<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                  FORM 10-K/A
                                AMENDMENT NO. 2
                                        
(Mark One)
   [X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                  For the fiscal year ended December 31, 1997

                                      OR

   [ ]      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 1-14516
                                        
                           PRENTISS PROPERTIES TRUST
            (Exact name of registrant as specified in its charter)

         MARYLAND                                                 75-2661588
(State or Other Jurisdiction of                               (I.R.S. Employer
Incorporation or Organization)                               Identification No.)
 
3890 West Northwest Highway, Suite 400, Dallas, Texas               75220
(Address of Registrant's Principal Executive Offices)            (Zip Code)
                                        
                                (214) 654-0886
             (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


       TITLE OF EACH CLASS             NAME OF EACH EXCHANGE ON WHICH REGISTERED
       -------------------             -----------------------------------------
Common Shares of Beneficial Interest,        New York Stock Exchange, Inc.
      par value $.01 per share        
                                                
                                                                          
   Preferred Share Purchase Rights           New York Stock Exchange, Inc.
                                        
     Securities registered pursuant to Section 12(g) of the Act:

                                     NONE
                               (Title of class)

     Indicate by check mark whether the registrant (i) 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 (ii) has been subject to such
filing requirements for the past 90 days.  Yes [X]  No [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

     The aggregate market value of the voting stock held by non-affiliates of
the registrant, as of December 16, 1998, was approximately $41,097,313.

     As of  December 16, 1998, the number of Common Shares of Beneficial
Interest outstanding was 38,926,488, and the number of outstanding Participating
Cumulative Redeemable Preferred Shares of Beneficial Interest, Series A, was
3,773,585.

                      DOCUMENTS INCORPORATED BY REFERENCE
                                        
     Part III incorporates by reference to the Company's Definitive Proxy
Statement to be filed with respect to the Annual Meeting of Shareholders to be
held on May 5, 1998.

                                       1
<PAGE>
 
                           PRENTISS PROPERTIES TRUST

                                     INDEX

                                                                       FORM 10-K
                                                                        REPORT
ITEM NO.                                                                 PAGE
--------                                                               ---------

Forward Looking Statements..............................................   3

                                    PART I
   1.  Business.........................................................   3
   2.  Properties.......................................................  15
   3.  Legal Proceedings................................................  16
   4.  Submission of Matters to a Vote of Security Holders..............  16

                                    PART II
 
   5.  Market for Registrant's Common Equity and Related Shareholder 
        Matters.........................................................  17
   6.  Selected Financial and Operating Data............................  20
   7.  Management's Discussion and Analysis of Financial Condition and 
        Results of Operations...........................................  23
  7A.  Quantitative and Qualitative Disclosures About Market Risk.......  30
   8.  Financial Statements and Supplementary Data......................  31
   9.  Changes in and Disagreements with Accountants on Accounting and 
        Financial Disclosure............................................  31

                                   PART III
 
  10.  Trustees and Executive Officers of the Company...................  31
  11.  Executive Compensation...........................................  31
  12.  Security Ownership of Certain Beneficial Owners and Management...  31
  13.  Certain Relationships and Related Transactions...................  31

                                    PART IV
                                        
  14.  Exhibits, Financial Statement Schedules, and Reports on 
        Form 8-K........................................................  31

                                       2
<PAGE>


     This Amendment No. 2 to Form 10-K (the "Form 10-K/A") amends and
supplements the annual report on Form 10-K for the fiscal year ended December
31, 1997, filed with the SEC on March 30, 1998 and amended by Amendment No. 1
filed with the SEC on December 24, 1998 (the "Form 10-K"), of Prentiss
Properties Trust (the "Company"). Capitalized terms used herein have the
meanings ascribed to such terms in the Form 10-K unless otherwise defined
herein.

     The Form 10-K is hereby amended and supplemented by amending and restating
the section entitled "Risk Factors" in Part I, Item 1, to comply with the SEC's
new plain English rules and to clarify other disclosures throughout the Form 10-
K.

 
                          FORWARD-LOOKING STATEMENTS
                                        
     This Form 10-K/A and the documents incorporated by reference herein may
contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of
the Securities Exchange Act of 1934, as amended (the "Exchange Act").  When used
in this prospectus, words such as "anticipate," "believe," "estimate," "expect,"
"intend," "predict," "project," and similar expressions, as they relate to us or
our management, identify forward-looking statements. Such forward-looking
statements are based on the beliefs of our management as well as assumptions
made by and information currently available to us.  These forward-looking
statements are subject to certain risks, uncertainties and assumptions,
including risks, uncertainties and assumptions related to the following:
<TABLE> 
<S>                                                      <C> 
 .  Our reliance on major tenants;                        .  Conflicts of interest;

 .  The geographic concentration of our properties;       .  Change in our investment, financing and borrowing
                                                            policies without shareholder approval;

 .  Risks associated with our real estate acquisition,    .  Our dependence on key personnel such as Michael V.
   redevelopment,development and construction               Prentiss and Thomas F. August;
   activities;

 .  Factors that could cause poor operating               .  Our third-party property management, leasing,    
   performance of our properties;                           development and construction business and related
                                                            services;                                         

 .  Our incurrence of debt;                               .  Effect of market interest rates on price of common
                                                            shares; and                                        
                                                         
 .  Limited ability of shareholders to effect a change    .  Effect of shares available for future sale on price
   of control;                                              of common shares.                                   

 .  Our failure to qualify as a REIT;                     .  Potential dilution of capital stock or decrease
                                                            of liquidity in connection with settlement of
                                                            forward agreements.
</TABLE>

Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated, expected or projected. Such forward-looking statements
reflect our current views with respect to future events and are subject to these
and other risks, uncertainties and assumptions, relating to our operations,
results of operations, growth strategy and liquidity. All subsequent written and
oral forward-looking statements attributable to us or individuals acting on our
behalf are expressly qualified in their entirety by this paragraph. You should
specifically consider the various factors identified in this Form 10-K/A and the
documents incorporated by reference herein, which could cause actual results to
differ.

                                    PART I
                                        
ITEM 1.   BUSINESS

OVERVIEW

     The Company is a self-administered and self-managed REIT that acquires,
owns, manages, leases, develops and builds office and industrial properties
throughout the United States.  The Company operates principally through Prentiss
Properties Acquisition Partners, L.P. and its subsidiaries (the "Operating

                                       3
<PAGE>
 
Partnership") and Prentiss Properties Limited, Inc. (the "Manager")(collectively
referred to herein as the "Company").  As of March 1, 1998, the Company owned
interests in a diversified portfolio of 229 primarily suburban Class A office
and suburban industrial properties containing approximately 19.9 million net
rentable square feet.  The properties are located in 18 major U.S. markets and
consist of 98 office buildings (the "Office Properties") containing
approximately 10.4 million net rentable square feet and 131 industrial buildings
(the "Industrial Properties" and together with the Office Properties, the
"Properties") containing approximately 9.4 million net rentable square feet.  As
of March 1, 1998, the Office Properties were approximately 96% leased to
approximately 850 tenants and the Industrial Properties were approximately 94%
leased to approximately 400 tenants.  The Company manages approximately 48.7
million net rentable square feet in 485 office and industrial properties in 23
U.S. markets that are owned by the Company and by third parties and that are
leased to approximately 3,000 tenants.  The Company also has six office
properties and four industrial properties under development, which together will
contain approximately 1.3 million net rentable square feet.

     As of the completion of the Company's initial public offering on October
22, 1996 (the "IPO"), the Company owned a total of 87 Properties.  Since the
IPO, the Company has acquired 133 Properties including, in the aggregate, 125 in
1997 and 1998.  In addition, the Company has nine separate and one attached
development projects in various stages of construction.

BUSINESS AND GROWTH STRATEGIES

     The Company's primary objective is to maximize shareholder value through
increases in distributable cash flow per share and appreciation in the value of
the Common Shares.  The Company intends to achieve this objective through a
combination of external and internal growth, while maintaining a conservative
balance sheet and pursuing a strategy of financial flexibility.

  External Growth

     Acquisitions.  The Company invests opportunistically, pursuing assets that
are: (i) managed by the Company or owned by the Company's existing management
clients which become available for sale; (ii) performing at a level believed to
be substantially below potential due to identifiable management weaknesses or
temporary market conditions; (iii) encumbered by indebtedness that is in default
or is not performing; (iv) held or controlled by short-term owners (such as
assets held by insurance companies and financial institutions under regulatory
pressure to sell); or (v) properties with below market leases which may be
released in the near term to improve cash flow.

     The Company believes it is particularly well-positioned to acquire
properties because of its: (i) presence in and knowledge of 23 markets across
the United States through a diversified base of approximately 3,000 tenants and
existing relationships with 61 different management clients; (ii) access to
capital as a public company, including its credit facilities; (iii) reputation
as a buyer with the ability to execute complicated transactions; (iv) fully-
integrated operations which allow rapid response to opportunities; (v) UPREIT
structure, which may allow sellers to defer tax consequences on sale; and (vi)
relationships with real estate brokers, institutional owners, and third-party
management clients, which often allow preferential access to opportunities.

     In evaluating potential acquisition opportunities, the Company relies on
the experience of its employees and on its internal research capabilities in
considering a number of factors, including: (i) macro-economic issues that
impact the market in which the property is located; (ii) location and
competition in the property's market; (iii) occupancy of and demand for
properties of a similar type in the same market; (iv) the construction quality
and condition of the property; (v) the potential for increased cash flow after
benefiting from the Company's renovations, refurbishment and upgrades; (vi)
purchase price relative to replacement costs;  and (vii) the potential to
generate revenue growth at or above levels of economic growth in the property's
market.  Further, the Company believes its development expertise enables it to
identify the potential for improvement in an acquisition opportunity, which
might not be apparent to a buyer without similar expertise.

     The Company has acquired 125 Properties since December 31, 1996.  The
following table sets forth the location, acquisition date, number of buildings,
net rentable square feet and contract purchase price of the Acquired Properties.
See "Item 2. Properties" for additional information relating to the Company's
Properties.

                                       4
<PAGE>
 
<TABLE>
<CAPTION>
                                                                             NUMBER OF               NET RENTABLE     PURCHASE
1997 ACQUIRED PROPERTIES      LOCATION                    ACQUISITION DATE   BUILDINGS     TYPE     SQUARE FEET(1)     PRICE
------------------------      --------                   ------------------  ---------  ----------  --------------  ------------
                                                                                                                        ($)
<S>                           <C>                        <C>                 <C>        <C>         <C>             <C>
4401 Fair Lakes Court         Northern Virginia            January 14, 1997      1          Office        58,621      6,100,000
Milw. Ind.-5211 S. 3rd        Milwaukee, WI               February 20, 1997      1      Industrial       360,000      9,800,000
San Tomas Road                Baltimore, MD                  March 18, 1997      1      Industrial       143,924      5,500,000
Six Flags Distribution        Dallas, TX                     March 19, 1997      2      Industrial       237,344      8,700,000
LA Industrials                Los Angeles, CA                March 25, 1997      2      Industrial       228,382      7,000,000
Natomas                       Sacramento, CA                  April 2, 1997      6          Office       566,092     74,200,000
Crescent Centre               Atlanta, GA                     April 8, 1997      1          Office       243,048     24,800,000
Corporetum Office Campus      Chicago, IL                       May 6, 1997      5          Office       323,728     50,500,000
Colonnade                     Los Angeles, CA                  May 29, 1997      6      Industrial       468,750     16,250,000
Seven Mile Crossing           Detroit, MI                      June 4, 1997      2          Office       244,816     21,800,000
Bachman West                  Dallas, TX                       June 4, 1997      1          Office        70,090      5,500,000
16801 S. Exchange             Chicago, IL                     June 19, 1997      1      Industrial       455,858     11,300,000
World Savings Center          Oakland, CA                     July 29, 1997      1          Office       271,055     37,500,000
Regents Centre                Phoenix, AZ                     July 31, 1997      2          Office       100,500      9,900,000
The Academy                   Los Angeles, CA                 July 31, 1997      3          Office       193,961     23,000,000
Calverton Office Park         Metro. Washington, DC         August 27, 1997      3          Office       307,802     28,500,000
Research Office Center        Metro. Washington, DC       September 9, 1997      2          Office       286,325     40,750,000
Gateway International         Baltimore, MD              September 15, 1997      2          Office       203,405     22,584,000
Terramics Properties          Suburban Philadelphia, PA    October 22, 1997     15          Office       904,000    134,000,000
Carlsbad Pacific Center       San Diego, CA               November 13, 1997      2          Office        89,755     16,000,000
Glendale Federal Bank Bldg.   Los Angeles, CA              December 1, 1997      2          Office       197,027     24,100,000
Oceanside                     San Diego, CA                December 9, 1997      1      Industrial       143,274      6,865,000
Highland Court                Denver, CO                  December 12, 1997      1          Office        99,460     10,500,000
Panorama Point                Denver, CO                  December 30, 1997      1          Office        79,175      8,200,000
7101 Wisconsin Avenue         Baltimore, MD               December 30, 1997      1          Office       237,265     33,750,000
Duni                          Milwaukee, WI               December 31, 1997      1      Industrial       300,120     13,700,000
                                                                                --                     ---------    -----------
Total Acquired Properties                                                       66                     6,813,777    650,799,000
                            
<CAPTION>                   
                                                                             NUMBER OF               NET RENTABLE     PURCHASE
1997 ACQUIRED PROPERTIES      LOCATION                    ACQUISITION DATE   BUILDINGS     TYPE     SQUARE FEET(1)     PRICE
------------------------      --------                   ------------------  ---------  ----------  --------------  ------------
                                                                                                                        ($)
<S>                           <C>                         <C>                <C>        <C>          <C>             <C>
Creamery Way                  Philadelphia, PA              January 9, 1998      3        Office         141,139     13,810,000
Silicon Valley                San Jose, CA                 January 13, 1998      6      Industrial       382,234     26,575,000
Carrara Place                 Denver, CO                   January 30, 1998      1        Office         234,222     31,000,000
Newport National              Suburban San Diego, CA       February 5, 1998     49       Off./Ind.     1,012,000     89,500,000
                                                                                --                     ---------    -----------
                                                                                59                     1,769,595    160,885,000
</TABLE> 
(1)  The area of a property for which a tenant is required to pay rent which
     includes the actual rentable area plus a portion of the common areas of the
     property allocated to the tenant.

     Development.  In addition to acquisition opportunities, the Company intends
to capitalize on its development capabilities by selectively developing (and
redeveloping) properties in markets with favorable current and projected long-
term demographic characteristics and supply-demand imbalances.  The Company
controls all aspects of the development process, including site selection,
project concept, design and construction, financing, leasing and property
management.  The Company intends to continue developing industrial and office
properties on a build-to-suit basis, but it will also consider selective
opportunities for speculative development, when appropriate. The Company
currently has six office properties and four industrial properties under
development, which together will contain approximately 1.3 million net rentable
square feet, for estimated total development costs of approximately $131.4
million.

                                       5
<PAGE>
 
  Internal Growth

     The Company seeks to maximize the profitability of the Properties by
renewing leases, maintaining high occupancy rates, increasing rental revenues,
and reducing operating costs.

     The Company achieves increases in rental revenues by negotiating leases
that include increases in rent during the lease term, by replacing expiring
leases with new leases at higher rental rates and by improving occupancy rates.
The Company also seeks to renew existing leases, which reduces the costs of
lease rollovers, reduces rental revenue fluctuations and enhances long-term
relationships with national tenants that may have space needs in the Company's
other markets.

     The Company achieves reductions in operating and administrative costs by
performing many functions (e.g., engineering, tax and legal) in-house instead of
hiring third parties and by employing benchmarking and best practices
methodologies.  The Company's benchmarking program compares operating costs and
efficiencies of each property with other Company Properties and with other
office and industrial properties.  Under the program, the Company conducts
periodic evaluations of forty key performance indicators at each building and
compares the results to a variety of benchmarks (e.g., specific buildings,
portfolios, regions and the industry).  The Company's best practices methodology
involves continuously analyzing benchmarking data, investigating properties that
perform better than the norm and regularly disseminating and sharing information
with respect to the best practices employed at the better performing Properties
throughout the Company's management system.  By employing these methodologies,
the Company believes that it can continue to capitalize on opportunities to
reduce operating costs and operate the Properties more efficiently and
effectively.

     With offices in 23 markets and one of the largest portfolios of properties
under management for a publicly traded, full service office and industrial
company, the Company realizes substantial benefits from its national
infrastructure and economies of scale.  The Company uses centralized cash
management, national alliances with service providers, a sophisticated budgeting
system proven effective in cost control, and state-of-the-art information
linking all offices to improve efficiency and increase profits.  Training
provided through Prentiss Properties University, a Company-wide professional
training program, helps to integrate new operations during periods of rapid
expansion, communicate new technology and procedures, and reduce turnover.

     Asset managers in each region develop a strategy and market positioning for
each Property.  Each Property is evaluated using sophisticated valuation
software to determine the overall effect of property-level decisions such as
lease structures and capital expenditures on asset value.  Asset managers also
work with property managers and engineers to determine where improvements, such
as lighting retrofits and energy management system upgrades, will maximize
returns.

THIRD-PARTY MANAGEMENT

     At March 1, 1998, the Company managed 129 office and 127 industrial
properties for 61 third-party management clients. These properties are located
in 16 markets throughout the United States, contain approximately 28.9 million
net rentable square feet and are leased to over 1,750 tenants.

     The Company's management business serves a broad base of clients, including
major financial institutions and pension funds, large corporate users, real
estate advisory firms and real estate investment groups.  The Company believes
it has successfully developed and maintained relationships with its management
clients, having served its ten largest management clients (measured by total
revenues) for an average of 7.1 years.  Since 1989, approximately 60% of new
third-party management business has been generated from existing clients.  Of
the Company's Properties, approximately 4.6 million net rentable square feet, or
28% of the Company's total net rentable square feet (46 Properties), have been
acquired from its management clients.

     In addition to property management and leasing, the Company offers its
clients a full range of fee-based services, including tenant construction,
marketing, insurance, accounting, tax, acquisition, disposition, facilities
management, corporate and asset management services.

                                       6
<PAGE>
 
FINANCING STRATEGY

     The Company intends to maintain a debt policy (the "Debt Limitation")
limiting the Company's total combined indebtedness plus its pro rata share of
indebtedness of unconsolidated subsidiaries ("Joint Venture Debt") to 50% of
the Company's total equity market capitalization plus its combined indebtedness
and pro rata share of Joint Venture Debt ("Total Market Capitalization").
However, the Company's organizational documents do not limit the amount of
indebtedness that the Company may incur.  Although the Company's Board of
Trustees has no present intention to do so, the Debt Limitation may be amended
or revised at any time and from time to time at the discretion of the Board of
Trustees without a vote of the shareholders of the Company.  A change in this or
similar policies could adversely affect the Company's financial condition,
results of operations or the market price of the Common Shares.  As of December
31, 1997, the Company had outstanding indebtedness of approximately $420.0
million or 27.40% of total market capitalization (excluding its pro rata share
of Joint Venture Debt) and has outstanding total indebtedness, including its pro
rata share of Joint Venture Debt, of approximately $490.0 million or 30.57% of
Total Market Capitalization.


RISK FACTORS

     An investment in us involves various risks. The following describes factors
that may affect our actual operating results and could cause results to differ
materially from those in any forward-looking statements. There may be other
factors, and new risk factors may emerge in the future. You should carefully
consider the following information.


The bankruptcy or insolvency of our major tenant or the failure of our major
tenant to pay rent could have a potential adverse effect on operating
performance.

     For the year ended December 31, 1997, rent from our largest tenant, IBM,
accounted for 5.3% of our total revenues. We have leases with IBM in two
properties. We have extended both leases so that 46% of the rentable area for
one of the properties will expire in the year 2009. 70% of the rentable area for
the other property will expire in the year 2011 and the remainder will expire in
2006. The bankruptcy or insolvency of, or a downturn in the business of, any
major tenant such as IBM could result in a failure or delay in the tenant's rent
payments. Such a failure would adversely affect our business.

The geographic concentration of our properties in markets which are in economic 
decline could have a material adverse effect on operating performance.

     Properties located in the Dallas, Austin, suburban Chicago and Northern
Virginia areas provided approximately 19%, 6%, 10% and 14% of total revenues in
1997, respectively. Like other real estate markets, these commercial real estate
markets have experienced economic downturns in the past, and future declines in
any of these economies or real estate markets could adversely affect our cash
available for distribution. Our financial performance and ability to make
distributions to our shareholders are, therefore, particularly sensitive to the
economic conditions in these markets. The local economic climate, which may be
adversely impacted by business layoffs or downsizing, industry slowdowns,
changing demographics and other factors, and local real estate conditions, such
as oversupply of or reduced demand for office, industrial and other competing
commercial properties, may affect our revenues and the value of our properties.

Our acquisition, redevelopment, development and construction activities may give
rise to unexpected cost and can make it difficult to predict revenue potential.

     Our acquisition of new properties and lack of operating history give rise
     to difficulties in predicting revenue potential.

     We intend to acquire office and industrial properties. These acquisitions
could fail to perform in accordance with our expectations. If we fail to
accurately estimate the occupancy levels, operating costs or costs of
improvements to bring an acquired property up to the standards established for
its intended market position, the operating performance of the property may be
below our expectations. Acquired properties may have characteristics or
deficiencies affecting their valuation or revenue potential that we have not yet
discovered. We cannot assure you that the operating performance of acquired
properties will increase or be maintained under our management.

                                       7
<PAGE>
 
     During 1997, we acquired a total of 66 properties containing 6.8 million
square feet.  Our ability to manage our growth effectively will require us to
integrate successfully our new acquisitions into our existing management
structure.  Many of our properties have relatively short or no operating history
under our management.  We have had limited control over the operation of these
buildings.


     Our redevelopment, development and construction activities may give rise to
     unexpected costs.

     We redevelop, develop and construct office and industrial buildings. The
risks associated with these activities include:

     .  abandonment of redevelopment or development opportunities resulting in a
        loss of invested capital;
     .  construction costs of a property exceeding original estimates
        potentially resulting in yields on invested capital lower than
        expected;
     .  occupancy rates and rents at a newly renovated or completed property may
        not be sufficient to make the property profitable;
     .  financing may not be available on favorable terms for redevelopment or
        development of a property possibly increasing the projected cost of the
        project;
     .  permanent financing may not be available on favorable terms to replace
        short-term construction loans and construction and lease-up may not be
        completed on schedule, resulting in increased interest expense and
        construction costs; 
     .  all necessary zoning, land-use, building, occupancy and other required
        governmental permits and authorizations may not be obtained or may not
        be obtained on a timely basis resulting in possible delays, decreased
        profitability and increased management time and attention; and
     .  increased management time required for such activities may divert their 
        attention from other aspects of our business.

Cost increases or revenue decreases can adversely affect property yields and 
values.

     The yields available from equity investments in real estate depend in large
part on the amount of income generated and expenses incurred. If our properties
do not generate revenues sufficient to meet operating expenses, including debt
service, tenant improvements, leasing commissions and other capital
expenditures, we may have to borrow additional amounts to cover fixed costs, and
our cash flow and ability to make distributions to our shareholders will be
adversely affected.

     Factors which may affect our revenues and the value of our properties
include:

     .  the national, state and local economic climate and real estate
        conditions, such as oversupply of or reduced demand for space and
        changes in market rental rates;
     .  the perceptions of prospective tenants of the safety, convenience and
        attractiveness of the properties;
     .  the ability of the owner to provide adequate management, maintenance and
        insurance;
     .  the ability to collect on a timely basis all rent from tenants;
     .  the expense of periodically renovating, repairing and reletting spaces;
     .  increasing operating costs, including real estate taxes and utilities,
        which may or may not be passed through to tenants; and
     .  our compliance with the laws, changes in the tax laws, fluctuations in 
        interest rates and the availability of financing.

     Certain significant expenditures associated with our properties, such as
mortgage payments, real estate taxes, insurance and maintenance costs, are
generally not reduced when circumstances cause a reduction in rental 

                                       8
<PAGE>
 
revenues from our properties. 

Tenant defaults and bankruptcy could cause rent collection difficulties.

     A significant portion of our income is derived from rental income on our
properties. As a result, our distributable cash flow and ability to make
expected distributions to our shareholders would be adversely affected if a
significant number of our tenants fail to pay their rent due to bankruptcy,
weakened financial condition or otherwise. At any time, a tenant may seek the
protection of the bankruptcy laws, which could result in delays in rental
payments or in the rejection and termination of such tenant's lease. These
events would cause a reduction in our cash flow and the amounts available for
distributions to our shareholders. We cannot assure you that tenants will not
file for bankruptcy protection in the future or, if any tenants file, that they
will affirm their leases and continue to make rental payments in a timely
manner. In addition, a tenant from time to time may experience a downturn in its
business. Such a downturn may weaken its financial condition, and it may stop
paying rent when due.

Property maintenance costs may escalate beyond our ability to recover such costs
through rents.

     Our properties are subject to increases in operating expenses such as
cleaning; electricity; heating, ventilation and air conditioning; elevator
repair and maintenance; insurance and administrative costs; and other general
costs associated with security, landscaping, repairs and maintenance.  While our
tenants generally are obligated to pay a portion of these escalating costs,
there can be no assurance that our tenants will agree to pay such costs upon
renewal or that new tenants will agree to pay such costs.  If operating expenses
increase, the local rental market may limit the extent to which rents may be
increased to meet increased expenses without decreasing occupancy rates.
Although we implement incentive measures including evaluation and bonus plans
based in-part on cost-savings at each of our properties, our ability to make
distributions to our shareholders could be adversely affected if operating
expenses increase without a corresponding increase in revenues.

Non-renewal of leases and non-reletting of space could adversely affect our
rental revenues.

