007, the Company acquired Commerce Campus, a 251,000 square foot multi-tenant office and flex business park located in Santa Clara, California, for $39.1 million, including transaction costs. The park, which was 79.8% leased at the time of acquisition, has 73 tenants in 11 separate one and two story buildings.

On February 16, 2007, the Company acquired Overlake Business Center, a 493,000 square foot multi-tenant office and flex business park located in Redmond, Washington, for $76.0 million, including transaction costs. The park, which was 90.0% leased at the time of acquisition, has 171 tenants in 27 separate one and two story buildings.

In 2006, the Company added 1.2 million square feet to its portfolio at an aggregate cost of $180.3 million. The Company acquired WesTech Business Park, a 366,000 square foot office and flex park in Silver Spring, Maryland, for $69.3 million; 88,800 square feet of multi-tenant flex buildings in Signal Hill, California, for $10.7 million; a 107,300 square foot multi-tenant flex park in Chantilly, Virginia, for $15.8 million; Meadows Corporate Park, a 165,000 square foot multi-tenant office park in Silver Spring, Maryland, for $29.9 million; Rogers Avenue, a 66,500 square foot multi-tenant industrial and flex park in San Jose, California, for $8.4 million; and Boca Commerce Park and Wellington Commerce Park, two multi-tenant industrial, flex and storage parks, aggregating 398,000 square feet, located in Palm Beach County, Florida, for $46.2 million. In connection with the Meadows Corporate Park purchase, the Company assumed a $16.8 million mortgage with a fixed interest rate of 7.20% through November, 2011, at which time it can be prepaid without penalty. In addition, in connection with the Palm Beach County purchases, the Company assumed three mortgages with a combined total of $23.8 million with a weighted average fixed interest rate of 5.84%.

During 2006, the Company sold a 30,500 square foot building located in Beaverton, Oregon, for $4.4 million resulting in a gain of $1.5 million. Additionally in 2006, the Company sold 32,400 square feet in Miami for a combined total of $3.7 million, resulting in a gain of $865,000.

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 table) from continuing operations are summarized for the three months ended March 31, 2007 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 with 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 GAAP. The table below reflects rental income, operating expenses and NOI from continuing operations for the three months ended March 31, 2007 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 table 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):

		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				21.0	%		$	15,809				24.3	%		$	4,183				20.5	%		$	11,626				25.9	%
Northern California			1,581				8.3	%			5,076				7.8	%			1,305				6.4	%			3,771				8.4	%
Southern Texas			1,161				6.1	%			2,802				4.3	%			1,341				6.5	%			1,461				3.3	%
Northern Texas			1,689				8.9	%			3,637				5.6	%			1,534				7.5	%			2,103				4.7	%
South Florida			3,597				19.0	%			7,748				11.9	%			2,475				12.1	%			5,273				11.8	%
Virginia			2,894				15.3	%			12,991				20.0	%			4,067				19.9	%			8,924				20.0	%
Maryland			1,771				9.3	%			9,532				14.6	%			2,999				14.7	%			6,533				14.6	%
Oregon			1,342				7.1	%			4,938				7.6	%			1,606				7.8	%			3,332				7.5	%
Arizona			679				3.6	%			1,655				2.5	%			690				3.4	%			965				2.2	%
Washington			269				1.4	%			936				1.4	%			239				1.2	%			697				1.6	%
Total before depreciation and amortization			18,968				100.0	%			65,124				100.0	%			20,439				100.0	%			44,685				100.0	%
Depreciation and amortization											—								21,640								(21,640	)
Total										$	65,124							$	42,079							$	23,045

Concentration of Credit Risk by Industry:

The information below depicts the industry concentration of our tenant base as of March 31, 2007. The Company analyzes this concentration to understand significant industry exposure risk.

Business services			12.5	%
Government			10.7	%
Financial services			9.9	%
Contractors			9.4	%
Computer hardware, software and related services			9.1	%
Warehouse, transportation and logistics			8.9	%
Health services			7.2	%
Retail			5.6	%
Communications			5.7	%
Home furnishings			3.9	%
Electronics			3.2	%
			86.1	%

The information below depicts the Company’s top ten customers by annual rents as of March 31, 2007 (in thousands):

										% of Total
Tenants		Square Footage				Annual Rents (1)				Annual Rents
U.S. Government			469			$	12,386				4.6	%
Kaiser Permanente			194				4,280				1.6	%
County of Santa Clara			97				3,192				1.2	%
Intel			214				3,095				1.2	%
Wells Fargo			102				1,706				0.6	%
AARP			102				1,542				0.6	%
Northrop Grumman			58				1,542				0.6	%
Axcelis Technologies			89				1,499				0.6	%
American Intercontinental University			74				1,236				0.5	%
MCI			73				1,234				0.5	%
			1,472			$	31,712				12.0	%

Three Months Ended March 31, 2007 Compared To Three Months Ended March 31, 2006

Results of Operations: Revenues increased $6.4 million for the three months ended March 31, 2007, over the same period in 2006 driven primarily by $5.3 million from assets acquired during 2006 and 2007 and $1.1 million as a result of improved occupancy and rental rates within the Company’s Same Park portfolio. The increase in Same Park revenue of $1.1 million was partially reduced by the $1.8 million bankruptcy settlement received during the first quarter of 2006. Net income allocable to common shareholders for the three months ended March 31, 2007 was $5.9 million or $0.27 per diluted share compared to $5.1 million or $0.23 per diluted share for the same period in 2006. The change for the three months in net income allocable to common shareholders was primarily from an increase in net operating income partially offset by an increase in interest expense and preferred equity distributions.