     We are subject to several risks upon expiration of leases for space located
at our properties. The leases may not be renewed, the space may not be relet or
the terms of renewal or reletting, including the costs of required renovations,
may be less favorable than current lease terms. Leases on a total of
approximately 16% of the total net rentable square feet in our properties will
expire in the 12 months ending December 31, 1998. If we are unable to relet
promptly or renew the leases for a particular property or properties, if the
rental rates upon such renewal or reletting are significantly lower than
expected rates or if our budgets for these purposes prove to be inadequate, then
our cash flow and ability to make expected distributions to our shareholders may
be adversely affected.

Some of our competitors in markets in which we have properties may have newer, 
better located or better capitalized properties.

     Numerous office and industrial properties compete with our properties in
attracting tenants to lease space. In each market we compete on a number of
factors including rental rates, tenant concession allowances, quality and
location of buildings, quality of property management, and other economic and
non-economic factors. Our major competitors in each market include the following
companies:

MARKETS             COMPETITORS
-------             -----------
 
Dallas, Houston,    Carr America, Equity Office Properties, Mack-Cali, Crescent
Denver, Austin      Real Estate Equities, ProLogis, Trammell Crow Company,
                    Lincoln Property Co.
 
Washington, D.C.,   Carr America, Equity Office Properties, Brandywine Realty,
Baltimore,          Boston Properties
Northern Virginia

Chicago, Detroit,   Carr America, Equity Office Properties, Centerpoint,
Kansas City,        ProLogis, Duke Realty, First Industrial, Liberty Property
Milwaukee           Trust

                                       9
<PAGE>
 
Philadelphia        Liberty Property Trust, Mack-Cali Realty, Brandywine Realty
 
Atlanta             Cousins Properties, Equity Office Properties, Carr America,
                    Weeks Corporation

San Diego, Los      Carr America, Speiker Properties, Kilroy Realty, Cornerstone
Angeles, Oakland,   Properties, Arden Realty, Shorenstein Co., Equity Office
Sacremento,         Properties, ProLogis, Boston Properties
Phoenix

     This competition could have an adverse effect on our operating performance
because some of these competing properties may be newer, better located or
better capitalized than our properties.

Properties with environmental problems could cause us to incur cleanup costs or
other liabilities.

     Under various federal, state, and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic substances
on, under or in the property. These laws often impose liability whether or not
the owner or operator knew of, or was responsible for, the presence of the
hazardous or toxic substances.  In addition, the presence of hazardous or toxic
substances, or the failure to remediate a property properly, may adversely
affect the owner's ability to borrow using the real property as collateral.
Persons who arrange for the disposal or treatment of hazardous or toxic
substances may also be liable for the costs of removal or remediation of
hazardous substances at the disposal or treatment facility, whether or not such
facility is or ever was owned or operated by them. Environmental laws and common
law principles impose liability for release of and exposure to hazardous
substances, including asbestos-containing materials, into the air, and third
parties may seek recovery from owners or operators of real property for personal
injury or property damage associated with exposure to released hazardous
substances, including asbestos-containing materials.

     As the owner of the properties, we may be liable for these types of costs.
We obtained Phase I environmental site assessments on all of our properties and
will obtain them on all of the properties we acquire in the future, prior to
their acquisition.  The purpose of Phase I environmental site assessments is to
identify potential sources of contamination for which we may be responsible and
to assess the status of environmental regulatory compliance.  For a number of
our properties, the Phase I environmental site assessments referenced prior
Phase II environmental site assessments obtained on such properties.  Phase II
environmental site assessments generally involve more invasive procedures than
Phase I environmental site assessments, such as soil sampling and testing or the
installation and monitoring of groundwater wells.

     Certain land in the vicinity of and underlying our Los Angeles industrial
properties was formerly the site of a synthetic rubber manufacturing plant owned
by the United States Government and subsequently owned or operated by numerous
companies, including Shell Oil Company and Dow Chemical Company.  During the
operation of the plant, wastes were disposed of in pits and ponds located south
of the properties.  On September 25, 1997, we were notified that an undefined
area, which may or may not include our Los Angeles industrial properties,
associated with the operation of the plant would be listed on the National
Priorities List. The National Priorities List is a federal list of abandoned
hazardous waste sites that must be cleaned up by either the government or the
potentially responsible parties. At this time, the EPA has not indicated the
precise boundaries of the National Priorities List site. We and the surrounding
landowners are challenging the listing. All past and present owners of the land
underlying our Los Angeles industrial properties, including the United States
Government, Dow, Shell and the former owner, LAPCO Industrial Parks, from whom
we purchased the Los Angeles industrial properties, are potentially responsible
parties for the investigation and remediation of the Plant Site. Shell has
agreed to:

     .  indemnify and hold harmless any successor of LAPCO, including us and any
        subsequent purchasers, tenants and lenders, from any liability relating
        to clean up or remediation costs for the plant site or for any
        contamination resulting from the plant site, and
     .  indemnify and hold harmless LAPCO and any successor of LAPCO, including
        us, from any liability arising out of any third party tort claims for
        personal injury or property damage.

     Except as noted above, the environmental site assessments have not revealed
any environmental condition, liability or compliance concern that we believe
could have a material adverse affect on our business, assets or results of
operations.  It is possible that the environmental site assessments relating to
any one of our 

                                       10
<PAGE>
 
properties do not reveal all environmental conditions, liabilities or compliance
concerns. In addition, there could be material environmental conditions,
liabilities or compliance concerns that arose at a property after the related
environmental site assessments report was completed.

Americans with Disabilities Act compliance could lead to unanticipated costs.

     The Americans with Disabilities Act of 1990 requires all public
accommodations and commercial facilities to meet federal requirements related to
access and use by disabled persons. Compliance with the Americans with
Disabilities Act requirements could require removal of access barriers, and non-
compliance could result in imposition of fines by the U.S. government or an
award of damages to private litigants. Although we believe that our properties
are substantially in compliance with these requirements, a determination that we
are not in compliance with the Americans with Disabilities Act could result in
the imposition of fines or an award of damages to private litigants. If we were
required to make unanticipated expenditures to comply with the ADA, our cash
flow and the amounts available for distributions to our shareholders may be
adversely affected.

Some of our properties may be subject to uninsured losses such as from 
earthquakes.

     We carry comprehensive liability, fire, flood, where appropriate, extended
coverage and rental loss insurance with respect to our properties, with policy
specifications and insured limits customarily carried for similar properties.
There are, however, certain types of losses, such as from earthquakes at
properties located in California or from wars, that may be either uninsurable or
the cost of obtaining insurance would be so high that it would be more prudent
to accept the risk of loss. Should an uninsured loss or a loss in excess of
insured limits occur, we could lose both capital invested in a property as well
as the anticipated future revenue from the property but would continue to be
obligated on any mortgagee indebtedness or other obligations related to the
property. Any such loss would adversely affect our business, financial condition
and results of operations.

Property ownership through partnerships and joint ventures could subject us to 
the contrary business objectives of our partners or co-ventures.

     Through an affiliate of  Prentiss Properties Acquisition Partners, L.P.,
the operating partnership, we own a non-controlling 50% interest in Broadmoor
Austin Joint Venture, which leases the Broadmoor Austin Office Properties in
Austin, Texas.  Through this interest, we act as managing venture partner and
have the authority to conduct the business and affairs of Broadmoor Austin Joint
Venture, subject to the approval and veto rights of the other venture partner.
IBM, the tenant leasing 100% of the space at that property, owns the remaining
50% interest in Broadmoor Austin Joint Venture through an affiliated entity.

     We may also participate with other entities in property ownership through
joint ventures or partnerships. Partnership or joint venture investments may
involve risks such as the following:

     .  our partners or co-venturers might become bankrupt,
     .  our partners or co-venturers might at any time have economic or other
        business interests or goals that are inconsistent with our business
        interests or goals, and
     .  our partners or co-venturers may be in a position to take action
        contrary to our instructions or make requests contrary to our policies
        or objectives, including our policy with respect to maintaining our
        qualification as a real estate investment trust.

     We will, however, seek to maintain sufficient control of such partnerships
or joint ventures to achieve our business objectives.  Our organizational
documents do not limit the amount of available funds that we may invest in
partnerships or joint ventures.

     In addition, we may acquire in the future either a limited partnership
interest in a property partnership without partnership management responsibility
or a co-venturer interest or co-general partnership interest in a property
partnership with shared responsibility for managing the affairs of a property
partnership or joint venture.  In such cases, we will not be in a position to
exercise sole decision-making authority regarding the property partnership or
joint venture.

                                       11
<PAGE>
 
Our properties are illiquid assets.

     Our investments in properties are relatively illiquid.  This illiquidity
will tend to limit our ability to vary our portfolio promptly in response to
changes in economic or other conditions.

Our incurrence of debt could have a material adverse effect on operating
performance.

     If principal payments due at maturity cannot be refinanced, extended or
paid with proceeds of other capital transactions, such as the issuance of new
equity capital, we expect that our cash flow will not be sufficient in all years
to pay distributions at expected levels and to repay all maturing debt.
Furthermore, if prevailing interest rates or other factors at the time of
refinancing result in higher interest rates upon refinancing, the interest
expense relating to such refinanced indebtedness would increase.  This increase
would adversely affect our cash flow and the amounts available for distributions
to our shareholders.  If a property is mortgaged to collateralize payment of
indebtedness and we are unable to meet mortgage payments, the property could be
foreclosed upon by or otherwise transferred to the mortgagee with a consequent
loss of income and asset value. We have $120 million in borrowings maturing in 
1998, which we intend to extend or refinance.

Our use of variable rate debt and derivative financial instruments may cause an 
increase in debt service costs.

     We have incurred and may incur in the future indebtedness that bears
interest at variable rates. Variable rate debt creates higher debt service
requirements if market interest rates increase, which would adversely affect our
cash flow and the amounts available for distributions to our shareholders. We 
enter into financial futures contracts and option contracts in the ordinary
course of our business to hedge or modify our exposures to interest rate
fluctuations related to our costs of financing. While our use of these
derivatives is intended to allow us to better manage certain risks, it is
possible that, over time, mis-matches may arise with respect to the derivatives
and the cash market instruments they are intended to hedge. Discrepancies can
also arise between the derivative and cash markets. Derivatives also have risks
that are similar in type to the risks of the cash market instrument on which
their values are based. For example, in times of market stress, sharp price
movements or reductions in liquidity in the cash markets may be related to
comparable or even greater price movements and reductions in liquidity in the
derivative markets. Further, the risks associated with derivatives are
potentially greater than those associated with the related cash market
instruments because of the additional complexity and potential for leverage. In
addition, derivatives may create credit risks, as well as legal, operational and
other risks beyond those associated with the underlying cash market instruments
on which their values are based. Credit risk involves the risk that a
counterparty on a derivative transaction will not fulfill its contractual
obligations. There can be no assurance, however, that hedging strategy or
techniques will be effective, that our profitability will not be adversely
affected during any period of changes in interest rates or that the costs of
hedging will not exceed the benefits.

     On September 19, 1997, we entered into two interest rate swap agreements 
with NationsBank and Societe Generale covering $60 million and $50 million, 
respectively, of our outstanding indebtedness. Our cost of seven year funds, 
before adding the spread, is fixed by these swap agreements at an average of 
6.25%.

                                       12
<PAGE>
 
     If we are unable to replace construction loans with permanent financing, we
     may have to sell development property at a loss.

     If new developments are financed through construction loans or if
acquisitions are financed with short-term bridge loans in anticipation of later,
permanent financing, there is a risk that upon completion of construction or the
maturity of the bridge loans, permanent financing may not be available or may be
available only on disadvantageous terms. As of December 31, 1997, we have $44.5
million in construction loan commitments of which we have drawn $10.1 million.
In the event that we are unable to obtain permanent financing for a property on
favorable terms, we could be forced to sell such property at a loss or the
property could be foreclosed upon by the lender and result in loss of income and
asset value.

Our shareholders' ability to effect a change of control may be limited.

     We have a shareholder rights plan.

     In February 1998, we adopted a shareholder rights plan and declared a
dividend of one purchase right for each common share of beneficial interest. The
purchase rights may have the effect of delaying, inhibiting or preventing a
transaction or a change in control of us that might involve a premium price for
the common shares or otherwise be in the best interest of our shareholders. The
purchase rights can cause substantial dilution to a person or group that
acquires 10% or more of our outstanding common shares without the purchase
rights having been redeemed by our board of trustees. However, because the
purchase rights are redeemable by our board of trustees, the purchase rights
should not interfere with any merger or other business combination approved by
our board of trustees.

     We have an ownership limitation.

     In order to maintain our qualification as a REIT under the Internal Revenue
Code of 1986, no more than 50% in value of our outstanding shares of beneficial
interest may be owned, directly or indirectly, by five or fewer individuals
during the last half of our taxable year, other than our 1996 taxable year. To
ensure that we will not fail to qualify as a REIT, our declaration of trust
authorizes our board of trustees to take such actions as are necessary and
desirable to preserve our qualification as a REIT. In particular, our
declaration of trust has an ownership limitation which provides that no person
may own, directly or indirectly, more than 8.5% of the number of outstanding
common shares, other than Michael V. Prentiss, who currently may own up to 15%
of the number of outstanding common shares, or more than 9.8% of the number of
outstanding preferred shares of beneficial interest of any series.

     Our board of trustees, upon receipt of a ruling from the IRS, an opinion of
counsel or other evidence satisfactory to our board of trustees, may exempt a
proposed transferee from the ownership limitation. For example, our board of
trustees has exempted Security Capital Preferred Growth Incorporated from the
ownership limitation on the condition that Security Capital not own more than
11% of the number of outstanding common shares. Our board of trustees may not
grant an exemption from the ownership limitation to any proposed transferee if
such exemption would result in the termination of our status as a REIT.

     The ownership limitation may have the effect of delaying, inhibiting or
preventing a transaction or a change in control that might involve a premium
price for the common shares or otherwise be in the best interests of our
shareholders.

     We have a staggered board.

     Our board of trustees is divided into three classes, with only a portion of
our board of trustees standing for election at each annual meeting.  The
staggered terms of trustees may reduce the possibility of a tender offer or an
attempt to change control of us, even though a tender offer or change in control
might be in the best interest of our shareholders.

                                       13
<PAGE>
 
     The board of trustees can issue additional shares.

     Our declaration of trust authorizes our board of trustees to:

     .  amend our declaration of trust, without shareholder approval, to
        increase or decrease the aggregate number of shares of beneficial
        interest or the number of shares of beneficial interest of any class
        that we have the authority to issue;
     .  issue additional authorized but unissued preferred or common shares; and
     .  classify or reclassify any unissued common shares or preferred shares
        and to set the preferences, rights and other terms of such classified or
        unclassified shares.

     These provisions may have the effect of delaying, deferring or preventing a
transaction or a change in control that might involve a premium price for the
common shares or otherwise be in the best interest of our shareholders.

If we ever fail to qualify as a REIT, we would not be able to deduct shareholder
distributions, and we would be taxed at corporate rates.

     We have operated and intend to continue to operate as a REIT for federal
income tax purposes.  We have not requested, and do not expect to request, a
ruling from the IRS that we qualify as a REIT.  Our REIT status will depend on
our continuing ability to meet various requirements concerning, among other
things, the ownership of our outstanding stock, the nature of our assets, the
sources of our income, and the amount of our distributions to our shareholders.
Because we have a limited history of operating as a REIT, we cannot assure you
that we will be able to maintain our status as a REIT.

     If we fail to qualify as a REIT for any taxable year, we would not be
allowed a deduction for distributions to our shareholders in computing our
taxable income and would be subject to federal income tax, including any
applicable alternative minimum tax, on our taxable income at regular corporate
rates. Unless entitled to relief under the Internal Revenue Code, we also would
be disqualified from treatment as a REIT for the four taxable years following
the year during which qualification was lost. As a result, cash available for
distribution would be reduced for each of the years involved. Although we intend
to continue to operate as a REIT, it is possible that future economic, market,
legal, tax or other considerations may cause our board of trustees, with the
consent of our shareholders holding at least two-thirds of all the outstanding
common shares, to revoke the REIT election.

     We have minimum distribution requirements that could require us to incur
     additional debt.

     In order to avoid corporate income taxation of the earnings that we
distribute, we are required each year to distribute to our shareholders at least
95% of our net taxable income, excluding any net capital gain.  In addition, we
will be subject to a 4% nondeductible excise tax on the amount, if any, by which
distributions paid by us with respect to any calendar year are less than the sum
of the following:

     .  85% of our ordinary income for that year,
     .  95% of our capital gain net income for that year, and
     .  100% of our undistributed taxable income from prior years.

     Beginning with the 1998 taxable year, we may elect to retain and pay income
tax on net capital gains.  These retained amounts will be treated as having been
distributed for purposes of the 4% excise tax.

     We have made and intend to continue to make distributions to our
shareholders to comply with the 95% distribution requirement and to avoid the
nondeductible excise tax.  Our income consists primarily of our share of the
income of the operating partnership, and the cash available for distribution to
our shareholders consists of our share of cash distributions from the operating
partnership.  Differences in timing between (1) the actual receipt of income and
actual payment of deductible expenses and (2) the related inclusion of income
and deduction of expenses in arriving at taxable income could require us,
through the operating partnership, to borrow funds on a short-term basis to meet
the 95% distribution requirement and to avoid the nondeductible excise tax.  The
requirement to distribute a substantial portion of our net taxable income could
cause us to distribute amounts that 

                                       14
<PAGE>
 
otherwise would be spent on future acquisitions, unanticipated capital
expenditures or repayment of debt, which would require us to borrow funds or to
sell assets to fund the costs of such items.

     If the operating partnership fails to be classified as a partnership for
     federal income tax purposes, we could lose our REIT status.

     We have not requested, and do not expect to request, a ruling from the IRS
that the operating partnership and each of its non-corporate subsidiaries have
been and will continue to be classified as partnerships for federal income tax
purposes. If the IRS were to challenge successfully the tax status of the
operating partnership or a non-corporate subsidiary as a partnership for federal
income tax purposes, the operating partnership or such non-corporate subsidiary
would be taxable as a corporation. In such event, we would likely cease to
qualify as a REIT. Furthermore, the imposition of a corporate income tax on the
operating partnership would reduce substantially the amount of cash available
for distribution from the operating partnership.

     Changes in tax laws could affect our REIT status.

     At any time, future legislation or administrative or judicial decisions or
actions could affect our tax treatment or qualification as a REIT.  For example,
on February 2, 1998, President Clinton released his budget proposal for fiscal
year 1999.  Several provisions of his proposal potentially could have affected
us if enacted in final form as then proposed.  Specifically, one proposal would
prohibit a REIT from owning, directly or indirectly, more than 10% of the voting
power or value of all classes of a C corporation's stock, other than the stock
of a qualified REIT subsidiary, after the effective date of such proposal.
We can give no assurance regarding whether this proposal will be enacted or
whether any future tax legislation or administrative or judicial decisions will
adversely affect our tax treatment or qualification as a REIT.

Conflicts of interests in our business could result in decisions not in your
best interest.

     Prentiss Principals could have differing objectives from other shareholders
     upon the sale, refinancing or prepayment of indebtedness of properties.

     Messrs. Prentiss, August and DuBois, our senior executive officers, and
their affiliates may have unrealized taxable gain associated with their units of
limited partnership interest in the operating partnership. Messrs. Prentiss,
August and DuBois may suffer different and more adverse tax consequences than
our other shareholders upon the sale or refinancing of properties that they
contributed to the operating partnership by Messrs. Prentiss, August and DuBois.
Therefore, Messrs. Prentiss, August and DuBois and our other shareholders may
have different objectives regarding the appropriate pricing and timing of any
sale or refinancing of properties. While we, through Prentiss Properties I,
Inc., the general partner of the operating partnership, have the exclusive
authority as to whether and on what terms to sell or refinance an individual
property, Messrs. Prentiss, August and DuBois may influence us not to sell, or
refinance or prepay the indebtedness associated with properties even though such
a transaction might otherwise be to our financial advantage, or may influence us
to refinance properties with a high level of debt. As of December 31, 1997, we
owned 13 properties with an aggregate purchase price of approximately $130.7
million which were subject to restrictions on transfer lasting from two to six
years unless the transfer is structured as a tax-deferred like kind exchange
under Section 1031 of the Internal Revenue Code.

     Our policies with respect to conflicts of interests may not eliminate the
     influence of conflicts.

     We have adopted policies intended to minimize conflicts of interest.  For
example, our bylaws require that all transactions in which executive officers or
trustees have a conflicting interest with us must be approved by a majority of
our trustees that are not affiliated with any of our affiliates or by the
holders of a majority of the common shares held by disinterested shareholders.
There can be no assurance that our policies will be successful in eliminating
the influence of conflicts.  Decisions could be made that might fail to reflect
fully the interests of all our shareholders.  Our declaration of trust includes
a provision permitting each individual trustee to engage in the type of business
activities conducted by us without first presenting any investment opportunities
to us, even though such investment opportunities may be within the scope of our
investment policies.

                                       15
<PAGE>
 
Our board of trustees may change policies and incur debt without shareholder
approval.

     Our board of trustees determines our investment, financing, borrowing and
distribution policies, and our policies with respect to all other activities,
including growth, capitalization and operations. Our board of trustees has
adopted a debt limitation policy limiting our total combined indebtedness plus
our pro rata share of joint venture debt to 50% or less of our total market
capitalization, but our organizational documents do not contain any limitation
on the amount of indebtedness we may incur. Although our board of trustees has
no present intention to do so, these policies may be amended or revised at any
time and from time to time at the discretion of our board of trustees without a
vote of our shareholders. A change in these policies could adversely affect our
financial condition, results of operations or the market price of the common
shares.

We are dependent on the services of Michael V. Prentiss and Thomas F. August.

     We are dependent on the efforts of our executive officers, particularly
Messrs. Prentiss and August.  The loss of their services could have an adverse
effect on our operations.  Each of Messrs. Prentiss and August have entered into
an employment agreement.  Messrs. Prentiss and August have agreed in their
employment agreements that for a period of two (2) years after they are no
longer employed by the Company they will not enter into employment with any
company which is in a business that is competitive to the business of the
Company. If this provision, or if similar provisions in other employment
agreements with our other employees are determined to not be binding on Messrs.
Prentiss or August, or any other employee, those persons would be able to enter
into employment with companies which compete with us immediately after those
persons ceased to be employed by us. Certain assets of affiliates of the
predecessor entities were not contributed to us in the transactions in which we
were formed, and our executive officers, including Messrs. Prentiss and August,
may devote some of their management time to those excluded assets.

Our third-party property management, leasing, development and construction
business and related services involve relationships which may be subject to 
early termination or a lack of control.

     Through the operating partnership and Prentiss Properties Limited, Inc.,
we engage in the business of management, leasing, development and construction
of properties owned by third parties. Risks associated with these activities
include the following:

     .  Related contracts, which are typically cancelable upon 30-days notice or
        upon specific events, including sale of the property, may be terminated
        by the property owner or may be lost in connection with a sale of such
        property;
     .  Contracts may not be renewed upon expiration or may not be renewed on
        terms consistent with current terms; and
     .  Rental revenues upon which management, leasing and development fees are
        based may decline as a result of general real estate market conditions
        or specific market factors affecting properties that we manage, lease or
        develop, resulting in decreased management or leasing fee income.

     The capital stock of Prentiss Properties Limited, Inc. is divided into two
classes: voting common stock, all of which is owned by Mr. Prentiss; and
nonvoting common stock, all of which we hold through the operating partnership.
The voting common stock represents 5% of the ownership interests in Prentiss
Properties Limited, Inc. and the nonvoting common stock represents 95% of the
ownership interests in Prentiss Properties Limited, Inc. Mr. Prentiss, as the
holder of all of Prentiss Properties Limited, Inc. voting common stock, has the
ability to elect the directors of Prentiss Properties Limited, Inc. We are not
able to elect directors and, therefore, are not able to influence the day-to-day
management decisions of Prentiss Properties Limited, Inc. As a result, the board
of directors and management of Prentiss Properties Limited, Inc. may implement
business policies or decisions that we would not have implemented and that are
adverse to our interests and which could adversely impact our net operating
income and cash flow.

We have shares available for future sale that could adversely affect the price
of our common shares.

     Under our declaration of trust, we have the authority to do the following:

                                       16
<PAGE>
 
     .  Amend our declaration of trust, without shareholder approval, to
        increase or decrease the aggregate number of shares of beneficial
        interest or the number of shares of beneficial interest of any class,
        including common shares, that we have the authority to issue and
     .  Issue additional authorized but unissued common shares or preferred
        shares.

     As of December 31, 1997, we had authorized 100,000,000 common shares, of
which 66,808,517 common shares were unissued. In addition, we have granted
options to purchase 2,288,437 common shares to executives officers, employees
and trustees, of which options to purchase 2,194,415 common shares remain
outstanding. Sales or issuances of a substantial number of common shares, or the
perception that such sales could occur could adversely affect prevailing market
prices of the common shares and dilute the percentage ownership held by our
shareholders.

     Limited partners of the operating partnership have the right to receive
either cash or one common share, subject to adjustments, in exchange for each
limited partnership unit they now hold if and to the extent they tender such
units for redemption and we or the general partner elect to redeem such units
for common shares.  We are party to registration rights agreements under which
we are required to register the issuance of common shares which we may issue
upon the redemption by the holders of units of limited partnership interest in
the operating partnership.  We can make no prediction concerning the effect that
such issuance or future sales of any such common shares will have on market
prices.

     In December 1997 and March 1998, we issued an aggregate of 3,773,585 Series
A Cumulative Convertible Preferred Shares to Security Capital in a private
placement. The Series A Preferred Shares are convertible into our common shares
beginning on January 1, 1999. Security Capital may sell such common shares
pursuant to a registration statement that we will file. We can make no
prediction concerning the effect that such issuance or future sales of any such
common shares will have on market prices.

Our shareholders may face potential dilution of capital stock or decrease of
liquidity in connection with settlement of the UBS forward agreement.

     The operating partnership and we have entered into a Purchase Agreement,
dated February 2, 1998, with UBS Limited and Union Bank of Switzerland, London
Branch, acting through its agent UBS Securities LLC (all as succeeded by UBS AG,
London Branch, acting through its agent Warburg Dillon Read LLC, "UBS-LB")
involving the sale of 1,100,000 common shares. The operating partnership and us
have also entered into a related forward stock contract, dated February 2, 1998,
with UBS-LB which provides for certain purchase price adjustments. The maturity
date of the UBS forward agreement is February 2, 1999, subject to acceleration
as described more fully below.

     The UBS forward agreement generally provides that if the market price of a
common share on the maturity date is less than a certain amount, which we refer
to as the "forward price," we must pay UBS-LB the difference multiplied by
1,100,000.  Similarly, if the market price of a common share is above the
forward price, UBS-LB must pay us the difference in common shares.  If we choose
not to, or if we cannot, settle in freely tradable common shares, we must
repurchase the 1,100,000 shares at the forward price in cash. Over the life of
the UBS forward agreement, the forward price will be adjusted by LIBOR plus 135
basis points, minus any dividends received on the common shares. The forward
price is calculated using the original issue price of $27.00 per share and
adjusting it to provide a return equal to LIBOR plus 135 basis points, less any
dividends paid during the same period.

     To secure our obligations under the UBS forward agreement, the UBS forward
agreement provides for quarterly payments of collateral equal to 1,100,000 times
105% of the amount by which the market price of a common share is below the
forward price.  The collateral may be in the form of cash, letters of credit or
freely tradable common shares.  

     Although the maturity date of the UBS forward agreement is February 2,
1999; if the closing price of the common shares falls below $16.40 for a period
of three consecutive trading days, or if the market value of our common shares,
excluding operating partnership

                                       17
<PAGE>
 
units, declines to or below $600 million, UBS-LB has the right to force a
complete settlement under the UBS forward agreement, if the closing price of the
common shares falls below $18.50 for a period of three consecutive trading days,
UBS-LB has the right to force a settlement with respect to 67% of the
transaction. UBS-LB also has the right to force a complete settlement under the
UBS forward agreement if we:

     .  are in default with respect to certain financial covenants under the UBS
        forward agreement,
     .  are in default under our credit facility with a syndicate of lenders or
        any other unsecured lending agreement, or
     .  fail to post sufficient cash collateral.

     Settlement in cash would involve the repurchase of 1,100,000 shares at a
price per share equal to the forward price. If we settled the UBS forward
agreement in cash, we would expect to use borrowings under our existing $300
million corporate revolver or various secured borrowings which we are currently
negotiating.

     Quarterly payments of collateral and the ultimate settlement of the UBS
forward agreement could adversely affect our liquidity or dilute our common
shares.  If the market price, is lower than the forward price, settlement in
common shares would dilute our capital stock. 

Year 2000 non-compliance may cause operational problems.

       The Y2K compliance problem is the result of computer programs designed to
use two digit rather than four digit years. Thus, the year 1998 is represented
as 98 and the year 2000 would be represented as 00. This could be interpreted as
either 1900 or 2000. To systems that have Y2K related issues, the time may seem
to have reverted back 100 years. Systems, equipment and software with exposure
to Y2K related problems exist not only in computerized information systems but
also in building operating systems such as elevators, alarm systems, energy
management systems, phone systems, and numerous other systems and equipment.
Failure to adequately identify and correct Y2K related problems could result in
a systems failure or malfunction with potential adverse effects including
personal injury, property damage, and disruption of operations. Any or all of
these failures could materially and adversely affect our business, financial
condition, or results of operations.

       Due to the exposure and potential liabilities inherent in both the
computerized information systems and non-information systems with imbedded
technology that we use internally, in September 1997, we created a Y2K committee
headed by the Vice President of Information Systems and co-chaired by the Vice
President of National Property Operations. 

                                       18
<PAGE>
 
     The total costs associated with required modifications to become Y2K
compliant are not expected to be material to our financial position. We
currently estimate the total Y2K readiness costs will be between $500,000 and
$600,000. These costs are net of our personnel costs that are considered to be
part of normal operating costs. Our readiness program is an ongoing process and
the estimates of costs and completion dates for the various categories described
above are subject to material change.

     Failure to correct a material Y2K problem could result in an interruption
in, or a failure of, certain normal business activities or operations that could
materially and adversely affect our results of operations, liquidity, and
financial position. Much of the uncertainty lies with the ability of critical
suppliers, service providers, contractors, and clients to fully remedy their Y2K
problems. Our Y2K plan should significantly reduce our level of uncertainty
regarding the Y2K problem.

     The most reasonable and likely worst case scenario might be the failure of
an energy management system in a building. This could adversely affect the
environmental conditions of the occupied space, thus creating discomfort and
inconvenience to the tenants until the condition could be manually corrected.
Persistence of this problem for a long period of time could result in an
increase in operating costs for the building until the energy management system
is restored to proper operations.

     We are making substantial effort to eliminate the exposure to any Y2K
issues; however, no one can accurately predict how many Y2K problem-related
failures will occur or the severity, duration, or financial consequences of
these potential failures, especially with regard to third-party systems. As a
result, a significant number of operational inconveniences and inefficiencies
facing us and our clients may divert our management's time, attention,
financial, and human resources from its ordinary business activities. In
addition, system failures may require significant efforts by us and our clients
to prevent or alleviate material business disruption.

ITEM 2.   PROPERTIES

     At December 31, 1997, the Company owned an interest in 161 Properties
totaling 16.8 million square feet with no individual Property representing 10%
or more of the Company's total assets at December 31, 1997 or gross revenues for
the year ended December 31, 1997.  The Properties consist of 84 Office
Properties comprising approximately 9.2 million net rentable square feet and 77
Industrial Properties comprising approximately 7.6 million net rentable square
feet. All of the Properties are wholly owned by the Company (through its
subsidiaries), except (i) the Broadmoor Austin properties, which are leased by a
joint venture in which the Company owns an approximate 50% non-controlling joint
venture interest; (ii) One Northwestern Plaza, in which the Company owns a 100%
leasehold interest; (iii) the Seven Mile Crossing Properties, in which the
Company also owns a 100% leasehold interest; and (iv) World Savings Center, with
respect to which the Company holds the existing note and has negotiated a deed
in lieu of foreclosure on the Property.

<TABLE>
PROPERTY DATA

                                                                                                   NET      PERCENT    TOTAL BASE
                                                                       YEAR(S)                   RENTABLE    LEASED     RENT FOR
                                                                        BUILT/       NUMBER OF    SQUARE     AS OF     YEAR ENDED
PROPERTY NAME                        TYPE           LOCATION          RENOVATED      BUILDINGS     FEET(A)  12/31/97   12/31/97/(B)/

-------------                     ----------  ---------------------  ------------    ---------  ----------  --------  -------------
                                                                                                                     (IN THOUSANDS)
<S>                               <C>         <C>                    <C>             <C>        <C>         <C>       <C> 
Calverton Office Park             Office      Metro. Wash., DC           1987            3         307,802     88          $  1,877
Research Office Center            Office      Metro. Wash., DC           1984            2         286,325     97             1,662
7101 Wisconsin Avenue             Office      Baltimore, MD              1991            1         237,265     92                25
Gateway International             Office      Baltimore, MD              1989            2         203,405     94               942
2411 Dulles Corner Road           Office      Northern Virginia          1990            1         176,522    100             3,398
2455 Horsepen Road                Office      Northern Virginia          1989            1         104,150    100             2,201
3141 Fairview Park Drive          Office      Northern Virginia          1988            1         192,108     95             2,430
</TABLE> 

                                       19
<PAGE>
 
<TABLE> 

<S>                               <C>         <C>                    <C>             <C>        <C>         <C>       <C> 
4401 Fair Lakes Court             Office      Northern Virginia          1988             1         58,621     95             1,002
8521 Leesburg Pike                Office      Northern Virginia          1984             1        145,257    100             2,734
Baltimore Industrial Properties   Industrial  Baltimore, MD            1974-1990          7        874,701     97             3,363
                                                                                        ---     ----------                 --------
     Total Mid-Atlantic Region                                                           20      2,586,156                   19,634
                                                                                        ---     ----------                 --------
1717 Deerfield Road               Office      Chicago, IL                1985             1        137,904    100             2,239
Corporetum Office Campus          Office      Chicago, IL              1984-1987          5        323,728     97             3,197
O'Hare Plaza II                   Office      Chicago, IL                1986             1        233,650     93             5,012
One Northwestern Plaza            Office      Suburban Detroit, MI       1989             1        241,751     97             4,567
Seven Mile Crossing               Office      Suburban Detroit, MI     1988-1990          2        244,816     96             2,449
Chicago Industrial Properties     Industrial  Chicago, IL             1987, 1988          4        681,934    100             1,479
Kansas City Industrial                                                                    
    Properties                    Industrial  Kansas City, MO          1975-1980          7      1,341,880    100             3,383
Milwaukee Industrial Properties   Industrial  Milwaukee, WI           1970-1987,                                    
                                                                         1996            19      1,899,204     91             4,832
                                                                                        ---     ----------                 --------
     Total Midwest Region                                                                40      5,104,867                   27,158
                                                                                        ---     ----------                 --------

Centerpointe                      Office      Sub. Philadelphia, PA      1987             1         42,230    100               148
Lake Center                       Office      Sub. Philadelphia, PA   1986, 1989          2        116,646     98               385
Woodland Falls                    Office      Sub. Philadelphia, PA    1986-1989          3        215,439     92               715
Southpoint                        Office      Sub. Philadelphia, PA    1986-1997          4        249,950     97               723
Valleybrooke                      Office      Sub. Philadelphia, PA    1984-1997          5        279,942    100               969
                                                                                        ---     ----------                 --------
     Total Northeast Region                                                              15        904,207                    2,940
                                                                                        ---     ----------                 --------

Crescent Centre                   Office      Atlanta, GA                1986             1        243,048     88             2,472
Cumberland Office Park            Office      Atlanta, GA              1972-1980          9        530,228     96             6,494
                                                                                        ---     ----------                 --------
     Total Southeast Region                                                              10        773,276                    8,966
                                                                                        ---     ----------                 --------

Highland Court                    Office      Denver, CO                 1986             1         99,460    100                74
PacificCare Building (FHP)        Office      Denver, CO                 1983             1        201,164     96             3,045
Panorama Point                    Office      Denver, CO                 1983             1         79,175    100                 7
Broadmoor Austin                  Office      Austin, TX                 1991             7      1,112,236    100                (C)
5307 East Mockingbird             Office      Dallas, TX                 1979             1        118,316     83               990
Bachman East                      Office      Dallas, TX                 1986             1        125,903     98             1,703
Bachman West                      Office      Dallas, TX                 1986             1         70,090     94               487
Cottonwood Office Center          Office      Dallas, TX                 1986             3        164,111     99             2,235
Park West C2                      Office      Dallas, TX                 1989             1        344,216    100             6,031
Park West E1                      Office      Dallas, TX                 1982             1        182,739    100             3,080
Park West E2                      Office      Dallas, TX                 1985             1        200,590     99             2,251
Walnut Glen Tower                 Office      Dallas, TX                 1985             1        464,289     96             8,025
Dallas Industrial Properties      Industrial  Dallas, TX               1970-1988          8        664,306    100             2,099
Houston Industrial Properties     Industrial  Houston, TX                1986             5         75,231     97               432
                                                                                        ---     ----------                 --------
     Total Southwest Region                                                              33      3,901,826                   30,459
                                                                                        ---     ----------                 --------

Regents Centre                    Office      Phoenix, AZ                1987             2        100,500    100               479
Glendale Federal Bank Building    Office      Los Angeles, CA            1991             2        197,027    100               363
The Academy                       Office      Los Angeles, CA            1991             3        193,961     91             1,609
World Savings Center              Office      Oakland, CA                1985             1        271,055     96                (D)
Natomas Corporate Center          Office      Sacramento, CA             1987             6        566,092     85             7,832
Carlsbad Pacific Center           Office      San Diego, CA              1986             2         89,755     98               208
Los Angeles Industrial                                                1968-1991,                                    
    Properties                    Industrial  Los Angeles, CA            1997            26      1,949,840     92             6,996
Oceanside                         Industrial  San Diego, CA              1991             1        143,274     96   
                                                                                        ---     ----------                 --------
     Total West Region                                                                   43      3,511,504                   17,487
                                                                                        ---     ----------                 --------

Total Properties                                                                        161     16,781,836                 $106,644
                                                                                        ===     ==========                 ========
</TABLE>
(A)  "Net Rentable Square Feet" means the area measurement of a building upon 
     which rent is calculated.
(B)  "Base Rent" means the fixed base rental amount paid by a tenant under the
     terms of the related lease agreement, which amount generally does not
     include payments on account of real estate taxes, operating expense
     escalations and utility charges.
(C)  The Company's approximate 50% interest in the Broadmoor Austin Properties
     is accounted for under the equity method and included in the Statement of
     Income under the "Equity in income of joint venture and unconsolidated
     subsidiaries" line item.
(D)  The Company holds a mortgage loan collateralized by this Property. The
     Company has negotiated a deed in lieu of foreclosure transaction, at no
     consideration, which provides for the conveyance of the Property from a
     partnership in which an affiliated party is the General Partner (Prentiss
     Properties WSC, Inc.) to the Company in an arms length transaction.

                                       20
<PAGE>
 
     At December 31, 1997, the Company's 161 Properties were subject to existing
mortgage indebtedness totaling $480.0 million which includes the Company's pro
rata share of joint venture debt. In addition, the Company had $10.0 million of
construction loans related to four Properties under development. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" for a discussion of mortgage debt
related to the Properties.

     The Company's Properties are leased by numerous tenants pursuant to
operating leases, which range on average from three to seven years in length.
The following table sets forth a schedule of rental rates the lease expirations
for leases in place as of December 31, 1997 for each of the 10 years beginning
with 1998 and thereafter for the 161 Properties described above.

<TABLE>
<CAPTION>
OFFICE PROPERTIES

PROPERTY                                  1998     1999    2000     2001    2002     2003    2004   2005    2006   2007  THEREAFTER
--------                                  ----     ----    ----     ----    ----     ----    ----   ----    ----   ----  ----------
<S>                                      <C>     <C>      <C>     <C>      <C>     <C>     <C>     <C>     <C>    <C>    <C>
ATLANTA                                                                                                      
       Square Feet Expiring (000's)         215     116      151      14       77     129      12       0       0       8         0
       Square Feet as a % of NRA            28%     15%      20%      2%      10%     17%      2%      0%      0%      1%        0%
       Annualized Base Rent in Expiring  $2,951  $1,538   $2,231    $263   $1,371  $2,251    $260      $0      $0    $158        $0
       Year (000's)                                                                                          
       Annualized Base Rent PSF in       $13.73  $13.26   $14.77  $18.79   $17.81  $17.45  $21.67   $0.00   $0.00  $19.75     $0.00
       Expiring Year                                                                                         
       Number of Leases Expiring             40      25       16       8       12       5       2       0       0       1         0
                                                                                                                        
DALLAS, HOUSTON, AUSTIN, DENVER                                                                                         
       Square Feet Expiring (000's)         182     119      244     193      181      38     216     171   1,133     471       155
       Square Feet as a % of NRA             6%      4%       8%      6%       6%      1%      7%      5%     36%     15%        5%
       Annualized Base Rent in Expiring  $3,094  $1,611   $3,576  $3,064   $3,022    $686  $3,069  $2,855 $22,416  $9,545    $3,643
       Year (000's)                                                                                          
       Annualized Base Rent PSF in       $17.00  $13.54   $14.66  $15.88   $16.70  $18.05  $14.21  $16.70  $19.78  $20.27     $0.00
       Expiring Year                                                                                         
       Number of Leases Expiring             32      31       36      21       20       2       3       4       4       5         0
                                                                                                                         
WASHINGTON D.C., BALTIMORE,                                                                                              
NORTHERN VIRGINIA                                                                                                        
       Square Feet Expiring (000's)         109     344      266     319      219       1      50      53      90     169         0
       Square Feet as a % of NRA             6%     20%      16%     19%      13%      0%      3%      3%      5%     10%        0%
       Annualized Base Rent in Expiring  $1,843  $6,545   $5,603  $6,020   $4,598     $17  $1,130  $1,184  $1,714  $3,745        $0
       Year (000's)                                                                                          
       Annualized Base Rent PSF in       $16.91  $19.03   $21.06  $18.87   $21.00  $17.00  $22.60  $22.34  $19.04  $22.16     $0.00
       Expiring Year                                                                                         
       Number of Leases Expiring             22      33       23      33       27       1       2       2       8       3         0
                                                                                                             
PHILADELPHIA                                                                                                 
       Square Feet Expiring (000's)         175     152      114      94       97      17      49       3      27      19       129
       Square Feet as a % of NRA            19%     17%      13%     10%      11%      2%      5%      0%      3%      2%       14%
       Annualized Base Rent in Expiring  $3,031  $2,820   $2,294  $1,871   $1,869    $341    $950     $55    $591    $406    $3,285
       Year (000's)                                                                                               
       Annualized Base Rent PSF in       $17.32  $18.55   $20.12  $19.90   $19.27  $20.06  $19.39  $18.33  $21.89  $21.37    $25.47
       Expiring Year                                                                                              
       Number of Leases Expiring             20      17       15      11        9       5       5       2       2       1         2
                                                                                                                  
CHICAGO, DETROIT, KANSAS CITY, MILWAUKEE                                                                          
       Square Feet Expiring (000's)         108      99      107     154      211     334      77      18      31       0         0
       Square Feet as a % of NRA             9%      8%       9%     13%      18%     28%      7%      2%      3%      0%        0%
       Annualized Base Rent in Expiring  $1,948  $2,041   $2,083  $2,914   $4,981  $6,766  $2,066    $483    $823      $0        $0
       Year (000's)                                                                                               
       Annualized Base Rent PSF in       $18.04  $20.62   $19.47  $18.92   $23.61  $20.26  $26.83  $26.83  $26.55   $0.00     $0.00
       Expiring Year                                                                                              
       Number of Leases Expiring             22      18       24      26       18       7       3       2       3       0         0
                                                                                                                  
SAN DIEGO, LOS ANGELES, OAKLAND, 
SACRAMENTO, PHOENIX                                                              
       Square Feet Expiring (000's)         135     201      332     268      143      41      22      92      17      21        34
       Square Feet as a % of NRA            10%     14%      23%     19%      10%      3%      2%      6%      1%      1%        2%
       Annualized Base Rent in Expiring  $2,752  $3,854   $6,389  $5,903   $2,278    $883    $446  $2,050    $409    $502      $850
       Year (000's)                                                                                               
       Annualized Base Rent PSF in       $20.39  $19.17   $19.24  $22.03   $15.93  $21.54  $20.27  $22.28  $24.06  $23.90    $25.00
       Expiring                                                                                                    
</TABLE>

                                       21
<PAGE>
 
<TABLE>
<CAPTION>
<S>                                     <C>     <C>      <C>     <C>      <C>     <C>     <C>     <C>     <C>    <C>    <C>
       Year                                                                                                       
       Number of Leases Expiring             71      28       31      14       10       3       1       2       2       1         1
                                                                                                                  
TOTAL OFFICE                                                                                                       
PROPERTIES                                                                                                   
       Square Feet Expiring (000's)         924   1,031    1,214   1,042      928     560     426     337   1,298     688       318
       Square Feet as a % of NRA            10%     11%      13%     11%      10%      6%      5%      4%     14%      8%        3%
       Annualized Base Rent in Expiring $15,619 $18,409  $22,176 $20,035  $18,119 $10,944  $7,921  $6,627 $25,953 $14,356    $7,778
       Year (000's)                                                                                          
       Annualized Base Rent PSF in       $16.90  $17.86   $18.27  $19.23   $19.52  $19.54  $18.59  $19.66  $19.99  $20.87    $24.46
       Expiring Year                                                                                         
       Number of Leases Expiring            207     152      145     113       96      23      16      12      19      11         3
                                                                                                             
<CAPTION>                                                                                                    
                                                                                                             
INDUSTRIAL PROPERTIES                                                                                        
                                                                                                             
PROPERTY                                  1998     1999    2000     2001    2002     2003    2004   2005    2006   2007  THEREAFTER
--------                                  ----     ----    ----     ----    ----     ----    ----   ----    ----   ----  ----------
<S>                                     <C>     <C>     <C>     <C>      <C>     <C>     <C>     <C>     <C>    <C>    <C>
DALLAS, HOUSTON, AUSTIN, DENVER
       Square Feet Expiring (000's)         111     101       77     161      216      51       0      20       0       0         0
       Square Feet as a % of NRA            15%     14%      10%     22%      29%      7%      0%      3%      0%      0%        0%
       Annualized Base Rent in Expiring     293     443      322     458      911     325       0     198       0       0         0
       Year (000's)                                                                                               
       Annualized Base Rent PSF in        $2.64   $4.39    $4.18   $2.84    $4.22   $6.37   $0.00   $9.90   $0.00   $0.00     $0.00
       Expiring Year                                                                                              
       Number of Leases Expiring              3      10        7       3        6       1       0       1       0       0         0
                                                                                                             
WASHINGTON D.C., BALTIMORE,
NORTHERN VIRGINIA                                                                                            
       Square Feet Expiring (000's)         104      95      476      51       17       0       0     108       0       0         0
       Square Feet as a % of NRA            12%     11%      54%      6%       2%      0%      0%     12%      0%      0%        0%
       Annualized Base Rent in Expiring     368     428    1,852     223       88       0       0     566       0       0         0
       Year (000's)                                                                                                     
       Annualized Base Rent PSF in        $3.54   $4.51    $3.89   $4.37    $5.18   $0.00   $0.00   $5.24   $0.00   $0.00     $0.00
       Expiring Year                                                                                                    
       Number of Leases Expiring              2       4        6       2        1       0       0       1       0       0         0
                                                                                                                        
CHICAGO, DETROIT, KANSAS CITY, MILWAUKEE                                                                                
       Square Feet Expiring (000's)       1,167     571      546     227      334       0     191       0       0      58       667
       Square Feet as a % of NRA            30%     15%      14%      6%       9%      0%      5%      0%      0%      1%       17%
       Annualized Base Rent in Expiring  $3,197  $1,763   $1,546    $776   $1,139      $0    $729      $0      $0    $345    $3,052
       Year (000's)                                                                                                     
       Annualized Base Rent PSF in        $2.74   $3.09    $2.83   $3.42    $3.41   $0.00   $3.82   $0.00   $0.00   $5.95     $4.58
       Expiring Year                                                                                                    
       Number of Leases Expiring             15      15       12       6        7       0       3       0       0       2         3
                                                                                                                        
SAN DIEGO, LOS ANGELES, OAKLAND, 
SACRAMENTO, PHOENIX                                                                    
       Square Feet Expiring (000's)         394     317      628     258       81      66      40      54       0       0        92
       Square Feet as a % of NRA            19%     15%      30%     12%       4%      3%      2%      3%      0%      0%        4%
       Annualized Base Rent in Expiring  $2,216  $1,163   $2,722  $1,113     $311    $410    $212    $321      $0      $0      $423
       Year (000's)                                                                                                     
       Annualized Base Rent PSF in        $5.62   $3.67    $4.33   $4.31    $3.84   $6.21   $5.30   $5.94   $0.00   $0.00     $4.60
       Expiring Year                                                                                                    
       Number of Leases Expiring             11       8       10       3        1       2       1       1       0       0         1
                                                                                                                        
TOTAL INDUSTRIAL                                                                                                        
PROPERTIES                                                                                                              
       Square Feet Expiring (000's)       1,776   1,084    1,727     697      648     117     231     182       0      58       759
       Square Feet as a % of NRA            23%     14%      23%      9%       8%      2%      3%      2%      0%      1%       10%
       Annualized Base Rent in Expiring   6,074   3,797    6,442   2,570    2,449     735     941   1,085       0     345     3,475
       Year (000's)                                                                                                     
       Annualized Base Rent PSF in        $3.42   $3.50    $3.73   $3.69    $3.78   $6.28   $4.07   $5.96   $0.00   $5.95     $4.58
       Expiring Year                                                                                                    
       Number of Leases Expiring             31      37       35      14       15       3       4       3       0       2         4
</TABLE>

     The Company is actively engaged in and has significant experience in the
development, redevelopment and renovation of office and industrial properties
("Development Properties"). The Company expects to have the total projected
costs of Development Properties comprise from 10% to 15% of its total market
capitalization at any point in time. At December 31, 1997, the Company had 1.3
million square feet of Properties under development. The table

                                       22
<PAGE>
 
below sets forth a schedule of the location, square feet and estimated cost of
each development project. Additionally the Company has commenced 8 new projects
with total projected costs of $149.0 million during 1998. In addition to new
building construction, the Company is involved in substantial levels of
construction activity in the normal course of owning and operating buildings.
Such activity includes building out interior space for tenants, expansions of
existing buildings, and repairs necessary to upgrade or maintain the quality of
the buildings.