The following table presents the operating results of the Company’s properties for the three months ended March 31, 2007 and 2006 in addition to other income and expense items affecting income from continuing operations. The Company breaks out Same Park operations to provide information regarding trends for properties the Company has held for the periods being compared (in thousands, except per square foot data):

		For the Three Months Ended
		March 31,
		2007				2006				Change
Rental income:
Same Park (17.5 million rentable square feet) (1)		$	58,782			$	57,686				1.9	%
Other facilities (1.9 million rentable square feet) (2)			6,342				1,068				493.8	%
Total rental income			65,124				58,754				10.8	%
Cost of operations:
Same Park			18,279				17,718				3.2	%
Other facilities			2,160				228				847.4	%
Total cost of operations			20,439				17,946				13.9	%
Net operating income (3):
Same Park			40,503				39,968				1.3	%
Other facilities			4,182				840				397.9	%
Total net operating income			44,685				40,808				9.5	%
Other income and expenses:
Facility management fees			183				149				22.8	%
Interest and other income			1,801				2,000				(10.0	%)
Interest expense			(1,107	)			(513	)			115.8	%
Depreciation and amortization			(21,640	)			(20,586	)			5.1	%
General and administrative			(1,702	)			(1,650	)			3.2	%
Income from continuing operations before minority interests		$	22,220			$	20,208				10.0	%
Same Park gross margin (4)			68.9	%			69.3	%			(0.6	%)
Same Park weighted average for the period:
Occupancy			93.4	%			92.7	%			0.8	%
Annualized realized rent per square foot (5)		$	14.39			$	14.23				1.1	%

Supplemental Market Data and Trends: In order to evaluate the performance of the Company’s overall portfolio over two given years, management analyzes the operating performance of a consistent group of properties owned and operated throughout both those years. The Company refers to those properties as the Same Park facilities. For the three months ended March 31, 2007 and 2006, the Same Park facilities constitute 17.5 million rentable square feet, which includes all assets in continuing operations that the Company owned and operated from January 1, 2006 through March 31, 2007, representing approximately 90% of the total square footage of the Company’s portfolio for the three months ended March 31, 2007.

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 table) from continuing operations are summarized for the three months ended March 31, 2007 and 2006. The Company’s property operations account for substantially all of the net operating income earned by the Company. See “Concentration of Portfolio by Region” above for more information on NOI, including why the Company

presents NOI and how the Company uses NOI. 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 GAAP.

The following table summarizes the Same Park operating results by major geographic region for the three months ended March 31, 2007 and 2006. In addition, the table reflects the comparative impact on the overall rental income, cost of operations and NOI from properties that have been acquired since January 1, 2006 and the impact of such is included in Other Facilities in the table below (in thousands):

Three Months Ended March 31, 2007 and 2006:

		Rental				Rental								Cost of				Cost of
		Income				Income								Operations				Operations								NOI				NOI
		March 31,				March 31,				Increase				March 31,				March 31,				Increase				March 31,				March 31,				Increase
Region		2007				2006				(Decrease)				2007				2006				(Decrease)				2007				2006				(Decrease)
Southern California		$	15,599			$	14,728				5.9	%		$	4,076			$	4,094				(0.4	%)		$	11,523			$	10,634				8.4	%
Northern California			4,888				4,866				0.5	%			1,238				1,231				0.6	%			3,650				3,635				0.4	%
Southern Texas			2,802				2,533				10.6	%			1,341				1,098				22.1	%			1,461				1,435				1.8	%
Northern Texas			3,637				4,648				(21.8	%)			1,534				1,360				12.8	%			2,103				3,288				(36.0	%)
South Florida			6,328				5,683				11.3	%			2,032				2,172				(6.4	%)			4,296				3,511				22.4	%
Virginia			12,603				12,927				(2.5	%)			3,946				3,761				4.9	%			8,657				9,166				(5.6	%)
Maryland			6,332				6,347				(0.2	%)			1,816				1,746				4.0	%			4,516				4,601				(1.8	%)
Oregon			4,938				4,295				15.0	%			1,606				1,613				(0.4	%)			3,332				2,682				24.2	%
Arizona			1,655				1,659				(0.2	%)			690				643				7.3	%			965				1,016				(5.0	%)
Total Same Park			58,782				57,686				1.9	%			18,279				17,718				3.2	%			40,503				39,968				1.3	%
Other Facilities			6,342				1,068				493.8	%			2,160				228				847.4	%			4,182				840				397.9	%
Total before depreciation and amortization			65,124				58,754				10.8	%			20,439				17,946				13.9	%			44,685				40,808				9.5	%
Depreciation and amortization			—				—				—				21,640				20,586				5.1	%			(21,640	)			(20,586	)			5.1	%
Total		$	65,124			$	58,754				10.8	%		$	42,079			$	38,532				9.2	%		$	23,045			$	20,222				14.0	%