<TABLE>
<CAPTION>

DEVELOPMENT PROJECT NAME              TYPE           LOCATION             SQUARE FEET    EST. COST ($000S)
------------------------              ----           --------             -----------    -----------------
<S>                                   <C>            <C>                  <C>            <C>             
2500 Cumberland Pkwy.                 Office         Atlanta, GA             145,000          $20,090    
The WestPoint Office Bldg.            Office         Dallas, TX              149,679           19,665    
Executive Center Del Mar              Office         San Diego, CA           111,596           18,950    
IBM Call Center                       Office         Dallas, TX              150,000           18,565    
3130 Fairview Park Dr.                Office         Northern Virginia       183,097           31,101    
                                                                          --------------------------------
   Office Subtotal                                                           739,372         $108,371    
                                                                          --------------------------------
375 N. Fairway Dr.                    Industrial     Chicago, IL             136,200            6,600    
5170-5250 6th Street                  Industrial     Milwaukee, WI           163,200            5,900    
Airworld Expansion                    Industrial     Kansas City, MO         150,022            5,009    
225 N. Fairway Dr.                    Industrial     Chicago, IL             111,634            5,500    
                                                                          --------------------------------
   Industrial Subtotal                                                       561,056          $23,009    
                                                                          --------------------------------
Total Developments in Process                                              1,300,428         $131,380    
                                                                          ================================
</TABLE>

     The Company operates in six regions nationwide, and competes with many
local, regional and national competitors in the office and industrial sectors.
None of the markets in which the Company operates are dominated by any one owner
or by the Company. In each market the Company competes on a number of factors
including rental rates, tenant concession allowances, quality and location of
buildings, quality of property management, and other economic and non-economic
factors. Major competitors in each market include the following companies:

MARKET                    COMPETITORS
------                    -----------
Dallas, Houston,          Carr America, Equity Office Properties, Mack-Cali,
Denver, Austin            Crescent Real Estate Equities, ProLogis, Trammell Crow
                          Company, Lincoln Property Co.

Washington D.C.,          Carr America, Equity Office Properties, Brandywine
Baltimore,                Realty, Boston Properties
Northern Virginia
         
Chicago, Detroit,         Carr America, Equity Office Properties, Centerpoint,
Kansas City,              ProLogis, Duke Realty, First Industrial, Liberty
Milwaukee                 Property Trust

Philadelphia              Liberty Property Trust, Mack-Cali Realty, Brandywine
                          Realty
                          
Atlanta                   Cousins Properties, Equity Office Properties, Carr
                          America, Weeks Corporation
                          
San Diego, Los Angeles,   Carr America, Speiker Properties, Kilroy Realty,
Oakland, Sacramento,      Cornerstone Properties, Arden Realty, Shorenstein Co.,
Phoenix                   Equity Office Properties, ProLogis, Boston Properties


ITEM 3.   LEGAL PROCEEDINGS

     Neither the Company nor its affiliates (other than in a representative
capacity), is presently subject to any material litigation. To the Company's
knowledge, no litigation been threatened against it or its affiliates other than
routine actions and administrative proceedings substantially all of which are
expected to be covered by liability insurance and which, in the aggregate, are
not expected to have a material adverse effect on the business or financial
condition of the Company.

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matter was submitted to a vote of security holders of the Company during
the fourth quarter of 1997, through the solicitation of proxies or otherwise.

                                       23
<PAGE>
 
                                    PART II
                                        
ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
          MATTERS
 
MARKET INFORMATION
 
     The Company's Common Shares commenced trading on The New York Stock
Exchange (the "NYSE") on October 17, 1996 under the symbol "PP".  As of March
18, 1998, the last reported sales price per Common Share on the NYSE was
$25 11/16 per Common Share.  The following table sets forth the high and
low sales price per Common Share reported on the NYSE as traded for the periods
indicated.
 
     PERIOD                                                  HIGH       LOW
     ------                                                 ------    -------
     1998
       First Quarter (through March 18, 1998).............  28 1/4    25 1/4
     1997
       Fourth Quarter.....................................  29 5/8    25 3/8
       Third Quarter......................................  29 3/4    24 13/16
       Second Quarter.....................................  26 3/8    23
       First Quarter......................................  28 1/4    24 5/8
     1996
       Fourth Quarter (Commencing October 17, 1996).......  25 1/8    20 1/2
                                                              
     The foregoing over-the-counter market quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.

SHAREHOLDER INFORMATION
 
     At March 18, 1998, the Company had approximately 242 holders of record and
approximately 16,000 beneficial owners, of its Common Shares. As of March 18,
1998, all of the Company's 2,830,189 Series A Convertible Preferred Shares,
which are convertible into the Company's Common Shares subject to certain
limitations, were held by Security Capital Preferred Growth, Incorporated
("SCPG"). In addition, the units of limited partnership interest in the
Operating Partnership ("Units") (which are redeemable for Common Shares subject
to certain limitations) were held by 9 entities and or persons.

     In order to comply with certain requirements related to qualification of
the company as a REIT, the Company's organizational documents limit the number
of outstanding Common Shares that may be owned by any single person or
affiliated group to 8.5% of the outstanding Common Shares (other than Michael V.
Prentiss, for whom the Ownership Limitation initially is 15%, and SCPG, for whom
the Ownership Limitation is 11%).
 
DISTRIBUTION INFORMATION
 
     The Company has adopted a policy of paying regular quarterly distributions
on its Common Shares and cash distributions have been paid on the Company's
Common Shares with respect to the period since its inception. The following
table sets forth information regarding the declaration and payment of
distributions by the Company since its commencement of operations on October 22,
1996.

                                       24
<PAGE>
 
          PERIOD WHICH              DISTRIBUTION  DISTRIBUTION   PER SHARE
          DISTRIBUTION                 RECORD       PAYMENT     DISTRIBUTION
            RELATES                     DATE          DATE         AMOUNT
          ------------              ------------  ------------  ------------
1998                                
   First Quarter (through March        3/31/98       4/17/98         $0.40
    18, 1998)                                                        
1997                                                                 
   Fourth Quarter                     12/31/97       1/16/98         $0.40
   Third Quarter                       9/30/97      10/17/97         $0.40
   Second Quarter                      6/30/97       7/17/97         $0.40
   First Quarter                       3/31/97       4/17/97         $0.40
1996                                
   Fourth Quarter  (Commencing        12/31/96       1/17/97         $0.31/(1)/
    October 22, 1996)
                                                                               
     /(1)/ Represents the pro rata portion (for the period from October 22, 1996
(inception of operations) to December 31, 1996) of a quarterly distribution of
$0.40.

     The foregoing distributions represent an approximate 10.6% and 57% return
of capital in 1997 and 1996, respectively. In order to maintain its
qualification as a REIT, the Company must make annual distributions to its
shareholders of at least 95% of its taxable income (which does not include net
capital gains). During the year ended December 31, 1997 and during the period
from October 22, 1996 to December 31, 1996, the Company declared distributions
totaling $1.60 and $0.31 per share, respectively. Under certain circumstances
the Company may be required to make distributions in excess of cash available
for distribution in order to meet such REIT distribution requirements. In such
event, the Company presently would expect to borrow funds, or to sell assets for
cash, to the extent necessary to obtain cash sufficient to make the
distributions required to retain its qualification as a REIT for federal income
tax purposes.
 
     The Company has declared a cash distribution for the first quarter of 1998
in the amount of $.40 per share, payable on April 17, 1998 to holders of record
on March 31, 1998. The Company currently anticipates that it will maintain at
least the current distribution rate for the immediate future, unless actual
results of operations, economic conditions or other factors differ from its
current expectations. Future distributions, if any, paid by the Company will be
at the discretion of the Board of Trustees of the Company and will depend on the
actual cash flow of the Company, its financial condition, capital requirements,
the annual distribution requirements under the REIT provisions of the internal
revenue code and such other factors as the Board of Trustees of the Company deem
relevant.
 
RECENT SALES OF UNREGISTERED SECURITIES
 
     Direct Placements of Securities
 
     On December 2, 1997, the Company executed an agreement (the "SCPG
Agreement") to issue and sell 3,773,585 shares of Series A Cumulative
Convertible Redeemable Preferred Shares of beneficial interest, $.01 par value,
(the "Series A Convertible Preferred Shares") to SCPG for a total price of
approximately $100 million, or $26.50 per share. Beginning January 1, 1999, and
upon the occurrence of certain events prior to that date, the Series A
Convertible Preferred Shares are convertible into the Company's Common Shares.
On December 30, 1997, the Company sold 2,830,189 Series A Convertible Preferred
Shares to SCPG pursuant to the SCPG Agreement, and expects to issue and sell the
remaining 943,396 Series A Convertible Preferred Shares under the SCPG Agreement
on or before March 31, 1998. The proceeds from the sales pursuant to the SCPG
Agreement were contributed to the Operating Partnership in exchange for Series A
Preferred units of limited partnership interest ("Series A Units"), and the
Operating Partnership used such proceeds to reduce its indebtedness. The sales
pursuant to the SCPG Agreement are exempt from registration under the Securities
Act of 1933, as amended (the "Securities Act") pursuant to Section 4(2) thereof.
 
     In connection with SCPG Agreement, the Company exempted SCPG from the
Ownership Limitation (as defined herein) on the condition that SCPG not own more
than 11% of the number of outstanding Common Shares.  The Company also agreed to
register under the Securities Act the Series A Convertible Preferred Shares,

                                       25
<PAGE>
 
including any Common Shares received upon conversion of the Series A Convertible
Preferred Shares, in December 1998.
 
     On February 2, 1998, the Company closed a direct placement of 1.1 million
Common Shares to an affiliate of Union Bank of Switzerland ("UBS") for a gross
consideration of $29.7 million, or $27.00 per share.  In a related transaction,
the Company entered into a forward stock contract with UBS which provides that
during the first year after the closing of the direct placement, the Company
will have the right to periodically consummate a share settlement with UBS based
on the then market price for the Common Shares.  Every 90 days the Company is
required, to the extent that the then current share price is less than the
forward price, to post collateral in an amount sufficient to cover any
shortfall. The forward price is calculated using the original issue price and
adding a return equal to LIBOR+ 135 basis points less any dividends paid on the
stock. 

     Upon maturity of the forward stock contract the Company may settle the
contract by either sale of shares sufficient to satisfy the obligation or
repurchase of the shares at the forward price for cash. At this time the Company
expects, and has reserved capacity from our various credit facilities to
repurchase the shares for cash. The Company has agreed that any shares issued in
such a settlement will be registered under the Securities Act. The proceeds from
the sales to UBS and its affiliates were contributed to the Operating
Partnership in exchange for Units, and the Operating Partnership used such
proceeds to reduce its indebtedness. The sales to UBS and its affiliates were
exempt from registration under the Securities Act pursuant to Section 4(2)
thereof.
 
     Share Exchange and Merger Transactions
 
     In connection with the Company's IPO, certain entities affiliated with the
Company (the "Merged Entities") received Units in exchange for certain assets
they contributed to the Operating Partnership. In February of 1998, (i) the
Merged Entities distributed 113,500 Units to certain employees of the Merged
Entities (the "Merged Entity Employees"), (ii) the Company issued 2,432,541
Common Shares in exchange for all of the capital stock of the Merged Entities to
the owners of the Merged Entities (the "Merged Entity Owners"), and (iii) the
Merged Entity Employees redeemed their 113,500 Units in exchange for an equal
number of Common Shares. These transactions were approved by all of the
independent members of the Company's Board of Trustees. The issuance of Common
Shares to the Merger Entity Employees and Merged Entity Owners was exempt from
Registration under the Securities Act pursuant to Section 4(2) thereof. The
Common Shares issued to the Merged Entity Owners and Merged Entity Employees are
"restricted," and the Company has registered these shares pursuant to
the registration statement required to be filed by the Company.
 
     The Merged Entity Employees either are employees of the Company or have
been employees of the Company within the past three years. Several of the Merged
Entity Owners are affiliates of the Company and include Michael V. Prentiss, the
Company's Chief Executive Officer, Thomas F. August, the Company's President and
Chief Operating Officer, and Dennis J. DuBois, an Executive Vice President of
the Company. In addition, Messrs. Prentiss and August are members of the
Company's Board of Trustees.
 
SHAREHOLDER RIGHTS PLAN
 
     At a meeting held on February 6, 1998, the Company's Board of Trustees
adopted a Shareholder Rights Plan (the "Rights Plan") similar to those adopted
by other public corporations. On February 17, 1998, pursuant to the Rights Plan,
the Company distributed as a dividend one Preferred Share Purchase Right (a
"Right") for each outstanding Common Share. Each Right entitles the holder to
buy one one-thousandth of a share (a "Unit") of the Company's Junior
Participating Cumulative Preferred Shares of Beneficial Interest, Series B, par
value $.01 per share (the "Series B Preferred Shares") at an exercise price of
$85, subject to adjustment. Each Unit of a Series B Preferred Share is
structured to be the equivalent of one Common Share.
 
     The Rights will become exercisable only if a person or group acquires,
obtains the right to acquire or announces a tender offer to acquire 10% (or, in
the case of SCPG and its affiliates, 11%) or more of the outstanding Common
Shares.  When exercisable, the Rights entitle the holder, upon payment of the
exercise price, to acquire Series B Preferred Shares or, at the option of the
Company, Common Shares (or in certain circumstances, cash, property or other
securities), having a value equal to twice the Right's exercise price.  If the

                                       26
<PAGE>
 
Company is acquired in a merger or other business combination or if 50% or more
of the Company's assets or earning power is transferred, each Right will entitle
the holder, other than the acquiring person, to purchase securities of the
surviving company having a market value equal to twice the exercise price of the
Right.
 
     Until such time as a person or group acquires or announces a tender offer
to acquire 10% (or, in the case of SCPG and its affiliates, 11%) or more of the
Common Shares, (i) the Rights will be evidenced by the Common Share certificates
and will be transferred with and only with such Common Share certificates, and
(ii) the surrender for transfer of any certificate for Common Shares will also
constitute the transfer of the Rights associated with the Common Shares
represented by such certificate. The Rights will expire on February 17, 2008,
and may be redeemed by the Company at a price of $.001 per right at any time
prior to the tenth day after an announcement that a 10% position has been
acquired.
 
     The Rights may have certain anti-takeover effects. The Rights will cause
substantial dilution to a person or group that acquires more than 10% (or, in
the case of SCPG and its affiliates, 11%) of the outstanding Common Shares of
the Company if certain events thereafter occur without the Rights having been
redeemed. However, because the Rights are redeemable by the Board of Trustees in
certain circumstances, the Rights should not interfere with any merger or other
business combination approved by the Board.
 
ITEM 6.   SELECTED FINANCIAL AND OPERATING DATA
 
     The following sets forth selected financial and operating data for the
Company and selected combined historical financial data for the Predecessor
Company.  The following data should be read in conjunction with the historical
consolidated and combined financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere in this Form 10-K.
 
     The selected combined historical financial statements of the Predecessor
Company include (i) the results of operations from 47 properties for the periods
presented, (ii) the results of operations of the 3141 Fairview Park Drive
Property for the portion of the periods after a Prentiss Group member acquired
the Property, (iii) the results of operations of the Plaza on Bachman Creek for
the portion of the periods after a Prentiss Group member acquired the Property,
(iv) a 25% equity interest in the Broadmoor Austin properties, (v) a 15% equity
interest in the Park West C2 Property for the portion of the periods in which
the Prentiss Group owned a non-controlling interest, and (vi) results of
operations of the Prentiss Properties service business conducted primarily by
Prentiss Properties Limited, Inc. ("PPL") in the periods presented.
 
     The selected historical consolidated financial data for the Company for the
year ended December 31, 1997 and the period October 22, 1996 through December
31, 1996 and the selected historical combined financial data for the period
January 1, 1996 through October 21, 1996 and the years ended December 31, 1995,
1994, and 1993 has been derived from the historical consolidated and combined
financial statements of the Company and the Predecessor Company and combined
financial statements of the Company and the Predecessor Company and the notes
thereto audited by Coopers and Lybrand, L.L.P., independent accountants.
 

                                       27
<PAGE>
 
<TABLE>
<CAPTION>
                                                                  COMPANY                           PREDECESSOR COMPANY HISTORICAL
                                               -------------------------------------------------   -------------------------------
                                                               HISTORICAL                             YEAR ENDED DECEMBER 31,
                                                 YEAR ENDED    OCT. 22, 1996     JAN. 1, 1996
                                                DEC 31, 1997   - DEC. 31, 1996   - OCT. 21, 1996     1995        1994        1993
                                               -------------   ---------------   ---------------   --------    --------    --------
<S>                                            <C>             <C>               <C>               <C>         <C>         <C>
STATEMENTS OF OPERATIONS DATA:
Rental income...................................  $  127,089       $  13,485          $ 27,086     $ 29,423    $ 25,256    $ 14,412
Fee and other income/(1)/.......................       4,639             302            17,510       25,741      26,702      23,609
                                                  ----------       ---------          --------     --------    --------    --------
    Total revenues..............................     131,728          13,787            44,596       55,164      51,958      38,021
Operating expenses/(1)/.........................      37,221           4,670            24,845       31,127      33,178      28,667
Real estate taxes...............................      13,742           1,162             3,085        3,030       2,691       1,631
Interest expense................................      21,955             846             5,951        3,882       3,191       1,444
Real estate depreciation and
  amortization..................................      21,600           2,696             5,993        7,060       5,451       3,312
Other depreciation and amortization.............                                                        106         106         106
Equity in income of  joint venture and
  unconsolidated subsidiaries/(1)/..............       5,208           1,427                18           11          13          (4)
                                                  ----------       ---------          --------     --------    --------    --------
Income before gains on sale, minority
  interest, and extraordinary item..............      42,418           5,840             4,740        9,970       7,354       2,857
Gains on sale...................................         641                               378                    1,718
Minority interest/(2)/..........................      (5,235)           (844)
                                                  ----------       ---------          --------     --------    --------    --------
    Income before extraordinary item............      37,824           4,996             5,118        9,970       9,072       2,857
Extraordinary item - (loss on early
   extinguishment of debt)......................        (878)
                                                  ----------       ---------          --------     --------    --------    --------
Net income......................................      36,946           4,996             5,118        9,970       9,072       2,857
Preferred dividends.............................         (25)
                                                  ----------       ---------          --------     --------    --------    --------
Net income applicable to common
  shareholders..................................      36,921           4,996             5,118        9,970       9,072       2,857
                                                  ==========       =========          ========     ========    ========    ========

Net income per Common Share - basic.............  $     1.48       $     .25
                                                  ==========       =========

Net income per Common Share
  before extraordinary item - basic.............  $     1.52       $     .25
                                                  ==========       =========

Weighted average number of Common
  Shares outstanding............................      24,930          20,002
                                                  ==========       =========

Net income per Common Share - diluted...........  $     1.46       $     .25
                                                  ==========       =========

Net income per Common Share before
  extraordinary item - diluted..................  $     1.49       $     .25
                                                  ==========       =========
Weighted average number of Common Shares
and Common Share equivalents
  outstanding...................................      25,307          20,332
                                                  ==========       =========

BALANCE SHEET DATA (END OF PERIOD):
  Real estate, before accumulated
    depreciation/(3)/...........................  $1,170,992       $ 501,035                       $153,148    $151,673    $ 89,116
  Real estate, after accumulated
    depreciation /(3)/..........................   1,134,849         482,528                        141,368     144,366      85,549
  Cash..........................................       7,075           7,226                          1,033       9,133       1,605
  Total assets..................................   1,239,846         531,026                        154,635     164,307     117,819
  Debt on real estate/(3)/......................     420,030         128,800                         46,442      46,732      20,473
  Total liabilities.............................     470,607         151,977                         50,769      51,713      23,773
  Shareholders' equity..........................     696,632         325,221                        103,866     112,594      94,046
OTHER DATA (END OF PERIOD):
EBITDA/(4)/.....................................  $   95,551       $  11,445          $ 20,458     $ 25,705    $ 20,789    $ 12,420
Funds from Operations/(5)/......................  $   66,047       $   8,935          $ 11,608     $ 18,114    $ 13,889    $  7,253
Cash flow from operations.......................      61,458           9,142            10,268     $ 16,238    $ 13,059    $  6,115
Cash flow from investing........................    (660,263)       (353,809)          (32,985)    $ (4,301)   $(40,909)   $(71,977)

Cash flow from financing........................     598,654         351,892            23,283     $(20,037)   $ 35,378    $ 59,463
PROPERTY DATA (END OF PERIOD):/(6)/
Number of Properties............................         161              95                57           55          54          47
Total GLA in sq. ft.............................      18,082           9,944             6,641        6,323       5,976       4,793
Occupancy %.....................................          96%             97%               95%          97%         96%         95%

</TABLE>
                                                                               
/(1)/  The Manager's operations are combined with the property operations in the
       historical statements of the Predecessor Company and are accounted for
       under the equity method in the Company's historical statements;
       therefore, the historical statements of the Predecessor Company include
       the Manager's revenues and expenses on a gross basis in the respective
       income and expense line items and the Company's historical statements
       present the Manager's net operations in the line item titled "Equity in
       income of joint venture and unconsolidated subsidiaries."

                                       28
<PAGE>
 
       Equity in income of joint venture and unconsolidated subsidiaries
       includes the Company's approximate 50% interest in the partnership owning
       the Broadmoor Austin Properties (the "Broadmoor Austin Partnership") on
       a historical basis, and the Predecessor Company's 25% in the Broadmoor
       Austin Properties, which is accounted for on the equity method for all
       periods presented. For more information on the operations and accounts of
       the Broadmoor Austin Partnership, refer to footnote (6) in the footnotes
       to the consolidated and combined financial statements of the Company and
       Predecessor Company, respectively.
       
/(2)/  Represents the approximate 10.3% interest in the Operating Partnership
       which is owned by the Minority Investors.

/(3)/  In accordance with generally accepted accounting principles (GAAP), the
       balance sheet as of December 31, 1997 reflects the Company's investment
       in the Broadmoor Austin Properties using the equity method of accounting.
       As a result, the Company's approximate 50% share of the Broadmoor Austin
       Partnership's real estate and related debt are not included in the line
       items titled "Real estate, before accumulated depreciation," "Real
       estate, after accumulated depreciation" and "Debt on real estate." The
       following schedule represents the Balance Sheet Data as of December 31,
       1997 on a historical basis. This presentation is provided for
       informational purposes only:
       
<TABLE>
<CAPTION>
                                                                                   ADJUSTMENTS
                                                                12/31/97          FOR COMBINING         12/31/97
                                                               BALANCE SHEET       BROADMOOR'S      BALANCE SHEET DATA
                                                             DATA AS PRESENTED    50% OWNERSHIP     BROADMOOR COMBINED
                                                             -----------------    -------------     ------------------
<S>                                                          <C>                  <C>               <C>

Real estate, before accumulated depreciation...............      $1,170,992          $69,921          $1,240,913
Real estate, after accumulated depreciation................      $1,134,849          $55,762          $1,190,611
Debt on real estate........................................      $  420,030          $70,000          $  490,030
</TABLE>
                                                                               
/(4)/  EBITDA means operating income before mortgage and other interest, income
       taxes, depreciation and amortization. The Company believes EBITDA is
       useful to investors as an indicator of the Company's ability to service
       debt and pay cash distributions. EBITDA, as calculated by the Company, is
       not comparable to EBITDA reported by other REITs that do not define
       EBITDA exactly as the Company defines that term. EBITDA does not
       represent cash generated from operating activities in accordance with
       GAAP, and should not be considered as an alternative to operating income
       or net income as an indicator of performance or as an alternative to cash
       flows from operating activities as an indicator of liquidity. The
       Company's EBITDA for the respective periods is calculated as follows:

<TABLE>
<CAPTION>
                                                                              COMPANY                                  
                                                                             HISTORICAL             
                                                                   -------------------------------  
                                                                     YEAR ENDED     OCT. 22, 1996   
                                                                   DEC 31, 1997     DEC. 31, 1996   
                                                                   ------------     --------------  
<S>                                                                <C>              <C>             
EBITDA                                                                                              
Net Income                                                              $36,946           $ 4,996   
Add:                                                                                                
  Interest expense..............................................         21,995               846   
  Real estate depreciation and amortization.....................         21,600             2,696   
  Other depreciation and amortization...........................                                    
  EBITDA of unconsolidated subsidiaries.........................          5,434             1,700   
  EBITDA of unconsolidated joint ventures.......................          9,419             1,810   
  Extraordinary loss on early extinguishment of debt............            878                     
  Minority interest/(1)/........................................          5,128               824   
Less:                                                                                               
  Gains on sale.................................................           (641)                    
  Equity in income of joint ventures and                                                            
    unconsolidated subsidiaries.................................         (5,208)           (1,427)  
                                                                        -------           -------   
EBITDA..........................................................        $95,551           $11,445   
                                                                        =======           =======

<CAPTION>                                                
                                                                             PREDECESSOR COMPANY HISTORICAL
                                                                  ----------------------------------------------------
                                                                                          YEAR ENDED DECEMBER 31,
                                                                                     ---------------------------------
                                                                  JAN. 1, 1996  
                                                                  OCT. 21, 1996        1995         1994         1993
                                                                  -------------      -------      -------      -------
<S>                                                               <C>                <C>          <C>          <C>
EBITDA                                                                                                       
Net Income                                                              $ 5,118      $ 9,970      $ 9,072      $ 2,857
Add:                                                                                                         
  Interest expense..............................................          5,951        3,882        3,191        1,444
  Real estate depreciation and amortization.....................          5,993        7,060        5,451        3,312
  Other depreciation and amortization...........................                         106          106          106
  EBITDA of unconsolidated subsidiaries.........................                                             
  EBITDA of unconsolidated joint ventures.......................          3,792        4,698        4,700        4,697
  Extraordinary loss on early extinguishment of debt............                                             
  Minority interest/(1)/........................................                                             
Less:                                                                                                        
  Gains on sale.................................................           (378)                   (1,718)            
  Equity in income of joint ventures and                                                                     
    unconsolidated subsidiaries.................................            (18)         (11)         (13)           4
                                                                         -------      -------      -------      -------
EBITDA..........................................................         $20,458      $25,705      $20,789      $12,420
                                                                         =======      =======      =======      =======
</TABLE>
 
    /(1)/  Represents the minority interest applicable to the holders of 
           limited partnership Units only.

/(5)/  "Funds from Operations" as defined by the National Association of Real
       Estate Investment Trusts ("NAREIT") means net income (computed in
       accordance with GAAP) excluding gains (or losses) from debt restructuring
       and sales of property, plus depreciation and amortization on real estate
       assets, and after adjustments for unconsolidated partnerships and joint
       ventures. The Company believes that Funds from Operations is helpful to
       investors as a measure of the performance of an equity REIT because,
       along with cash flow from operating activities, financing and investing
       activities it provides investors with an indication of the ability of the
       Company to incur and service debt, to make capital expenditures and to
       fund other cash needs. The Company's Funds from Operations are not
       comparable to Funds from Operations reported by other REITs that do not
       define that term using the current NAREIT definition. The Company
       believes that in order to facilitate a clear understanding of the
       combined historical operating results of the Prentiss Group and the
       Company, Funds from Operations should be examined in conjunction with net
       income as presented in the audited consolidated and combined financial
       statements and notes thereto of the Company and Predecessor Company
       included elsewhere in this Form 10-K. Funds from Operations does not
       represent cash generated from operating activities in accordance with
       GAAP and should not be considered as an alternative to net income as an
       indication of the Company's performance or to cash flows as a measure of
       liquidity or ability to make distributions. The Company's and Predecessor
       Company's Funds from Operations for the respective periods is calculated
       as follows:

                                       29
<PAGE>
 
<TABLE>
<CAPTION>
                                                               COMPANY
                                                              HISTORICAL                  PREDECESSOR COMPANY HISTORICAL
                                                     -----------------------------   -------------------------------------------
                                                      YEAR ENDED     OCT. 22, 1996    JAN. 1, 1996     YEAR ENDED DECEMBER 31,
                                                     DEC 31, 1997    DEC. 31, 1996   OCT. 21, 1996     1995      1994      1993
                                                     ------------    -------------   -------------   --------  --------  --------
                                                                 (IN THOUSANDS, EXCEPT PER SHARE AND PROPERTY DATA)
<S>                                                  <C>              <C>             <C>            <C>       <C>       <C>
FUNDS FROM OPERATIONS                           
Net Income..........................................     $36,946            $4,996         $ 5,118    $ 9,970   $ 9,072    $2,857
Add:                                                                                                          
  Real estate depreciation and amortization.........      21,600             2,696           5,993      7,060     5,451     3,312
  Real estate depreciation and amortization of                                                                 
   unconsolidated joint ventures....................       2,136               419             875      1,084     1,084     1,084
  Minority interest/(1)/............................       5,128               824                             
Extraordinary loss on early extinguishment of debt..         878                                             
Less:                                                                                                        
  Gains on sale.....................................        (641)                             (378)              (1,718)
                                                         -------            ------         -------    -------   -------    ------
Funds from Operations...............................     $66,047            $8,935         $11,608    $18,114   $13,889    $7,253
                                                         =======            ======         =======    =======   =======    ======
</TABLE>
                                                                               
    /(1)/ Represents the minority interest applicable to the holders of limited
          partnership Units only.

/(6)/  The Property Data includes information on the Broadmoor Austin, Park West
       C2, 3141 Fairview Park Drive and Plaza on Bachman Creek Properties only
       for the end of the periods subsequent to the Prentiss Group's acquisition
       of an ownership interest in the respective properties.

ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS
 
     The following discussion should be read in conjunction with the "Selected
Financial and Operating Data" and the historical consolidated and combined
financial statements and related notes thereto for Prentiss Properties Trust,
including the Operating Partnership and its subsidiaries (collectively, the
"Company") and the Predecessor Company, respectively. The following discussion
is based primarily on the consolidated financial statements of the Company for
the period subsequent to formation of the Company and on the combined financial
statements of the Predecessor Company for the period prior to the formation. The
combined financial statements of the Predecessor Company include (i) the results
of operations from 47 properties for the period presented, (ii) the results of
operations of the 3141 Fairview Park Drive property for the portion of the
period after a Prentiss Group (as defined below) member acquired the property,
(iii) the results of operations of the Plaza on Bachman Creek for the portion of
the period after a Prentiss Group member acquired the property, (iv) a 25%
equity interest in the Broadmoor Austin properties, (v) a 15% equity interest in
the Park West C2 property for the portion of the period in which the Prentiss
Group owned a non-controlling interest, and (vi) results of operations of the
Prentiss Properties service business conducted primarily by Prentiss Properties
Limited, Inc. ("PPL") in the periods presented. The properties owned by the
Operating Partnership (through its subsidiaries) prior to the formation of the
Company consist of Cumberland Office Park, 5307 East Mockingbird, Walnut Glen
Tower, 8521 Leesburg Pike, all of the industrial properties in Baltimore,
Maryland, except 9050 Junction Drive and San Tomas Road, all of the industrial
properties in Milwaukee, Wisconsin, except 5211 S. 3/rd/ and the Duni Building,
all of the industrial properties in Dallas, Texas, except the Six Flags
Distribution Center, and all of the industrial properties in Kansas City,
Missouri.
 
     Historical results set forth in the "Selected Financial and Operating
Data," the combined financial statements of the Predecessor Company, and the
consolidated financial statements of the Company should not be taken as an
indication of future operations of the Company.
 
OVERVIEW
 
     Prentiss Properties Trust was formed under the laws of the state of
Maryland on July 12, 1996, to be a self-administered and self-managed real
estate investment trust ("REIT"). Prentiss Properties Trust owns a limited
partnership interest and, through a wholly-owned subsidiary, Prentiss Properties
I, Inc. (the "General Partner"), a sole general partnership interest in Prentiss
Properties Acquisition Partners, L.P. (the "Operating Partnership").

                                       30
<PAGE>
 
     The Company succeeded to substantially all of the interests of PPL and
its affiliates in (i) a portfolio of office and industrial properties, and (ii)
the national acquisition, property management, leasing, development and
construction businesses of PPL and its affiliates (the "Prentiss Group").  The
acquisition, property management, leasing, development and construction
businesses are carried out by the Operating Partnership and the Company's
majority-owned affiliate, Prentiss Properties Limited, Inc. (the "Manager") of
which the Company owns a 95% non-voting economic interest.
 
     On October 22, 1996, the Company commenced operations after completing
an initial public offering (the "IPO") of 16,000,000 common shares of beneficial
interest, $0.01 par value per share ("Common Shares").  The Company issued an
additional 2,400,000 Common Shares on October 31, 1996, pursuant to the exercise
of the underwriters' over-allotment option.  The combined 18,400,000 Common
Shares were issued at a price per share of $20.00.  The Company used
approximately $87.4 million of the net proceeds and issued 1,879,897 Common
Shares of the Company for a total consideration of approximately $125.0 million
to purchase certain limited partners' interests in the Operating Partnership.
The Company contributed the remaining net proceeds of the IPO to the Operating
Partnership in exchange for additional limited partnership units in the
Operating Partnership ("Units").  Subsequent to these transactions, the Company
held an approximate 86.0% interest in the Operating Partnership.
 
     The Prentiss Group members, who, prior to the IPO, collectively served as
the general partner of the Operating Partnership, contributed to the Operating
Partnership all of their interests in the Properties (as defined below) and
certain management contracts of PPL (the "Contracts") in exchange for 3,295,995
Units.
 
     On May 5, 1997, the Company completed an offering (the "Follow-on
Offering") of 6,000,000 Common Shares of beneficial interest, $0.01 par value
per share. The Common Shares were issued at a price per share of $24.00. The
Company contributed the net proceeds of $136.8 million from the Follow-on
Offering to the Operating Partnership in exchange for additional Units.
 
     On October 22, 1997, the Company issued 524,180 Units in conjunction with
the acquisition of 15 Class "A" office Properties (the "Terramics Properties").
The Units were valued at $14.2 million. The purchase price of the Terramics
Properties totaled approximately $134 million, including approximately $14
million of debt assumed, $106 million in cash and the aforementioned issuance of
Units valued at $14.2 million.
 
     On November 24, 1997, the Company completed an offering (the "Second 
Follow-on Offering") of 6,900,000 Common Shares of beneficial interest, $0.01
par value per share. The 6,900,000 Common Shares were issued at a net price per
share of $25.00 for total net proceeds of $172.5 million. The Company
contributed the net proceeds of the Second Follow-on Offering to the Operating
Partnership in exchange for additional Units.
 
     On December 2, 1997, the Company executed an agreement (the "SCPG
Agreement") to issue and sell 3,773,585 shares of Series A Cumulative
Convertible Redeemable Preferred Shares of beneficial interest, $.01 par value
(the "Series A Convertible Preferred Shares") to Security Capital Preferred
Growth, Incorporated ("SCPG") for a total price of approximately $100 million,
or $26.50 per share. Beginning January 1, 1999, and upon the occurrence of
certain events prior to that date, the Series A Convertible Preferred Shares are
convertible into the Company's Common Shares. On December 30, 1997, the Company
sold 2,830,189 Series A Convertible Preferred Shares to SCPG pursuant to the
SCPG Agreement, and expects to issue and sell the remaining 943,396 Series A
Convertible Preferred Shares under the SCPG Agreement on or before March 31,
1998. In connection with the SCPG Agreement, the Company exempted SCPG from the
Ownership Limitation (as defined herein) on the condition that SCPG not own more
than 11% of the number of outstanding Common Shares. The Company also agreed to
register the Series A Convertible Preferred Shares, including any Common Shares
received upon conversion of the Series A Convertible Preferred Shares, in
December 1998.
 
 

                                       31
<PAGE>
 

     Upon completion of the IPO and certain related transactions (collectively,
the "Formation Transactions"), the Company owned 87 Properties (the "Initial
Properties"), which consisted of 28 office (the "Initial Office Properties") and
59 industrial (the "Initial Industrial Properties") containing an aggregate of
8.9 million net 

                                       32
<PAGE>
 
rentable square feet. Between the closing of the IPO and December 31, 1997, the
Company acquired 74 additional Properties (the "Acquired Properties"). As of
December 31, 1997 the Company owned 161 operating Properties consisting of 84
office and 77 industrial Properties (collectively, the "Properties") containing
16.8 million net rentable square feet (excluding the development of 1.3 million
square feet) and located in 18 major markets throughout the United States.

     The Acquired Properties consist of 56 Class "A" suburban office Properties
(the "Acquired Office Properties") totaling approximately 5.3 million square
feet and 18 suburban industrial Properties (the "Acquired Industrial
Properties") totaling approximately 2.6 million square feet.  The Acquired
Office Properties are located in the markets of Phoenix, Los Angeles, Oakland,
Sacramento, San Diego, Denver, metropolitan Washington, D.C., Atlanta, Chicago,
suburban Baltimore, suburban Detroit, suburban Philadelphia, Northern Virginia;
and Dallas.  The Acquired Industrial Properties are located in the markets of
Chicago, Milwaukee, Los Angeles, San Diego, suburban Baltimore, and Dallas.  The
purchase price of the Acquired Properties totaled approximately $767 million,
which was funded principally with borrowings under the Line of Credit (as
defined below), proceeds from the Company's securities offerings and other
indebtedness incurred or assumed directly by the Company and its subsidiaries.

RESULTS OF OPERATIONS

     The results of operations for the years ended December 31, 1997, 1996 and
1995 include the operations of the Company and Predecessor Company,
respectively.  Consequently, the comparisons of the years provide only limited
information regarding the operations of the Company as currently constituted.

Comparison of Year Ended December 31, 1997 to Year Ended December 31, 1996

     Rental revenues increased by $86.5 million, or 213.3%, to $127.1 million
from $40.6 million primarily as a result of the Properties acquired concurrent
with and subsequent to the Company's IPO.  As described above, the Predecessor
Company includes only results of operations of 47 Properties for the full fiscal
year.  The rental income for the combined 47 Properties increased by $2.4
million, or 8.1%, from the year ended December 31, 1996 to the year ended
December 31, 1997.  Rental income at the 3141 Fairview Park Property, acquired
in February 1996, and the 113 Properties acquired concurrent with and subsequent
to the IPO account for a $84.1 million increase in rental income.

     Property operating and maintenance expenses increased by $19.4 million, or
174.0%, primarily as a result of the Properties acquired concurrent with or
subsequent to the Company's IPO.  The property operating and maintenance
expenses for the 47 Predecessor Company Properties increased by approximately
$.5 million, or 5.5%, from the fiscal year ended December 31, 1996 to the fiscal
year ended December 31, 1997.  Property operating and maintenance expenses at
the 3141 Fairview Park Property and the 113 Properties acquired concurrent with
or subsequent to the IPO increased by approximately $18.9 million from the
fiscal year ended December 31, 1996 to the fiscal year ended December 31, 1997.

     Real estate taxes increased by $9.5 million, or 223.6%, primarily as a
result of the Properties acquired concurrent with or subsequent to the Company's
IPO. The real estate tax expense for the 47 Predecessor Companies Properties
decreased by approximately $.1 million, or 2.6%, from the year ended December
31, 1996 to the year ended December 31, 1997. The 3141 Fairview Park Property
combined with the 113 Properties acquired concurrent with or subsequent to the
IPO account for a $9.6 million increase in real estate tax expense.

     Interest expense increased by $15.8 million, or 298.1%, primarily as a
result of the increase in debt on real estate from $128.8 million at December
31, 1996 to $420.0 million at December 31, 1997.  The increase in debt service
is attributable to borrowings incurred and assumed in connection with the 113
Properties acquired concurrent with or subsequent to the IPO.

     The decrease in management fees and development, leasing, sale and other
fees as well as general and administrative expenses and personnel costs for the
year ended December 31, 1997 from the year ended December 31, 1996 is primarily
attributable to the Company's use of the equity method of accounting for the
majority of the Company's third-party management service business, and thus, the
inclusion of the third-party management service operations in the equity in
income of joint venture and unconsolidated subsidiaries line item for the year

                                       33
<PAGE>
 
ended December 31, 1997.  The Predecessor Company's third-party management
services are combined into the operations of the Predecessor Company and
therefore included on a gross basis in the line items (i) management fees; (ii)
development, leasing, sale and other fees; (iii) general and administrative; and
(iv) personnel costs.

Comparison of Year Ended December 31, 1996 to Year Ended December 31, 1995

     Rental revenues increased by $11.1 million, or 37.9%, due primarily to the
Properties acquired after December 31, 1995.  Revenues for the Properties
acquired prior to December 31, 1995 increased by $.6 million, or 2.0%.

     With respect to Properties acquired prior to December 31, 1995, property
operating and maintenance expenses increased by $.6 million for the year ended
December 31, 1996 from the year ended December 31, 1995, $.3 million of which
related to bad debt expense recognized on a bankrupt tenant.  The additional
costs related primarily to the Properties with increased rental income during
1996.

     With respect to Properties acquired prior to December 31, 1995, real estate
taxes increased by $.3 million, resulting primarily from increased property tax
appraisals received on the Cumberland Office Park and Walnut Glen Tower
Properties.

LIQUIDITY AND CAPITAL RESOURCES

     Cash and cash equivalents were $7.1 million and $7.2 million at December
31, 1997 and December 31, 1996, respectively. The decrease in cash and cash
equivalents is primarily a result of cash flows used in investing activities
exceeding cash flows provided by operating and financing activities. Net cash
provided by operating activities was $61.5 million for the year ended December
31, 1997 compared to the $19.4 million for the year ended December 31, 1996. The
increase is primarily due to the cash flows from operations of the 3141 Fairview
Park Property and the 113 Properties acquired concurrent with or subsequent to
the IPO.

     Net cash used in investing activities increased from $386.8 million for the
year ended December 31, 1996 to $660.3 million for the year ended December 31,
1997.  This increase is due primarily to cash paid for the Properties acquired
concurrent with or subsequent to the IPO.

     Net cash provided by financing activities of $598.7 million for the year
ended December 31, 1997 increased from $375.2 million for the year ended
December 31, 1996.  This increase is primarily attributable to proceeds from
securities offerings, mortgage loans and other indebtedness incurred to fund the
acquisition of the 66 Properties acquired in 1997.

     Upon the closing of the IPO, the Company closed a three-year, $100 million
revolving credit facility (the "Line of Credit") with Bank One, Texas, N.A. and
NationsBank of Texas, N.A.  Initially, borrowings under the Line of Credit bore
interest at 30-day, 60-day or 90-day LIBOR at the option of the Company, plus
200 basis points per annum and were collateralized by first mortgage liens on
certain of the Properties.  On January 24, 1997, the Company increased the
amount available under its Line of Credit from $100 million to $150 million and
reduced the interest rate on borrowings under the Line of Credit from LIBOR plus
200 basis points to LIBOR plus 175 basis points. On December 31, 1997, the
Company replaced the Line of Credit with a new $300 million unsecured line of
credit with a group of 12 banks (the "New Credit Facility"). The New Credit
Facility reduced the interest rate on borrowings from LIBOR plus 175 basis
points to LIBOR plus 137.5 basis points. The New Credit Facility is unsecured
and has a term of three years. Additionally, the Company is required to pay an
unused commitment fee of 20 basis points per annum if the unused portion of the
New Credit Facility is greater than the related balance outstanding. The fee is
reduced to 15 basis points per annum if the unused portion is less than the
balance outstanding. The fee is computed on a quarterly basis. No commitment fee
was paid for the year ended December 31, 1997. At December 31, 1997, the Company
had no borrowings outstanding under the New Credit Facility.

     In February 1997, the Company closed a 10-year fixed rate mortgage loan
with an initial outstanding balance of $180.1 million (the "Mortgage Loan").
The Mortgage Loan is collateralized by liens on 53 Properties.  The Mortgage
Loan was obtained from an affiliate of Lehman Brothers Inc. ("Lehman").  Under
the terms of the Mortgage Loan, the Company pays interest only at a rate of
approximately 7.58% until the Mortgage Loan's maturity in February 2007. A
portion of the proceeds from the Mortgage Loan was used to fund the acquisition
of the Properties acquired subsequent to the funding of the Mortgage Loan.

                                       34
<PAGE>
 
     In July 1997, the Company closed on a short-term variable rate loan (the
"Acquisition Loan").  The Proceeds were used to fund the purchase of the
Mortgage Note Receivable (as described herein at Note 5 of the Financial
Statements) and repay a portion of the outstanding balance on the Line of
Credit. The Acquisition Loan is collateralized by 16 Properties, which had an
initial maturity in August 1998 and subsequently extended to January 1999 and
initially bore interest at a rate of LIBOR plus 165 basis points. On October 10,
1997, the interest rate on the Acquisition Loan was reduced to LIBOR plus 125
basis points. As of December 31, 1997, the Company had drawn the entire $120
million available under the Acquisition Loan. The Company anticipates converting
the Acquisition Loan to a multi-year facility and has entered into a seven-year
interest rate swap locking in cost of funds of 6.25% (before the spread over
LIBOR) on $110 million (the "Interest Rate Swap"). The Interest Rate Swap
consists of two separate agreements intended to manage the relative mix of the
Company's debt between fixed and variable rate instruments. The Interest Rate
Swap agreement modifies a portion of the interest characteristics of the
Company's Acquisition Loan debt without an exchange of the underlying principal
amount and effectively converts variable rate debt to fixed rate debt. The fixed
rates to be paid, the effective fixed rate, and the variable rate to be received
by the Company are summarized in the following table:

<TABLE>
<CAPTION>
                                                         SWAP RATE 
                                                         RECEIVED   
                   SWAP RATE PAID   EFFECTIVE FIXED    (VARIABLE) AT
NOTIONAL AMOUNT       (FIXED)            RATE            12/31/97           SWAP MATURITY
---------------    --------------   ---------------    -------------        -------------   
<S>                <C>              <C>                <C>                <C>
$50 million            6.253%           7.503%             5.718%         September 30, 2004
$60 million            6.248%           7.498%             5.718%         September 30, 2004
</TABLE>

     The differences to be paid or received by the Company under the terms of
the Interest Rate Swap agreement are accrued as interest rates change and
recognized as an adjustment to interest expense by the Company pursuant to the
terms of the two agreements and will have a corresponding effect on its future
cash flows.  Agreements such as these contain a credit risk that the
counterparties may be unable to meet the terms of the agreement.  The Company
minimizes that risk by evaluating the creditworthiness of its counterparties,
which is limited to major banks  and financial institutions, and does not
anticipate non-performance by the counterparties.

     On December 5, 1997, the Company closed a $60 million, six-year, non-
recourse term loan, collateralized by 11 Properties, at a rate of 6.80%, (the
"CIGNA Loan").

     The Company is obligated under seven mortgage notes each collateralized by
an individual Property (the "Property Mortgage Loans"). These loans bear
interest at rates ranging from 7.27% to 8.63% and mature at varying dates from
April 1998 to April 2014. The Company is also obligated under a mortgage note
collateralized by the Broadmoor Austin Properties in which the Company, through
the Operating Partnership, owns an approximate 50% general partner interest in
the entity owning these Properties. The Company's approximate 50% interest is
accounted for under the equity method of accounting.

     In addition, the Company is obligated under three loans (the "Construction
Loans") to fund the construction and development of four properties.  The
Construction Loans provide for total funding of $44.5 million, of which $10.1
million had been drawn at December 31, 1997.  The Construction Loans bear
interest at varying rates from 7.28% to 7.38% and mature at dates from August
2000 to December 2000.

The following table sets forth the Company's mortgage debt as of December 31,
1997:
                                 MORTGAGE DEBT

<TABLE>
<CAPTION>
                                                                                                                           ANNUAL
                                              PRINCIPAL          INTEREST                                                INTEREST
            PROPERTY(IES)                       AMOUNT             RATE          AMORTIZATION        MATURITY             PAYMENT
--------------------------------------    ------------------   -------------     ------------   ------------------    -----------
<S>                                       <C>                  <C>               <C>            <C>                   <C>
Mortgage Loan.........................     $180,100,000/(1)/        7.58%            None       February 27, 2007     $13,651,580
Acquisition Loan......................      120,000,000/(2)/        7.46%/(3)/       None       January 1, 1999         8,952,000
PacifiCare Building (FHP).............        6,000,000             7.30%            None       November 1, 2000          438,000
Walnut Glen Tower.....................       10,000,000             7.50%            None       January 31, 2001          750,000
Crescent Centre.......................       12,000,000             7.95%            None       March 1, 2004             954,000
Bachman Creek - West..................        3,060,050             8.63%           25 yr       November 30,2002          264,082
</TABLE> 

                                       35
<PAGE>
 
<TABLE> 

<S>                                       <C>                  <C>               <C>            <C>                   <C>
Broadmoor Austin Properties/(4)/......       70,000,000             9.75%            None       April 1, 2001           6,825,000
Southpoint (V)........................        5,500,000             8.22%/(5)/       None       April 10, 1998            452,100
Southpoint (III)......................        8,200,960             7.75%           20 yr       April 14, 2014            635,574
CIGNA Loan /(6)/......................       60,000,000             6.80%            None       December 10, 2003       4,080,000
Highland Court........................        5,118,411             7.27%           25 yr       April 1, 2006             372,108
CEP Building K........................        3,040,643             7.47%/(7)/       None       August 1, 2000            227,136
Exec. Center Del Mar..................        3,614,916             7.37%/(8)/       None       December 14, 2000         266,419
Westpoint.............................        3,395,397             7.37%/(8)/       None       November 15,  2000        250,241
                                          ------------------   -------------     ------------   ------------------    -----------
Total/Weighted Average................   $  490,030,377             7.78%                                             $38,118,240
                                          =================    =============                                          ===========
</TABLE>

(1)  The Mortgage Loan is collateralized by the following 53 Properties: Park
     West E1, Park West E2, One Northwestern Plaza, 3141 Fairview Park Drive,
     O'Hare Plaza II, 1717 Deerfield, 2411 Dulles Corner Road, 4401 Fair Lakes
     Court, Kansas City Industrial Properties (seven Properties), certain of the
     Los Angeles Industrial Properties (18 Properties), certain of the Milwaukee
     Industrial Properties (17 Properties), and the certain of the Chicago
     Industrial Properties (three Properties).
(2)  The Acquisition Loan is collateralized by the following 16 Properties:
     Natomas Corporate Center (six Properties), The Academy (three Properties),
     Seven Mile Crossing (two Properties), and Corporetum Office Campus (five
     Properties).
(3)  Represents the weighted average interest rate for the Interest Rate Swap of
     $50 million at an effective rate of 7.503% and $60 million at an effective
     rate of 7.498%.  Additionally, rate shown reflects a variable rate on $10
     million equal to LIBOR + 1.25%; on December 31, 1997, LIBOR was equal to
     5.72%.
(4)  The Company, through the Operating Partnership, owns an approximate 50%
     general partnership interest in the entity that owns the Broadmoor Austin
     Properties, which interest is accounted for under the equity method of
     accounting.  The amount shown reflects the Company's proportionate share of
     the mortgage indebtedness collateralized by the Properties.
(5)  Represents a variable rate equal to LIBOR + 2.50%; on December 31, 1997,
     LIBOR was equal to 5.72%.
(6)  The CIGNA Loan is collateralized by the following 11 Properties: Lake
     Center (two Properties), Southpoint (I and II), Valleybrooke (five
     Properties) and Woodland Falls (I and IV).
(7)  Represents a variable rate equal to LIBOR + 1.75%; on December 31, 1997,
     LIBOR was equal to 5.72%.
(8)  Represents a variable rate equal to LIBOR + 1.65%; on December 31, 1997,
     LIBOR was equal to 5.72%.

     The Company's policy is to limit combined indebtedness plus its pro rata
share of joint venture debt and construction loans so that at the time such debt
is incurred, it does not exceed 50% of the Company's total market capitalization
(the "Debt Limitation").  As of December  31, 1997, the Company had outstanding
total indebtedness, including its pro rata share of joint venture debt and the
Construction Loans of approximately $490 million, or approximately 30.57% of
total market capitalization based on a common share price of $27.94 per Common
Share.  As of December  31, 1997, the Company had the approximate capacity to
borrow up to an additional $1.1 billion under the Debt Limitation.  The amount
of indebtedness that the Company may incur, and the policies with respect
thereto, are not limited by the Company's Declaration of Trust and Bylaws, and
are solely within the discretion of the Company's Board of Trustees.

     The Company's Properties require periodic investments of capital for 
tenant-related capital expenditures and for general capital improvements. For
the year December 31, 1997, the Company's recurring non-incremental revenue
generating capital expenditures totaled $6.9 million. The Company's recurring
non-incremental revenue-generating capital expenditures exclude approximately
$2.0 million related to the Walnut Glen Tower Property for the year ended
December 31, 1997, which were reserved during the formation of the Company.

     The Company has considered its short-term liquidity needs and the adequacy
of adjusted estimated cash flows and other expected liquidity sources to meet
these needs. The Company believes that its principal short-term liquidity needs
are to fund normal recurring expenses, debt service requirements and the minimum
distribution required to maintain the Company's REIT qualification under the
Code. The Company anticipates that these needs will be fully funded from the
Company's cash flows provided by operating activities and, when necessary to
fund shortfalls resulting from the timing of collections of accounts receivable
in the ordinary course of business, from the New Credit Facility, leasing
development and construction business and from the Manager.  The Manager's sole
sources of income are fees generated by its office and industrial real estate
management, leasing, development and construction business.

     The Company expects to meet its long-term liquidity requirements for the
funding of activities such as development, property acquisitions, scheduled debt
maturities, major renovations, expansions and other non-recurring capital
improvements through long-term secured and unsecured indebtedness and through
the issuance of additional debt and equity securities.  The Company also intends
to use proceeds from the New Credit Facility to fund property acquisitions,
development, redevelopment, expansions and capital improvements on an interim
basis.

     The Company expects to make distributions to its shareholders primarily
based on its distributions from the Operating Partnership.  The Operating
Partnership's income will be derived primarily from lease revenues 

                                       36
<PAGE>
 
from the Properties and, to a limited extent, from fees generated by its office
and industrial real estate management service business.

FUNDS FROM OPERATIONS

     "Funds from Operations" as defined by the National Association of Real
Estate Investment Trusts ("NAREIT") means net income (computed in accordance
with generally accepted accounting principles), excluding gains (or losses) from
debt restructuring and sales of property, plus depreciation and amortization,
and after adjustments for unconsolidated partnerships and joint ventures. The
Company believes that in order to facilitate a clear understanding of its
operating results, Funds from Operations should be examined in conjunction with
net income as presented in the audited consolidated and combined financial
statements of the Company and Predecessor Company, respectively. Funds from
Operations does not represent cash generated from operating activities in
accordance with generally accepted accounting principles and should not be
considered as an alternative to net income as an indication of the Company's
performance or to cash flows as a measure of liquidity or ability to make
distributions.

<TABLE>
<CAPTION>
                                                           (in thousands)
                                                                                              PREDECESSOR COMPANY HISTORICAL
                                                               COMPANY               -----------------------------------------------
                                                             HISTORICAL                              YEAR ENDED DECEMBER 31,
                                                 -------------------------------     -----------------------------------------------

                                                     YEAR ENDED    OCT. 22, 1996     JAN. 1, 1996
                                                   DEC. 31, 1997   DEC. 31, 1996     OCT. 21, 1996      1995       1994       1993
                                                   --------------  -------------     -------------   ----------  ---------  --------

<S>                                                <C>             <C>              <C>              <C>         <C>        <C>
FUNDS FROM OPERATIONS
Net Income.......................................        $36,946          $4,996           $ 5,118      $ 9,970   $ 9,072     $2,857

Add:                                                                              
 Real estate depreciation and amortization.......         21,600           2,696             5,993        7,060     5,451      3,312

 Real estate depreciation and amortization of                                     
  unconsolidated joint ventures..................          2,136             419               875        1,084     1,084      1,084

 Minority interest/(1)/..........................          5,128             824  
 Loss on early extinguishment of debt............            878                  
Less:                                                                             
     Gains on sale...............................           (641)                             (378)                (1,718)
                                                         -------          ------           -------      -------   -------     ------

Funds from Operations............................        $66,047          $8,935           $11,608      $18,114   $13,889     $7,253

                                                         =======          ======           =======      =======   =======     ======

</TABLE>

/(1)/ Represents the minority interest applicable to the holders of limited
      partnership Units only.

     The Company's share of Funds from Operations increased by $42.0 million for
the year ended December 31, 1997 from the year ended December 31, 1996, and
increased by $2.1 million for the year ended December 31, 1996, from the year
ended December 31, 1995 as a result of the factors discussed in the analysis of
operating results.

IMPACT OF THE YEAR 2000 ISSUE

     The Year 2000 ("Y2K") compliance problem is the result of computer
programs designed to use two digit rather than four digit years. Thus, the year
1998 is represented as 98 and the year 2000 would be represented as 00. This
could be interpreted as either 1900 or 2000. To systems that have Y2K related
issues, the time may seem to have reverted back 100 years. Systems, equipment
and software with exposure to Y2K related problems exist not only in
computerized information systems but also in building operating systems such as
elevators, alarm systems, energy management systems, phone systems, and numerous
other systems and equipment. Failure to adequately identify and correct Y2K
related problems could result in a systems failure or malfunction with potential
adverse effects including personal injury, property damage, and disruption of
operations. Any or all of these failures could materially and adversely affect
our business, financial condition, or results of operations.

     Due to the exposure and potential liabilities inherent in both the
computerized information systems and non-information systems with imbedded
technology that we use internally, in September 1997, we created a Y2K committee
headed by the Vice President of Information Systems and co-chaired by the Vice
President of National Property Operations. 

     The total costs associated with required modifications to become Y2K
compliant are not expected to be material to our financial position. We
currently estimate the total Y2K readiness costs will be between [$500,000 and
$600,000]. These costs are net of our personnel costs that are considered to be
part of normal operating costs. Our readiness program is an ongoing process and
the estimates of costs and completion dates for the various categories described
above are subject to material change.

     Failure to correct a material Y2K problem could result in an interruption
in, or a failure of, certain normal business activities or operations that could
materially and adversely affect our results of operations, liquidity, and
financial position. Much of the uncertainty lies with the ability of critical
suppliers, service providers, contractors, and clients to fully remedy their Y2K
problems. Our Y2K plan should significantly reduce our level of uncertainty
regarding the Y2K problem.

     The most reasonable and likely worst case scenario might be the failure of
an energy management system in a building. This could adversely affect the
environmental conditions of the occupied space, thus creating discomfort and
inconvenience to the tenants until the condition could be manually corrected.
Persistence of this problem for a long period of time could result in an
increase in operating costs for the building until the energy management system
is restored to proper operations.

     We are making substantial effort to eliminate the exposure to any Y2K
issues; however, no one can accurately predict how many Y2K problem-related
failures will occur or the severity, duration, or financial consequences of
these potential failures, especially with regard to third-party systems. As a
result, a significant number of operational inconveniences and inefficiencies
facing us and our clients may divert our management's time, attention,
financial, and human resources from its ordinary business activities. In
addition, system failures may require significant efforts by us and our clients
to prevent or alleviate material business disruption.

                                       37
<PAGE>
 
RECENTLY ISSUED ACCOUNTING STANDARDS

     In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income"
and FAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information."

     FAS No. 130 establishes standards for reporting comprehensive income by
showing changes in the amounts of those items that affect comprehensive income
on the face of the financial statements.  FAS No. 130 does not require a
specific format for the financial statement in which comprehensive income is
reported, but does require that an amount representing total comprehensive
income be reported in that statement.  FAS No. 130 is effective for fiscal years
beginning after December 15, 1997 and requires reclassification of earlier
financial statements for comparative purposes.  The Company believes that upon
implementation, FAS No. 130 will not have a material impact on the financial
statements of the Company.

     FAS No. 131 requires disclosure of segment data in an entity's annual
financial statements and selected segment information in their quarterly report
to shareholders.  FAS No. 131 also requires entity-wide disclosures about the
products and services an entity provides, the material countries in which it
holds assets and reports revenues, and its major customers.  FAS No. 131
supersedes FASB Statement 14, "Financial Reporting for Segments of a Business
Enterprise," and is effective for fiscal years beginning after December 15,
1997.  The Company believes that upon implementation, FAS No. 131 will not have
a material impact on the financial statements of the Company.

POTENTIAL CHANGES IN LAW REGARDING OWNERSHIP OF SUBSIDIARIES

     On February 2, 1998, the Clinton Administration released a summary of its
proposed budget plan for fiscal year 1999, which contained provisions that, if
enacted, would affect REITs, including the Company (the "REIT Proposals").  One
such provision would prohibit REITs from owning, directly or indirectly, more
than 10% of the voting power or value of all classes of a C corporation's stock
(other that the stock of a qualified REIT subsidiary) after the effective date
of such proposal.  Because the Company owns more than 10% of the value of the
Manager, the REIT Proposals could adversely affect the manner in which the
Company structures its ownership of the Manager and the magnitude of the
property management activities conducted by the Company in the future.  It is
currently impossible to determine whether the REIT Proposals will be enacted
into legislation and, if enacted, the impact that the final form of such
legislation may have on the Company.

INFLATION

     Most of the leases on the Properties require tenants to pay increases in
operating expenses, including common area charges and real estate taxes, thereby
reducing the impact on the Company of the adverse effects of inflation. Leases
also vary in term from one month to 15 years, further reducing the impact on the
Company of the adverse effects of inflation.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company has entered into a seven-year interest rate swap locking in
cost of funds of 6.25% (before the spread over LIBOR) on $110 million (the
"Interest Rate Swap").  The Interest Rate Swap consists of two separate
agreements intended to manage the relative mix of the Company's debt between
fixed and variable rate instruments.  The Interest Rate Swap agreement modifies
a portion of the interest characteristics of the Company's Acquisition Loan debt
without an exchange of the underlying principal amount and effectively converts
variable rate debt to fixed rate debt.  The fixed rates to be paid, the
effective fixed rate, and the variable rate to be received by the Company are
summarized in the following table:

<TABLE>
<CAPTION>
                                                         SWAP RATE
                   SWAP RATE PAID   EFFECTIVE FIXED      RECEIVED
 NOTIONAL AMOUNT      (FIXED)            RATE          (VARIABLE) AT      SWAP MATURITY
 ---------------   --------------   ---------------      12/31/97         --------------
                                                       ------------
 
<S>                <C>              <C>               <C>                 <C>
$50 million            6.253%           7.503%            5.718%           September 30, 2004
$60 million            6.248%           7.498%            5.718%           September 30, 2004
</TABLE>

                                       38
<PAGE>
 
     The differences to be paid or received by the Company under the terms of
the Interest Rate Swap agreements are accrued as interest rates change and
recognized as an adjustment to interest expense by the Company pursuant to the
terms of the two agreements and will have a corresponding effect on its future
cash flows.  Agreements such as these contain a credit risk that the
counterparties may be unable to meet the terms of the agreement.  The Company
minimizes that risk by evaluating the creditworthiness of its counterparties,
which is limited to major banks  and financial institutions, and does not
anticipate nonperformance by the counterparties.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The Financial Statements and Financial Statement Schedule on appear at page
F-1 to page F-30 of this Form 10-K.

ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURES

     None.

                                   PART III

ITEM 10.  TRUSTEES AND EXECUTIVE OFFICERS OF THE COMPANY

     The information regarding the Trustees and Executive Officers of the
Company is incorporated herein by reference to the captions "Proposal One--
Election of Class II Trustees," "Trustees, Executive Officers and Compensation"
and "Compliance with Section 16(a) of the Exchange Act of 1934", "Proposal Two -
Amendment to the 1996 Plan" and "Proposal Three - Amendment to the Trustees
Plan" in the Company's definitive proxy statement to be filed with respect to
its Annual Meeting of Shareholders.

ITEM 11.  EXECUTIVE COMPENSATION

     The information regarding Executive Compensation is incorporated herein by
reference to the captions "Trustees, Executive Officers and Compensation" in the
Company's definitive proxy statement to be filed with respect to its Annual
Meeting of Shareholders.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information regarding Security Ownership of Certain Beneficial Owners
and Management is incorporated herein by reference to the captions "Beneficial
Ownership of the Company's Common Shares" in the Company's definitive proxy
statement to be filed with respect to its Annual Meeting of Shareholders.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information regarding Certain Relationships and Related Transactions is
incorporated herein by reference to the caption "Certain Relationships and
Related Transactions" in the Company's definitive proxy statement to be filed
with respect to its Annual Meeting of Shareholders.

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)  The following Financial Statements, Financial Statement Schedule and
Exhibits are filed as part of this report:

                                       39
<PAGE>
 
(1)  Financial Statements
 
     .    Report of Independent Accountants
     .    Consolidated Balance Sheets of Prentiss Properties Trust (the
          "Company") as of December 31, 1997 and December 31, 1996
     .    Consolidated Statements of Income of the Company for the Year Ended
          December 31, 1997 and for the Period October 22, 1996 (inception of
          operations) to December 31, 1996 and Combined Statements of Income for
          the Predecessor Company for the Period January 1, 1996 to October 21,
          1996, and the Year Ended December 31, 1995
     .    Consolidated Statement of Changes in Shareholders' Equity of the
          Company for the Year Ended December 31, 1997 and for the Period
          October 22, 1996 (inception to operations) to December 31, 1996 and
          Combined Statements of Changes in Equity of the Predecessor Company
          for the Period January 1, 1996 to October 21, 1996 and the Year Ended
          December 31, 1995
     .    Consolidated Statement of Cash Flows of the Company for the Year Ended
          December 31, 1997 and for the Period October 22, 1996 (inception of
          operations) to December 31, 1996 and Combined Statements of Cash Flows
          of the Predecessor Company for the Period January 1, 1996 to October
          21, 1996, and the Year Ended December 31, 1995
     .    Notes to Consolidated and Combined Financial Statements

(2)  Financial Statement Schedule
     .    Schedule III:  Real Estate and Accumulated Depreciation


(3)  Exhibits

EXHIBIT NO.                 DESCRIPTION
-----------                 -----------
   3.1        -- Form of Amended and Restated Declaration of Trust of the
                 Registrant (filed as Exhibit 3.1 to the Company's Registration
                 Statement of Amendment No. 1 of Form S-11, File No. 333-09863,
                 and incorporated by reference herein).
   3.2        -- Bylaws of the Registrant (filed as Exhibit 3.2 to the Company's
                 Registration Statement on Amendment No. 1 of Form S-11, File
                 No. 333-09863, and incorporated by reference herein).
   3.3        -- Articles Supplementary, dated December 18, 1997, Classifying
                 and Designating a Series of Preferred Shares of Beneficial
                 Interest as Series A Cumulative Convertible Redeemable
                 Preferred Shares of Beneficial Interest and Fixing Distribution
                 and Other Preferences and Rights of Such Shares (filed as
                 Exhibit 3.1 to the Company's Current Report on Form 8-K, filed
                 January 15, 1998, SEC File No. 001-14516). 
   3.4        -- Articles Supplementary, dated February 17, 1998, Classifying
                 and Designating a Series of Preferred Shares of Beneficial
                 Interest as Junior Participating Cumulative Convertible
                 Redeemable Preferred Shares of Beneficial Interest, Series B,
                 and Fixing Distribution and Other Preferences and Rights of
                 Such Shares (filed as an Exhibit to the Company's Registration
                 Statement on Form 8-A filed on February 17, 1998, SEC File
                 No.000-23813).
   4.1        -- Form of Common Share Certificate (filed as Exhibit 4.1 to the
                 Company's Registration Statement on Amendment No. 1 of Form S-
                 11, File No. 333-09863, and incorporated by reference herein).
   4.2        -- Rights Agreement, dated February 6, 1998, between the Company
                 and First Chicago Trust Company of New York, as Rights Agent
                 (filed as an Exhibit 4.1 to the Company's Registration
                 Statement on Form 8-A filed on February 17, 1998, File No.
                 000-23813).

                                       40
<PAGE>
 
   4.3        -- Form of Rights Certificate (included as Exhibit A to the Rights
                 Agreement (Exhibit 4.2)).
   10.1       -- Second Amended and Restated Agreement of Limited Partnership
                 (included as exhibit 10.2 in the Company's Annual Report on
                 Form 10-K, filed March 25, 1997). 
   10.2       -- First Amendment to Second Amended and Restated Agreement of
                 Limited Partnership of Prentiss Properties Acquisition
                 Partners, L.P. (filed as Exhibit 4.1 to the Company's Current
                 Report on Form 8-K, filed January 15, 1998).
   10.3       -- Credit Agreement, dated October 6, 1997, among Prentiss
                 Properties Acquisition Partners, L.P., as Borrower, Nationsbank
                 of Texas, N.A., as Administrative Agent and Lender, Bank One,
                 Texas, N.A., as Documentation Agent and Lender, Crestar Bank,
                 as Lender, Comerica Bank, as Lender, and First National Bank of
                 Chicago, as Lender (filed as Exhibit 99.1 to the Company's
                 Current Report on Form 8-K filed November 3, 1997).
   10.4       -- Credit Agreement, dated December 30, 1997, among Prentiss
                 Properties Acquisition Partners, L.P., as Borrower, each of the
                 lenders that are a signatory therein, Bank One, Texas, N.A., as
                 Administrative Agent, and Nationsbank of Texas, N.A., as
                 Syndication Agent (filed as Exhibit 10.4 to the Company's
                 Current Report on Form 8-K filed February 10, 1998).
   10.5       -- Form of Employment Agreement for Michael V. Prentiss (filed as
                 Exhibit 10.3 to the Company's Registration Statement on
                 Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.6       -- Form of Employment Agreement for Thomas F. August (filed as
                 Exhibit 10.4 to the Company's Registration Statement on
                 Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.7       -- Form of Agreement Not to Compete for Richard B. Bradshaw(filed
                 as Exhibit 10.5 to the Company's Registration Statement on
                 Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.8       -- Form of Agreement Not to Compete for Dennis J. DuBois (filed as
                 Exhibit 10.6 to the Company's Registration Statement on
                 Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.9       -- Contribution Agreement by and between the Operating Partnership
                 and PPL (filed as Exhibit 10.7 to the Company's Registration
                 Statement on Amendment No. 1 of Form S-11, File No. 333-09863,
                 and incorporated by reference herein).
   10.10      -- Agreement of Purchase and Sale of Partnership Interest by and
                 Among Prentiss Properties Austin, L.P. and PPL (filed as
                 Exhibit 10.8 to the Company's Registration Statement on
                 Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.11      -- Agreement of Purchase and Sale of Partnership Interests by and
                 Among Prentiss Properties Burnett, Inc., Prentiss Properties
                 Burnett II, Inc. and PPL (filed as Exhibit 10.9 to the
                 Company's Registration Statement on Amendment No. 1 of Form 
                 S-11, File No. 333-09863, and incorporated by reference 
                 herein).
   10.12      -- Agreement of Purchase and Sale of Partnership Interest and
                 Option Agreement by and Between 11,000 Burnet Road Corporation
                 and PPL (filed as Exhibit 10.10 to the Company's Registration
                 Statement on Amendment No. 1 of Form S-11, File No. 333-09863,
                 and incorporated by reference herein).
   10.13      -- Agreement of Purchase and Sale of Partnership Interests by and
                 Among Fairview Eleven, Inc., the Prentiss Principals and PPL
                 (filed as Exhibit 10.11 to the Company's Registration Statement
                 on Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.14      -- Agreement of Purchase and Sale of Partnership Interest by and
                 Between Prentiss Properties Itasca, L.P. and PPL (filed as
                 Exhibit 10.12 to the Company's Registration Statement on
                 Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).

                                       41
<PAGE>
 
   10.15      -- Agreement of Purchase and Sale of Partnership Interests by and
                 Between Prentiss O'Hare Illinois, Inc., Prentiss O'Hare
                 Illinois II, Inc. and PPL (filed as Exhibit 10.13 to the
                 Company's Registration Statement on Amendment No. 1 of Form 
                 S-11, File No. 333-09863, and incorporated by reference
                 herein).
   10.16      -- Agreement of Purchase and Sale of Partnership Interests by and
                 Between Prentiss Properties C-2 Investors, L.P. and PPL (filed
                 as Exhibit 10.14 to the Company's Registration Statement 
                 on Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.17      -- Agreement of Sale of Partnership Interest by and Among New York
                 Life Insurance Company, Prentiss Properties Austin, L.P. and
                 PPL (filed as Exhibit 10.15 to the Company's Registration
                 Statement on Amendment No. 1 of Form S-11, File No. 333-09863,
                 and incorporated by reference herein).
   10.18      -- Purchase Agreement by and Between the Operating Partnership and
                 PPL (filed as Exhibit 10.16 to the Company's Registration
                 Statement on Amendment No. 1 of Form S-11, File No. 333-09863,
                 and incorporated by reference herein).
   10.19      -- Agreement of Purchase and Sale and Joint Escrow Instructions by
                 and Between LAPCO Industrial Parks and PPL (filed as Exhibit
                 10.17 to the Company's Registration Statement on Amendment No.
                 1 of Form S-11, File No. 333-09863, and incorporated by
                 reference herein).
   10.20      -- First Amendment to Agreement of Purchase and Sale and Joint
                 Escrow Instructions by and Between LAPCO Industrial Parks and
                 PPL (filed as Exhibit 10.18 to the Company's Registration
                 Statement on Amendment No. 1 of Form S-11, File No. 333-09863,
                 and incorporated by reference herein).
   10.21      -- Agreement of Purchase and Sale of Partnership Interests by and
                 Among LW-RTC, Inc., LW-LP, Inc., NP Investment VI Co. and PPL
                 (filed as Exhibit 10.19 to the Company's Registration Statement
                 on Amendment No. 1 of Form S-11, File No. 333-09863, and
                 incorporated by reference herein).
   10.22      -- Agreement of Sale (Real Property) by and Between Property Asset
                 Management Inc. and PPL (Annapolis, Maryland) (filed as Exhibit
                 10.20 to the Company's Registration Statement on Amendment No.
                 1 of Form S-11, File No. 333-09863, and incorporated by
                 reference herein).
   10.23      -- Agreement of Sale (Real Property) by and Between Property Asset
                 Management Inc. and PPL (Irving, Texas) (filed as Exhibit 10.21
                 to the Company's Registration Statement on Amendment No. 1 of
                 Form S-11, File No. 333-09863, and incorporated by reference
                 herein).
   10.24      -- Agreement of Sale (Real Property) by and Between Property Asset
                 Management Inc. and PPL (Houston, Texas) (filed as Exhibit
                 10.22 to the Company's Registration Statement on Amendment No.
                 1 of Form S-11, File No. 333-09863, and incorporated by
                 reference herein).
   10.25      -- Letter Agreement dated as of August 5, 1996 from PPL to LW-LP,
                 Inc., LW-RTC, Inc. and NP Investment VI Co. (filed as Exhibit
                 10.23 to the Company's Registration Statement on Amendment No.
                 1 of Form S-11, File No. 333-09863, and incorporated by
                 reference herein).
   10.26      -- Real Estate Purchase and Sale Agreement by and Between
                 Principal Mutual Life Insurance Company and Prentiss Properties
                 Investors, Inc. (filed as Exhibit 10.24 to the Company's
                 Registration Statement on Amendment No. 1 of Form S-11, File
                 No. 333-09863, and incorporated by reference herein).
   10.27      -- 1996 Share Incentive Plan (filed as Exhibit 10.25 to the
                 Company's Registration Statement on Amendment No. 1 of Form S-
                 11, File No. 333-09863, and incorporated by reference herein).
   10.28      -- Agreement of Purchase and Sale by and Between Dulles Corner
                 Properties II Limited Partnership ("Seller") and Prentiss
                 Properties Acquisition Partners, L.P. ("Purchaser") dated
                 December 27, 1996 (filed as Exhibit 10.1 to the Company's
                 current report on Form 8-K, filed January 15, 1997). 

                                       42
<PAGE>
 
   10.29      -- Agreement of Purchase and Sale and Escrow Instructions by and
                 between 1740 CREEKSIDE OAKS INVESTORS ("Seller") and Prentiss
                 Properties Acquisition Partners, L.P. ("Purchaser") dated
                 February 17, 1997 (filed as Exhibit 10.1 to the Company's
                 Current Report on Form 8-K/A filed June 12, 1997). 
   10.30      -- Agreement of Purchase and Sale and Escrow Instructions by and
                 between 1750 CREEKSIDE OAKS INVESTORS ("Seller") and Prentiss
                 Properties Acquisition Partners, L.P. ("Purchaser") dated
                 February 17, 1997 (filed as Exhibit 10.2 to the Company's
                 Current Report on Form 8-K/A filed June 12, 1997). 
   10.31      -- Agreement of Purchase and Sale and Escrow Instructions by and
                 between 1760 CREEKSIDE OAKS INVESTORS ("Seller") and Prentiss
                 Properties Acquisition Partners, L.P. ("Purchaser") dated
                 February 17, 1997 (filed as Exhibit 10.3 to the Company's
                 Current Report on Form 8-K/A filed June 12, 1997). 
   10.32      -- Agreement of Purchase and Sale and Escrow Instructions by and
                 between RIVER CITY BANK ("Seller") and Prentiss Properties
                 Acquisition Partners, L.P. ("Purchaser") dated February 17,
                 1997 (filed as Exhibit 10.4 to the Company's Current Report on
                 Form 8-K/A filed June 12, 1997). 
   10.33      -- Agreement of Purchase and Sale and Escrow Instructions by and
                 between 2495 NATOMAS INVESTORS ("Seller") and Prentiss
                 Properties Acquisition Partners, L.P. ("Purchaser") dated
                 February 17, 1997 (filed as Exhibit 10.5 to the Company's
                 Current Report on Form 8-K/A filed June 12, 1997).
   10.34      -- Agreement of Purchase and Sale and Escrow Instructions by and
                 between 2525 NATOMAS INVESTORS ("Seller") and Prentiss
                 Properties Acquisition Partners, L.P. ("Purchaser") dated
                 February 17, 1997 (filed as Exhibit 10.6 to the Company's
                 Current Report on Form 8-K/A filed June 12, 1997).
   10.35      -- Contribution Agreement between Prentiss Properties Acquisition
                 Partners, L.P. , and certain Pennsylvania limited partnerships
                 named therein (filed as Exhibit 10.1 to the Company's Current
                 Report on Form 8-K, filed October 16, 1997).
   10.36      -- Contribution Agreement between Prentiss Properties Acquisition
                 Partners, L.P., and certain New Jersey limited partnerships
                 named therein (filed as Exhibit 10.2 to the Company's Current
                 Report on Form 8-K, filed October 16, 1997).
   10.37      -- Agreement to Acquire Limited Partnership Interests between OTR
                 and Prentiss Properties Acquisition Partners, L.P.(filed as
                 Exhibit 10.3 to the Company's Current Report on Form 8-K, filed
                 October 16, 1997).
   10.38      -- Agreement to Assign Property Agreements and Other Assets
                 between Terramics Management Company, Terramics Property
                 Associates, Terramics Property Company and Prentiss Properties
                 Acquisition Partners, L.P. (filed as Exhibit 10.4 to the
                 Company's Current Report on Form 8-K, filed October 16, 1997).
   10.39      -- Stock Purchase Agreement among Southpoint Land Holdings, Inc.,
                 Valleybrooke Land Holdings, Inc., certain shareholders thereof
                 and Prentiss Properties Limited, Inc. (filed as Exhibit 10.5 to
                 the Company's Current Report on Form 8-K, filed October 16,
                 1997).
   10.40      -- Put and Call Option Agreement For Remaining Shares among
                 certain sellers named therein and Prentiss Properties Limited,
                 Inc. (filed as Exhibit 10.6 to the Company's Current Report on
                 Form 8-K, filed October 16, 1997).
   10.41      -- Purchase Agreement entered into by and between Jacob Brouwer
                 and Jeanette Brouwer (as "Sellers") and Prentiss Properties
                 Acquisition Partners, L.P. (as "Buyer") in respect to the
                 purchase and sale of the properties referred to therein as
                 "Carlsbad Pacifica" (filed as Exhibit 10.1 to the Company's
                 Current Report on Form 8-K filed February 10, 1998).
   10.42      -- Purchase Agreement entered into by and between JJB Land
                 Company, LLC, (as "Seller") and Prentiss Properties Acquisition
                 Partners, L.P. (as "Buyer") in respect to the purchase and sale
                 of the properties referred to therein as "The Plaza" (filed as
                 Exhibit 10.2 to the Company's Current Report on Form 8-K filed
                 February 10, 1998).

                                       43
<PAGE>
 
   10.43      -- Contribution/Purchase Agreement entered into by and between the
                 Sellers (therein identified) and Prentiss Properties
                 Acquisition Partners, L.P. (as "Buyer") in respect to the
                 purchase and sale of the properties referred to therein as the
                 "Shiley Interests" and "NNC Interests" (filed as Exhibit 10.3
                 to the Company's Current Report on Form 8-K filed February 10,
                 1998).
   23.1**     -- Consent of PricewaterhouseCoopers LLP.
   27.1*      -- Financial Data Schedule.
---------------
*  Previously filed. 
** Filed herewith. 

(b)  Reports on Form 8-K 

     The Company filed a Current Report on Form 8-K on October 16, 1997, to
include in the Company's filings under the Securities Exchange Act of 1934, as
amended, certain Item 7 Exhibits, including (i) certain material agreements
relating to the Company's acquisition of the assets of certain affiliated
partnerships of Terramics Property Associates; and (ii) certain information
previously filed under the Securities Act of 1933, as amended.

     The Company filed a Current Report on Form 8-K on November 3, 1997, (i) to
report under Item 2 the completion of the acquisition of certain significant
properties, (ii) to report under Item 5 the completion of the acquisition of
certain insignificant properties, and (iii) to file financial statements with
respect to the significant acquisitions reported under Item 2.

     The Company filed a Current Report on Form 8-K on November 21, 1997, to
report under Item 5 a public offering of 6,000,000 Common Shares underwritten by
Lehman Brothers, Inc. on a firm commitment basis, and to file as Item 7 Exhibits
an Underwriting Agreement between the Company, Prentiss Properties Acquisition
Partners, L.P., Prentiss Properties I, Inc. and Lehman Brothers Inc., dated
November 18, 1997, and a Form Tax Opinion of Hunton & Williams.

                                       44
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
 
                         INDEX TO FINANCIAL STATEMENTS
 
FINANCIAL STATEMENTS                                                        PAGE
--------------------                                                        ----
 
    Report of Independent Accountants...................................... F-2
 
    Consolidated Balance Sheets of Prentiss Properties Trust (the 
    "Company") as of December 31, 1997 and December 31, 1996............... F-3
 
    Consolidated Statements of Income of the Company for the Year Ended
    December 31, 1997 and for the Period October 22, 1996 (inception of
    operations) to December 31, 1996 and Combined Statements of Income for
    the Predecessor Company for the Period January 1, 1996 to October 21,   
    1996, and the Year Ended December 31, 1995............................. F-4
 
    Consolidated Statement of Changes in Shareholders' Equity of the
    Company for the Year Ended December 31, 1997 and for the Period
    October 22, 1996 (inception to operations) to December 31, 1996 and
    Combined Statements of Changes in Equity of the Predecessor Company
    for the Period January 1, 1996 to October 21, 1996 and the Year Ended   
    December 31, 1995...................................................... F-5
 
    Consolidated Statement of Cash Flows of the Company for the Year Ended
    December 31, 1997 and for the Period October 22, 1996 (inception of
    operations) to December 31, 1996 and Combined Statements of Cash Flows
    of the Predecessor Company for the Period January 1, 1996 to October    
    21, 1996, and the Year Ended December 31, 1995......................... F-6
 
    Notes to Consolidated and Combined Financial Statements................ F-7
 
 
FINANCIAL STATEMENT SCHEDULE
 
    Schedule III:  Real Estate and Accumulated Depreciation................ F-28

                                      F-1
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
                                        
To the Board of Trustees and Shareholders
of Prentiss Properties Trust

We have audited the accompanying consolidated and combined financial statements
and the financial statement schedule of Prentiss Properties Trust (the
"Company") and the Predecessor Company as defined in Note 1.  These consolidated
and combined financial statements and the financial statement schedule are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated and combined financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of Prentiss Properties Trust as of December 31, 1997 and December 31,
1996, and the consolidated and combined results of operations  and cash flows
for the year ended December 31, 1997, for the periods October 22, 1996 through
December 31, 1996 and January 1, 1996 through October 21, 1996, and the year
ended December 31, 1995, respectively, in conformity with generally accepted
accounting principles.  In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be set forth therein.

COOPERS & LYBRAND L.L.P.


Dallas, Texas
February 5, 1998, except as to
Note 23 for which the date
is February 18, 1998

                                      F-2
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                          CONSOLIDATED BALANCE SHEETS
                                        
                   (dollars in thousands, except share data)
                                        
<TABLE>
<CAPTION>
                                                                              THE COMPANY
                                                                   ----------------------------------
                                                                       DECEMBER 31,       DECEMBER 31,
                                                                           1997               1996
                                                                        ----------          --------
                                                 ASSETS                           
<S>                                                                <C>                <C>
Assets:                                                                               
Real estate....................................................         $1,170,992          $501,035
   Less: accumulated depreciation..............................            (36,143)          (18,507)
                                                                        ----------          --------
                                                                         1,134,849           482,528
                                                                                      
Deferred charges and other assets, net.........................             24,636            11,747
Mortgage note receivable.......................................             36,331    
Receivables, net...............................................             10,865             5,356
Cash and cash equivalents......................................              7,075             7,226
Escrowed cash..................................................              4,524               867
Other receivables (affiliates).................................              1,928             1,346
Investments in joint venture and unconsolidated subsidiaries...             19,638            21,956
                                                                        ----------          --------
  Total assets.................................................         $1,239,846          $531,026
                                                                        ==========          ========
                                                                                      
                      LIABILITIES AND SHAREHOLDERS' EQUITY                                                  
                                                                                      
Liabilities:                                                                          
  Debt on real estate..........................................         $  420,030          $128,800
  Accounts payable and other liabilities.......................             35,795            15,868
  Distributions payable........................................             14,782             7,309
                                                                        ----------          --------
     Total liabilities.........................................            470,607           151,977
                                                                        ----------          --------
                                                                                      
Minority interest in operating partnership.....................             71,547            52,857
                                                                        ----------          --------
Minority interest in real estate partnerships..................              1,060               971
                                                                        ----------          --------

Commitments and contingencies                                                         

Shareholders' equity:                                                                 
  Preferred Shares $.01 par value, 20,000,000 shares                                  
    authorized, 2,830,189 shares issued and outstanding........             75,000              
      Common Shares $.01 par value, 100,000,000 shares                      
      authorized, 33,191,483 and 20,279,897 shares issued                                                       
      and outstanding..........................................                332               203 
 Additional paid-in capital....................................            628,086           326,309 
 Distributions in excess of accumulated earnings...............             (6,786)           (1,291) 
                                                                        ----------          --------
   Total shareholders' equity..................................            696,632           325,221
                                                                        ----------          --------
   Total liabilities and shareholders' equity..................         $1,239,846          $531,026
                                                                        ==========          ========
</TABLE>


   The accompanying notes are an integral part of these financial statements.

                                      F-3
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
                                        
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                 THE COMPANY                  PREDECESSOR COMPANY
                                                       -------------------------------   -----------------------------
                                                                      OCTOBER 22, 1996   JANUARY 1, 1996
                                                        YEAR ENDED         THROUGH           THROUGH       YEAR ENDED 
                                                       DECEMBER 31,     DECEMBER 31,       OCTOBER 21,    DECEMBER 31,
                                                           1997             1996              1996            1995
                                                       ------------   ----------------   ---------------  ------------
<S>                                                    <C>            <C>                <C>              <C>
 
Revenues:
    Rental income....................................      $127,089            $13,485           $27,086       $29,423
    Mortgage interest................................         1,780                                            
    Management fees..................................           925                192             7,903         9,979
    Development, leasing, sale and other fees........         1,934                110             9,607        15,762
                                                           --------            -------           -------       -------
         Total revenues..............................       131,728             13,787            44,596        55,164
                                                           --------            -------           -------       -------
Expenses:                                                                                                      
    Property operating and maintenance...............        30,602              3,618             7,550         7,696
    Real estate taxes................................        13,742              1,162             3,085         3,030
    General and administrative.......................         3,141                547             5,304         6,293
    Personnel costs, net.............................         3,478                505            11,991        17,138
    Interest expense.................................        21,131                759             4,549         3,783
    Amortization of deferred financing costs.........           824                 87             1,402            99
    Depreciation and amortization....................        21,600              2,696             5,993         7,166
                                                           --------            -------           -------       -------
         Total expenses..............................        94,518              9,374            39,874        45,205
                                                           --------            -------           -------       -------
                                                                                                               
Equity in income of joint venture and unconsolidated   
    subsidiaries.....................................         5,208              1,427                18            11
                                                           --------            -------           -------       -------
                                                                                                               
Income before gains on sale, minority interest, and                                                            
 extraordinary item..................................        42,418              5,840             4,740         9,970
Gains on sale........................................           641                                  378       
Minority interest....................................        (5,235)              (844)
                                                           --------            -------           -------       -------
                                                                                                               
Income before extraordinary item.....................        37,824              4,996             5,118         9,970
Extraordinary item - (loss) on early                                                                           
     extinguishment of debt..........................          (878)                                           
                                                           --------            -------           -------       -------  

Net income...........................................        36,946              4,996             5,118         9,970

Preferred dividends..................................           (25)                                           
                                                           --------            -------           -------       -------  

Net income applicable to common shareholders.........      $ 36,921            $ 4,996           $ 5,118       $ 9,970
                                                           ========            =======           =======       =======
 
Net income per Common Share before extraordinary
    item - basic.....................................      $   1.52            $   .25
 
Extraordinary item...................................           .04            
                                                           --------            -------

Net income per Common Share - basic..................      $   1.48            $   .25 
                                                           ========            =======
                                                                                       
Weighted average number of Common Shares
    outstanding - basic..............................        24,930             20,002
                                                           ========            =======

Net income per Common Share before extraordinary
    item - diluted...................................      $   1.49            $   .25

Extraordinary item...................................           .03
                                                           --------            -------

Net income per Common Share - diluted................      $   1.46            $   .25
                                                           ========            =======
 
Weighted average number of Common Shares               
     and Common Share equivalents
     outstanding - diluted...........................        25,307             20,332
                                                           ========            =======
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                      F-4
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
              CONSOLIDATED AND COMBINED STATEMENTS OF CHANGES IN
                             SHAREHOLDERS' EQUITY
                                        
                   (dollars in thousands, except share data)
                                        
<TABLE>
<CAPTION>
                                                            
                                                PREDECESSOR   
                                                  COMPANY                THE COMPANY - SHAREHOLDER'S EQUITY
                                                -----------       ------------------------------------------------
                                                                                                        DIST. IN EXCESS
                                                     NET       PREFERRED    COMMON    ADD'L. PAID-IN     ACCUM.
                                      TOTAL         EQUITY       SHARES     SHARES        CAPITAL       EARNINGS
                                    --------       --------    ---------    ------    --------------    --------
<S>                                 <C>            <C>         <C>          <C>       <C>               <C>
 
Balance at December 31, 1994...     $112,594       $112,594
   Net income..................        9,970          9,970
   Distributions...............      (15,250)       (15,250)
   Distributions of PPL           
    income.....................       (4,498)        (4,498)
   Equity on purchase of Park       
     West C2...................        1,050          1,050
                                    --------       -------- 

Balance at December 31, 1995...      103,866        103,866
   Net income..................        5,118          5,118
   Distributions...............       (6,375)        (6,375)
   Distributions of PPL income.       (2,395)        (2,395)
   Equity on purchase of Plaza
    on Bachman Creek...........        3,314          3,314
                                    --------       --------
 
Balance at October 21, 1996....      103,528        103,528
   Acquisition of Predecessor
    Company's interest.........      (98,316)       (98,316)
   Contribution of Predecessor
    Company's interest.........                      (5,212)                              $  5,212
   Net proceeds from issuance
    of Common Shares
    (20,279,897 Common Shares).      321,300                                 $203          321,097
   Distributions declared
    ($.31 per share)...........       (6,287)                                                           $ (6,287)
   Net income..................        4,996                                                               4,996
                                    --------       --------     -------      ----         --------      --------
 
Balance at December 31, 1996...      325,221                                  203          326,309        (1,291)
   Net proceeds from issuance
    of Common Shares                 301,906                                  129          301,777
    (12,911,586 Common Shares).
   Net proceeds from issuance
    of Preferred Shares               75,000                    $75,000
    (2,830,189 Preferred 
    Shares)....................
   Distributions declared,
    ($1.60 per Common Share)...      (42,416)                                                            (42,416) 
   Preferred distributions
    declared, ($.01 per 
    Preferred Share)..........           (25)                                                                (25) 
   Net income.................        36,946                                                              36,946
                                    --------       --------     -------      ----         --------      --------
   
   Balance at December 31,          $696,632       $            $75,000      $332         $628,086      $ (6,786)
    1997......................      ========       ========     =======      ====         ========      ========
</TABLE>


  The accompanying notes are an integral part of these financial statements.

                                      F-5
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
              CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
                                        
                            (dollars in thousands)
<TABLE>
<CAPTION>
                                                                                           
                                                                    THE COMPANY                 PREDECESSOR COMPANY
                                                           ------------------------------  -----------------------------
                                                                           OCT. 22, 1996    JAN. 1, 1996
                                                             YEAR ENDED       THROUGH         THROUGH       YEAR ENDED          
                                                           DEC. 31, 1997   DEC. 31, 1996   OCT. 21, 1996   DEC. 31, 1995
                                                           --------------  --------------  --------------  -------------
<S>                                                        <C>             <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:                    
 Net income..............................................      $36,946         $ 4,996        $ 5,118         $ 9,970
                                                                                                         
 Adjustments to reconcile net income to                                                                  
 net cash provided by operating activities:                                                             
  Minority interest......................................        5,235             844                        
  Extraordinary item.....................................          878                                        
  Gains on sale..........................................         (641)                          (378)        
  Provision for doubtful accounts........................           59             201           (120)           (150)
  Depreciation and amortization..........................       21,600           2,696          5,993           7,166
  Amortization of deferred financing costs...............          824              87          1,402              99
  Equity income of joint venture and                                                                          
   unconsolidated subsidiaries...........................       (5,208)         (1,427)           (18)            (11)
  Non-cash compensation..................................           50                                        
 Changes in assets and liabilities:                                                                                       
  Deferred charges and other assets......................       (5,277)         (1,845)        (2,199)            176
  Receivables............................................       (5,499)         (2,377)          (497)           (265)
  Escrowed cash..........................................       (2,376)          1,325           (898)            (93)
  Other receivables (affiliates).........................         (582)         (1,524)          (527)            102
  Accounts payable and other liabilities.................       15,449           6,166          2,392            (756)
                                                             ---------         -------        -------         -------
                                                                                                         
  Net cash provided by operating activities..............       61,458           9,142         10,268          16,238
                                                             ---------         -------        -------         -------
CASH FLOWS FROM INVESTING ACTIVITIES:                                                                    
 Purchase of real estate.................................     (587,495)        335,689)       (33,544)         (4,669)
 Investment in real estate...............................      (63,809)                                       
 Investment in mortgage note receivable..................      (36,331)                                       
 Investment in unconsolidated subsidiary.................         (667)        (20,902)                       
 Proceeds from sales of real estate......................       21,593                            559         
 Cash from contributed assets............................                        2,409                        
 Increase in deposits on real estate.....................         (824)                                           368
 Distributions received from joint venture                                                               
  and unconsolidated subsidiaries........................        7,270             373                              
                                                             ---------         -------        -------         -------
 Net cash used in investing activities...................     (660,263)        353,809)       (32,985)         (4,301)
                                                             ---------         -------        -------         -------
CASH FLOWS FROM FINANCING ACTIVITIES:                                                                    
 Net proceeds from sale of Common Shares.................      306,785         337,604                        
 Net proceeds from sale of Preferred Shares..............       75,000                                        
 Partner's contributions.................................                                       3,314         
 Contributions from minority interest holders............                          950                             
 Distributions paid to limited partners..................       (4,977)                        (6,375)        (15,250)
 Distributions paid to common shareholders...............      (35,427)                                       
 Distributions paid for minority interest                                                                     
  in consolidated subsidiaries...........................          (17)                                        
 Proceeds from debt on real estate.......................      745,286         112,800         29,000         
 Repayments of debt on real estate.......................     (487,996)        (99,462)          (261)           (289)
 Distribution of PPL income..............................                                      (2,395)         (4,498)
                                                             ---------         -------        -------         -------
 Net cash provided by (used in) financing activities.....      598,654         351,892         23,283         (20,037)
                                                             ---------         -------        -------         -------
                                                                                                         
 Net change in cash and cash equivalents.................         (151)          7,225            566          (8,100)
 Cash and cash equivalents, beginning of period..........        7,226               1          1,033           9,133
                                                             ---------         -------        -------         -------
 Cash and cash equivalents, end of period................    $   7,075           7,226        $ 1,599           1,033
                                                             =========         =======        =======         =======
SUPPLEMENTAL CASH FLOW INFORMATION:                                                                      
 Cash paid for interest..................................    $  17,815             983        $ 4,720           3,786
                                                             =========         =======        =======         =======
</TABLE>

  The accompanying notes are an integral part of these financial statements.

     (1)  FORMATION TRANSACTIONS

                                      F-6
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


     The Organization, IPO and Offerings

     Prentiss Properties Trust was formed under the laws of the state of
Maryland on July 12, 1996, to be a self-administered and self-managed real
estate investment trust ("REIT"). Prentiss Properties Trust owns a limited
partnership interest and a sole general partnership interest in Prentiss
Properties Acquisition Partners, L.P. (the "Operating Partnership") through a
wholly-owned subsidiary, Prentiss Properties I, Inc., a Delaware corporation.
Prentiss Properties Trust, as referred to herein, includes its majority-owned
Operating Partnership and subsidiaries (collectively, the "Company").

     The Company succeeded to substantially all of the interests of Prentiss
Properties Limited, Inc. ("PPL") and its affiliates in (i) a portfolio of office
and industrial properties and (ii) the national acquisition, property
management, leasing, development and construction businesses of PPL and its
affiliates (the "Prentiss Group").  The acquisition, property management,
leasing, development and construction businesses are carried out by the
Operating Partnership and, Prentiss Properties Limited, Inc. (the "Manager") of
which the Company owns a 95% non-voting economic interest.

     On October 22, 1996, the Company commenced operations after completing an
initial public offering (the "IPO") of 16,000,000 common shares of beneficial
interest, $0.01 par value per share ("Common Shares").  The Company issued an
additional 2,400,000 Common Shares on October 31, 1996, pursuant to the exercise
of the underwriters' over-allotment option.  The combined 18,400,000 Common
Shares were issued at a price per share of $20.00.  The Company used
approximately $87.4 million of the net proceeds and issued 1,879,897 Common
Shares of the Company for a total consideration of approximately $125.0 million
to purchase certain limited partners' interests in the Operating Partnership.
The Company contributed the remaining net proceeds of the IPO to the Operating
Partnership in exchange for additional limited partnership units in the
Operating Partnership ("Units").  Subsequent to these transactions, the Company
held an approximate 86.0% interest in the Operating Partnership.

     The Prentiss Group members, who, prior to the IPO, collectively served as
the general partner of the Operating Partnership, contributed to the Operating
Partnership all of its interests in the Properties (as defined below) and
certain management contracts of PPL (the "Contracts") in exchange for 3,295,995
Units.

     Upon completion of the IPO and certain related transactions (collectively,
the "Formation Transactions"), the Company owned 87 properties (the "Initial
Properties"), which consisted of 28 office (the "Initial Office Properties") and
59 industrial (the "Initial Industrial Properties") containing an aggregate of
8.9 million net rentable square feet.  Between the closing of the IPO and
December 31, 1997, the Company acquired 74 additional Properties, (the "Acquired
Properties").  As of December 31, 1997 the Operating Partnership and
unconsolidated subsidiaries owned 161 operating Properties consisting of 84
office and 77 industrial Properties (collectively, the "Properties") containing
16.8 million net rentable square feet and located in 18 major markets throughout
the United States.  At December 31, 1997, the Company held an approximate 89.7%
interest in the Operating Partnership.  A brief description of the Properties
acquired and other significant transactions occurring during the 12 months ended
December 31, 1997 follows.

     On January 14, 1997, the Company acquired a single Class "A" office
Property containing 58,621 square feet located in the Northern Virginia area.
The purchase price of the Property, excluding closing costs, totaled $6.1
million.

     On February 20, 1997, the Company acquired a single industrial Property
containing 360,000 square feet located in the Milwaukee, Wisconsin, area.  The
purchase price of the Property, excluding closing costs, totaled $9.8 million.

                                      F-7
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


     On March 18, 1997, the Company acquired a single industrial Property
containing 143,924 square feet located in the suburban Baltimore, Maryland,
area.  The purchase price of the Property, excluding closing costs, totaled $5.5
million.

     On March 19, 1997, the Company acquired two industrial Properties
containing 237,344 square feet located in the Dallas, Texas, area.  The purchase
price of the Properties, excluding closing costs, totaled $8.7 million.

     On March 25, 1997, the Company acquired two industrial Properties
containing 228,382 square feet located in the Los Angeles, California, area.
The purchase price of the Properties, excluding closing costs, totaled $7.0
million.

     On April 2, 1997, the Company acquired six Class "A" office Properties
containing 566,092 square feet located in the Sacramento, California, area.  The
purchase price of the Properties, excluding closing costs, totaled $74.2
million.

     On April 8, 1997, the Company acquired a single Class "A" office Property
containing 243,048 square feet located in the Atlanta, Georgia, area.  The
purchase price of the Property, excluding closing costs, totaled $24.8 million,
including $12.0 million of debt assumed in the purchase.

     On May 5, 1997, the Company completed an offering (the "Follow-on
Offering") of 6,000,000 Common Shares of beneficial interest, $0.01 par value
per share.  The Common Shares were issued at a price per share of $24.00.  The
Company contributed the net proceeds of the Follow-on Offering to the Operating
Partnership in exchange for additional Units.

     On May 6, 1997, the Company acquired five Class "A" office Properties
containing 323,728 square feet located in the Chicago, Illinois, area.  The
purchase price of the Properties, excluding closing costs, totaled $50.5
million.

     On May 29, 1997, the Company acquired six industrial Properties containing
468,750 square feet located in the Los Angeles, California, area.  The purchase
price of the Properties, excluding closing costs, totaled $16.3 million.

     On June 4, 1997, the Company acquired two Class "A" office Properties
containing 244,816 square feet located in the suburban Detroit, Michigan, area.
The purchase price of the Properties, excluding closing costs, totaled $21.8
million.

     On June 4, 1997, the Company acquired a single Class "A" office Property
containing 70,090 square feet in Dallas, Texas, adjacent to the Company's
corporate office.  The purchase price of the Property, excluding closing costs,
totaled $5.5 million, including $3.1 million of debt assumed in the purchase.

     On June 19, 1997, the Company acquired a single industrial Property
containing 455,858 square feet located in the Chicago, Illinois, area.  The
purchase price of the Property, excluding closing costs, totaled $11.3 million.

     On July 31, 1997, the Company acquired two Class "A"  office Properties
containing 100,500 square feet located in the Phoenix, Arizona, area.  The
purchase price of the Properties, excluding closing costs, totaled $9.9 million.

     On July 31, 1997, the Company acquired three Class "A"  office Properties
containing 193,961 square feet located in Los Angeles, California.  The purchase
price of the Properties, excluding closing costs, totaled $23.0 million.

                                      F-8
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


     On August 27, 1997, the Company acquired three Class "A" office Properties
containing 307,802 square feet located in the metropolitan Washington, D.C.,
area.  The purchase price of the Properties, excluding closing costs, totaled
$28.5 million.

     On September 9, 1997, the Company acquired two Class "A" office Properties
containing 286,325 square feet located in the metropolitan Washington, D.C.
area.  The purchase price of the Properties, excluding closing costs, totaled
$40.8 million.

     On September 15, 1997, the Company acquired two Class "A" office Properties
containing 203,405 square feet located in the suburban Baltimore, Maryland,
area.  The purchase price of the Properties, excluding closing costs, totaled
$22.6 million.

     On October 22, 1997, the Company acquired 15 Class "A" office Properties
containing 904,000 square feet located in the suburban Philadelphia,
Pennsylvania, area, as well as the rights to acquire land capable of supporting
1.1 million net rentable square feet of development.  The purchase price of the
Properties (the "Terramics Properties"), excluding estimated closing costs,
totaled approximately $134 million, including approximately $14 million of debt
assumed, approximately $106 million in cash, and the issuance of 524,180 Units
valued at $14 million.

     On November 13, 1997, the Company acquired two Class "A" office Properties
containing 89,755 square feet located in the San Diego, California, area.  The
purchase price of the Properties, excluding closing costs, totaled $16.0
million.

     On November 24, 1997, the Company completed an offering (the "Second
Follow-on Offering") of 6,900,000 Common Shares of beneficial interest, $0.01
par value per share.  The 6,900,000 Common Shares were issued at a net price per
share of $25.00.  The Company contributed the net proceeds of the Second Follow-
on Offering to the Operating Partnership in exchange for additional Units.

     On December 1, 1997, the Company acquired two Class "A" office Properties
containing 197,027 square feet located in the Los Angeles, California, area.
The purchase price of the Properties, excluding closing costs, totaled $24.1
million.

     On December 9, 1997, the Company acquired a single industrial Property
containing 143,274 square feet located in the San Diego, California, area.  The
purchase price of the Property, excluding closing costs, totaled $6.9 million.

     On December 12, 1997, the Company acquired a single Class "A" office
Property containing 99,460 square feet located in the Denver, Colorado, area.
The purchase price of the Property, excluding closing costs, totaled $10.5
million, including $5.1 million of debt assumed in the purchase.

     On December 30, 1997, the Company acquired a single Class "A" office
Property containing 79,175 square feet located in the Denver, Colorado area.
The purchase price of the Property, excluding closing costs, totaled $8.2
million.

     On December 30, 1997, the Company acquired a single Class "A" office
Property containing 237,265 square feet located in the suburban Baltimore,
Maryland, area.  The purchase price of the Property, excluding closing costs,
totaled $33.8 million.

     On December 30, 1997, pursuant to an agreement (the "SCPG Agreement")
entered into between the Company and Security Capital Preferred Growth
Incorporated ("SCPG"), the Company issued 2,830,189 Series "A" Cumulative
Convertible Redeemable Preferred Shares ("Series A Convertible Preferred
Shares") for $26.50 per share.  The Company contributed the net proceeds from
the sale of the Series A Convertible Preferred Shares to 

                                      F-9
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


the Operating Partnership in exchange for preferred Units. The 2,830,189 Series
A Convertible Preferred Shares outstanding are Convertible into an equal number
of Common Shares and have rights to a dividend equal to the dividend paid on
Common Shares. Pursuant to the SCPG Agreement, 943,396 additional Series A
Convertible Preferred Shares may be issued at the Company's option on or before
March 31, 1998.

     On December 31, 1997, the Company acquired a single industrial Property
containing 300,120 square feet located in the Milwaukee, Wisconsin, area.  The
purchase price of the Property, excluding closing costs, totaled $13.7 million.

The following summarizes the Company's portfolio of Properties at December 31,
1997:

<TABLE>
<CAPTION>
                                              # OF         COMPANY                                      COMPANY
    PROPERTY NAME                 TYPE       BLDGS.      OWNERSHIP %         MARKET                      NOTES
    -------------                 ----       ------      -----------         ------                      ------
<S>                               <C>        <C>         <C>             <C>                            <C> 
Calverton Office Park             Office         3          100%         Metro. Wash., DC         
Research Office Center            Office         2          100%         Metro. Wash., DC         
7101 Wisconsin Avenue             Office         1          100%         Baltimore, MD            
Gateway International             Office         2          100%         Baltimore, MD            
2411 Dulles Corner Road           Office         1          100%         Northern Virginia        
2455 Horsepen Road                Office         1          100%         Northern Virginia        
3141 Fairview Park Drive          Office         1          100%         Northern Virginia        
4401 Fair Lakes Court             Office         1          100%         Northern Virginia        
8521 Leesburg Pike                Office         1          100%         Northern Virginia        
Baltimore Industrial Properties   Industrial     7           99%         Baltimore, MD                    (A)
                                             --------                                             
   Total Mid-Atlantic Region                    20                                                
                                             --------                                             
1717 Deerfield Road               Office         1          100%         Chicago, IL              
Corporetum Office Campus          Office         5          100%         Chicago, IL              
O'Hare Plaza II                   Office         1          100%         Chicago, IL              
One Northwestern Plaza            Office         1          100%         Suburban Detroit, MI     
Seven Mile Crossing               Office         2          100%         Suburban Detroit, MI     
Chicago Industrial Properties     Industrial     4          100%         Chicago, IL              
Kansas City Industrial Properties Industrial     7          100%         Kansas City, MO          
Milwaukee Industrial Properties   Industrial    19          100%         Milwaukee, WI            
                                             --------                                             
   Total Midwest Region                         40                                                
                                             --------                                             
Centerpointe                      Office         1          100%         Suburban Philadelphia, PA
Lake Center                       Office         2          100%         Suburban Philadelphia, PA
Southpoint                        Office         4          100%         Suburban Philadelphia, PA
Valleybrooke                      Office         5          100%         Suburban Philadelphia, PA
Woodland Falls                    Office         3          100%         Suburban Philadelphia, PA
                                             --------                                             
    Total Northeast Region                      15                                                
                                             --------                                             
Crescent Centre                   Office         1          100%         Atlanta, GA              
Cumberland Office Park            Office         9          100%         Atlanta, GA              
                                             --------                                             
    Total Southeast Region                      10                                                
                                             --------                                             
Highland Court                    Office         1          100%         Denver, CO               
PacificCare Building (FHP)        Office         1          100%         Denver, CO               
Panorama Point                    Office         1          100%         Denver, CO               
Broadmoor Austin                  Office         7           50%         Austin, TX                       (B)
5307 East Mockingbird             Office         1          100%         Dallas, TX               
Bachman East                      Office         1          100%         Dallas, TX               
Bachman West                      Office         1          100%         Dallas, TX               
Cottonwood Office Center          Office         3          100%         Dallas, TX               
Park West C2                      Office         1          100%         Dallas, TX               
Park West E1                      Office         1          100%         Dallas, TX               
Park West E2                      Office         1          100%         Dallas, TX               
Walnut Glen Tower                 Office         1          100%         Dallas, TX               
</TABLE> 

                                      F-10
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


<TABLE> 
<CAPTION> 
<S>                               <C>        <C>         <C>             <C>                            <C> 
Dallas Industrial Properties      Industrial     8          100%         Dallas, TX               
Houston Industrial Properties     Industrial     5          100%         Houston, TX              
                                             --------                                             
    Total Southwest Region                      33                                                
                                             --------                                             
Regents Centre                    Office         2          100%         Phoenix, AZ              
Glendale Federal Bank Building    Office         2          100%         Los Angeles, CA          
The Academy                       Office         3          100%         Los Angeles, CA          
World Savings Center              Office         1          100%         Oakland, CA                      (C)
Natomas Corporate Center          Office         6          100%         Sacramento, CA           
Carlsbad Pacific Center           Office         2          100%         San Diego, CA            
Los Angeles Industrial Properties Industrial    26          100%         Los Angeles, CA          
Oceanside                         Industrial     1           95%         San Diego, CA                    (D)
                                             --------
    Total West Region                           43
                                             --------
                                               
Total Properties                               161
                                             ========
</TABLE>

(A)  Four of the Baltimore industrial Properties are owned by three
     partnerships. The Company holds the majority general partnership interest
     in each of the Partnerships and consolidates the accounts and operations of
     each partnership.
(B)  The Company holds a non-controlling, approximate 50% interest in the
     Broadmoor Austin Associates Joint Venture.  The Broadmoor Austin Associates
     Joint Venture owns and operates an office complex in Austin, Texas,
     consisting of seven Properties.  The Company accounts for its interests
     using the equity method of accounting.
(C)  The Company owns the mortgage loan collateralized by the Property.
(D)  This Property is wholly-owned by the Manager.

     With the exception of the Broadmoor Austin Properties, all Properties are
majority-owned by the Company. The accounts and operations of all Properties
except the Broadmoor Austin Properties and the Oceanside Property are
consolidated in the Company.  The Company owns an approximate 50% interest in
Broadmoor Austin and accounts for its interest using the equity method of
accounting.  The Company also owns a 95% non-voting economic interest in the
Manager.  The Manager conducts the majority of the Company's third-party
management operations and, due to the non-voting nature of the Company's
ownership interest in the Manager, the Company accounts for its interest using
the equity method of accounting.

(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 Principles of Consolidation

     The consolidated financial statements include the accounts of the Company,
the Operating Partnership and other subsidiaries. All significant intercompany
balances and transactions have been eliminated.

 Real Estate

     Real estate and leasehold improvements are stated at the lower of
depreciated cost or net realizable value. In accordance with Statement of
Financial Accounting Standards No. 121, ''Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed of,'' the Operating
Partnership will record impairment losses on long-lived assets used in
operations when events and circumstances indicate that the assets might be
impaired and the estimated undiscounted cash flows to be generated by those
assets are less than the carrying amounts of those assets.  The Company
periodically reviews its Properties to determine if its carrying costs will be
recovered from future operating cash flows.  In cases where the Company does not
expect to recover its carrying costs, the Company recognizes an impairment loss.
No such impairment losses have been recognized to date.

  Depreciation on buildings and improvements is provided under the straight-line
method over an estimated useful life of 30 to 40 years for office buildings and
25 to 30 years for industrial buildings.  Interest expense and other directly
related expenses incurred during construction periods are capitalized and
depreciated commencing with the date placed in service, on the same basis as the
related assets.

                                      F-11
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


     Maintenance and repairs are charged to operations as incurred; major
renewals and betterments are capitalized. When assets are sold or retired, their
costs and related accumulated depreciation are removed from the accounts with
the resulting gains or losses reflected in net income (loss).

 Deferred Charges

     Deferred financing costs are recorded at cost and are being amortized over
the life of the related debt. Leasing commissions and leasehold improvements are
deferred and amortized over the terms of the related leases. Other deferred
charges are amortized over terms applicable to the expenditure.

 Cash and Cash Equivalents

     Cash and cash equivalents consist of cash on hand and investments with
maturities of three months or less when purchased.

 Escrowed Cash

     Escrowed funds as of December 31, 1997 and 1996 are comprised of funds on
deposit with lenders for the payment of real estate taxes.

Investment in Joint Venture and Unconsolidated Subsidiaries

     Included in Investments in joint venture and unconsolidated subsidiaries
are the Company's non-controlling investment in the Broadmoor Austin Associates
Joint Venture ("Broadmoor Austin") and the Company's non-controlling investment
in the Manager. The Company accounts for its approximate 50% investment in
Broadmoor Austin and its 95% investment in the Manager using the equity method
of accounting, and thus reports its share of income and losses based on its
ownership interest in the respective entities. The difference between the
carrying value of the Company's interest in Broadmoor Austin and the book value
of the underlying equity is being amortized over 40 years.

 Income Taxes

     The Company elects to be taxed as a REIT under Sections 856 through 860 of
the Internal Revenue Code of 1986, as amended (the "Code") for the year ended
December 31, 1997. If the Company qualifies for taxation as a REIT, the Company
generally will not be subject to federal corporate income tax on its taxable
income that is distributed to its shareholders. A REIT is subject to a number of
organizational and operational requirements, including a requirement that it
currently distribute at least 95% of its annual taxable income. The Predecessor
Company's statements combine the operations of partnerships and an S-
corporation, neither of which is directly subject to income tax. The tax effect
of its activities accrues to the individual partners and/or principals of the
respective entity. The Manager consists of a legal entity subject to federal
income tax on its taxable income at regular corporate rates.

 Leases

     The Company and Predecessor Company, each as lessor, has retained
substantially all of the risks and benefits of ownership and accounts for its
leases as operating leases.

 Revenue Recognition

     Rental income is recognized on a straight-line basis over the term of each
respective lease.

                                      F-12
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


     Management company income, principally management fees and recoveries of
the Manager, is recognized as earned. Other income consists of (i) development
fees, which are recognized ratably over each project's development period, as
defined; (ii) leasing fees, which are generally recognized upon tenant occupancy
of the leased premises unless such fees are irrevocably due and payable upon
lease execution, in which case recognition occurs on the lease execution date;
(iii) sale fees, which are recognized upon completion of the asset sale; and
(iv) termination fees, which are recognized when earned.

 Distributions

     The Company pays regular quarterly distributions on the Company's Common
Shares outstanding which are dependent on receipt of distributions from the
Operating Partnership.  The Company pays a quarterly dividend to holders of the
Company's Series A Convertible Preferred Shares.  The preferred dividends are
equal to the dividends paid for Common Shares.

     Earnings and profits, which will determine the taxability of distributions
to shareholders, will differ from income reported for financial reporting
purposes due to the differences for federal tax purposes primarily in the
estimated useful lives used to compute depreciation. Distributions declared in
1997 and 1996 represent an approximate 10.6% and 57% return of capital for
federal income tax purposes, respectively.

 Minority Interest

     Minority interest in the Operating Partnership represents the limited
partners' proportionate share of the equity in the Operating Partnership.
Income is allocated to minority interest based on the weighted average
percentage ownership through the year.  Minority interest in real estate
partnerships represents the limited partners' proportionate share of the equity
in real estate partnerships, of which the Operating Partnership has a majority
ownership interest and the accounts of which are consolidated into the Operating
Partnership.

 Concentration of Credit Risk

     The Company places cash deposits at major banks.  Management believes that
through its cash investment policy the credit risk related to these deposits is
minimal.

 Distributions of PPL Income

     PPL retained certain assets and liabilities which were not transferred to
the Operating Partnership pursuant to the formation of the Company. These assets
and liabilities are inconsistent with the Company's investment objectives or are
not continuing businesses. All revenues and expenses related to the management
contracts that were contributed to the Operating Partnership upon formation are
reflected in the accompanying financial statements. The Combined Statements of
Changes in Shareholders' Equity and the Combined Statements of Cash Flows for
the Predecessor Company reflect the distributions of the PPL income, as the
benefit of each period's net income from these contracts has been distributed to
the principals of PPL.

 Use of Estimates in the Preparation of Financial Statements

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

                                      F-13
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


  Fair Value of Financial Instruments

     Statement of Financial Accounting Standards No. 107, "Disclosures About
Fair Value of Financial Instruments," effective for years ending after December
15, 1992, requires disclosures about the fair value of financial instruments
whether or not such instruments are recognizable in the balance sheet.  The
Company's financial instruments include short-term investments, tenant accounts
receivable, accounts payable, other accrued expenses and mortgage loans payable.
The fair values of these financial instruments were not materially different
from their carrying or contract values.

(3)  REAL ESTATE

     Real estate consisted of the following at December 31, 1997 and 1996:

                                                   (in thousands)
                                                1997           1996
                                                ----           ----
                                                            
     Land.................................   $  183,400      $ 86,711
     Buildings and improvements...........      927,416       409,060
     Construction in progress.............       60,176         5,264
                                             ----------      --------
       Total..............................    1,170,992       501,035
     Less: Accumulated depreciation.......      (36,143)      (18,507)
                                             ----------      --------
                                             $1,134,849      $482,528
                                             ==========      ========
                                                                                
     For the year ended December 31, 1997, capitalized interest costs totaled
$2.0 million. The Company capitalized no interest costs during the period
October 22, 1996 through December 31, 1996.

(4)  DEFERRED CHARGES AND OTHER ASSETS, NET

     Deferred charges and other assets consisted of the following at December
31, 1997 and 1996:

                                                   (in thousands)
                                                1997           1996
                                                ----           ----
                                                            
     Deferred leasing and tenant charges..   $ 28,831        $ 18,919
     Deferred financing costs.............      4,326           1,219
     Prepaid and other assets.............      4,355           1,704
       Less:  Accumulated amortization....    (12,876)        (10,095)
                                             --------        --------
                                             $ 24,636        $ 11,747
                                             ========        ========

(5)  MORTGAGE NOTE RECEIVABLE

     On July 29, 1997, the Company acquired, from an unaffiliated third party, a
mortgage loan collateralized by a 271,055-square-foot Class "A" office Property
in Oakland, California.  The purchase price of the mortgage loan and accrued but
unpaid interest totaled approximately $37.5 million. The Company has negotiated
a deed in lieu of foreclosure transaction, at no consideration, which provides
for the conveyance of the Property from a partnership in which an affiliated
party is the general partner (Prentiss Properties WSC, Inc.) to the Company in
an arms-length transaction.

(6)  RECEIVABLES, NET

  Receivables consisted of the following at December 31, 1997 and 1996:

                                      F-14
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


                                                   (in thousands)
                                                 1997          1996
                                                 ----          ----
                                                            
     Rents and services.....................   $ 5,263        $2,858
     Accruable rental income................     5,330         1,749
     Other..................................       777         1,195
                                               -------        ------
       Total................................    11,370         5,802
     Less: Allowance for doubtful accounts..      (505)         (446)
                                               -------        ------
                                               $10,865        $5,356
                                               =======        ======

     Accruable rental income represents rental income earned in excess of rent
payments received pursuant to the terms of the individual lease agreements.

(7)  INVESTMENT IN JOINT VENTURE AND UNCONSOLIDATED SUBSIDIARIES

     At December 31, 1997, the carrying value of the Company's interest in
Broadmoor Austin and the Manager is $14.9 million and $4.8 million,
respectively.

     The following is summarized financial information for 100% of Broadmoor
     Austin at December 31, 1997 and 1996 and for the years then ended:

                                                   (in thousands)
     BALANCE SHEET:                              1997          1996 
     -------------                               ----          ---- 
     Real estate and deferred charges, net..   $111,524      $115,856
     Total assets...........................    126,341       129,513
     Mortgage note payable..................    140,000       140,000
     Venturers' deficit.....................    (17,134)      (14,097)

     INCOME STATEMENT:                           1997          1996
     ----------------                            ----          ---- 
     Rental income..........................   $ 19,462      $ 19,776
     Interest expense.......................     13,650        13,527
     Depreciation and amortization..........      4,333         4,333
     Net income.............................        884           927

     The following is summarized financial information for 100% of the Manager
     at December 31, 1997 and 1996 and for the year ended December 31, 1997 and
     for the period from October 22, 1996 through December 31, 1996:

                                                   (in thousands)
     BALANCE SHEET:                              1997          1996 
     -------------                               ----          ---- 
     Total assets...........................   $ 21,668      $ 10,862 
     Total liabilities......................     16,700         5,270
     Owners' equity.........................      4,968         5,556
 
     INCOME STATEMENT:                           1997          1996
     ----------------                            ----          ---- 
     Fee income.............................   $ 26,682      $  5,418
     Personnel costs, net...................     14,825         2,579
     General office and administrative......      6,257         1,059
     Net income.............................      4,788         1,401

                                      F-15
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS

(8)  DEBT ON REAL ESTATE

     Debt at December 31, 1997 and 1996 consists of the following (in
thousands):

<TABLE>
<CAPTION>
                                                                         (in thousands)
                                                                   1997                  1996
                                                                   ----                  ----
<S>                                                  <C>                    <C>
Mortgage Loan......................................              $180,100
Acquisition Loan...................................               120,000
New Credit Facility/Line of Credit.................                                    $ 72,800
Term Loan..........................................                60,000                40,000
Property Mortgage Loans............................                49,879                16,000
Construction Loans.................................                10,051
                                                                 --------              --------
                                                                 $420,030/(A)/         $128,800
                                                                 ========              ========
</TABLE>
                                                                                
     (A) The amount shown excludes the Company's approximate 50% share of the
         mortgage indebtedness which is collateralized by the Broadmoor Austin
         Properties.

     Upon the closing of the IPO, the Company closed a three-year, $100 million
revolving credit facility (the "Line of Credit") with Bank One, Texas, N.A. and
NationsBank of Texas, N.A.  Initially, borrowings under the Line of Credit bore
interest at 30-day, 60-day or 90-day LIBOR, at the option of the Company, plus
200 basis points per annum, and were collateralized by first mortgage liens on
certain of the Properties.  On January 24, 1997, the Company increased the
amount available under its Line of Credit from $100 million to $150 million and
reduced the interest rate on borrowings under the Line of Credit from LIBOR plus
200 basis points to LIBOR plus 175 basis points. On December 31, 1997, the
Company replaced the Line of Credit with a new $300 million unsecured line of
credit with a group of 12 banks (the "New Credit Facility").  The New Credit
Facility reduced the interest rate on borrowings from LIBOR plus 175 basis
points to LIBOR plus 137.5 basis points.  The New Credit Facility is unsecured
and has a term of three years.  Additionally, the Company is required to pay an
unused commitment fee of 20 basis points per annum if the unused portion of the
New Credit Facility is greater than the related balance outstanding.  The fee is
reduced to 15 basis points per annum if the unused portion is less than the
balance outstanding.  The fee is computed on a quarterly basis.  No commitment
fee was paid for the year ended December 31, 1997. At December 31, 1997, the
Company had no borrowings outstanding under the New Credit Facility.

     In February 1997, the Company closed a 10-year fixed rate mortgage loan
with an initial outstanding balance of $180.1 million (the "Mortgage Loan"). The
Mortgage Loan is collateralized by liens on 53 Properties. The Mortgage Loan was
obtained from an affiliate of Lehman Brothers Inc. ("Lehman"). Under the terms
of the Mortgage Loan, the Company pays interest only at a rate of approximately
7.58% until the Mortgage Loan's maturity in February 2007. A portion of the
proceeds from the Mortgage Loan was used to fund the acquisition of the
Properties acquired subsequent to the funding of the Mortgage Loan.

     In July 1997, the Company closed on a short-term variable rate loan (the
"Acquisition Loan").  The Proceeds were used to fund the purchase of the
Mortgage Note Receivable (as described herein at Note 5) and repay a portion of
the outstanding balance on the Line of Credit.  The Acquisition Loan is
collateralized by 16 Properties, will mature in August 1998, and initially bore
interest at a rate of LIBOR plus 165 basis points.  On October 10, 1997, the
interest rate on the Acquisition Loan was reduced to LIBOR plus 125 basis
points.  As of December 31, 1997, the Company had drawn the entire $120 million
available under the Acquisition Loan.  The Company anticipates converting the
Acquisition Loan to a multi-year facility and has entered into a seven-year
interest rate swap locking in cost of funds of 6.25% (before the spread over
LIBOR) on $110 million (the "Interest Rate Swap").  The Interest Rate Swap
consists of two separate agreements intended to manage the relative mix of the
Company's debt between fixed and variable rate instruments.  The Interest Rate
Swap agreement modifies a portion of the interest characteristics of the
Company's Acquisition Loan debt without an exchange of the underlying principal

                                     F-16
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


amount and effectively converts variable rate debt to fixed rate debt.  The
fixed rates to be paid, the effective fixed rate, and the variable rate to be
received by the Company are summarized in the following table:

<TABLE>
<CAPTION>
                                                                           SWAP RATE                        
                                                                           RECEIVED                         
                           SWAP RATE PAID        EFFECTIVE FIXED        (VARIABLE) AT                       
   NOTIONAL AMOUNT            (FIXED)                 RATE                  12/31/97           SWAP MATURITY
   ---------------            -------                 ----                  --------           -------------
<S>                        <C>                   <C>                    <C>                  <C>
$50 million                   6.253%                  7.503%                5.718%           September 30, 2004
$60 million                   6.248%                  7.498%                5.718%           September 30, 2004 
</TABLE>

     The differences to be paid or received by the Company under the terms of
the Interest Rate Swap agreement are accrued as interest rates change and
recognized as an adjustment to interest expense by the Company pursuant to the
terms of the two agreements and will have a corresponding effect on its future
cash flows.  Agreements such as these contain a credit risk that the
counterparties may be unable to meet the terms of the agreement.  The Company
minimizes that risk by evaluating the creditworthiness of its counterparties,
which is limited to major banks  and financial institutions, and does not
anticipate non-performance by the counterparties.

     On December 5, 1997, the Company closed a $60 million, six-year, non-
recourse term loan, collateralized by 11 Properties, at a rate of 6.80%, (the
"CIGNA Loan").

     The Company is obligated under seven mortgage notes each collateralized by
an individual Property (the "Property Mortgage Loans").  These loans bear
interest at rates ranging from 7.27% to 8.63% and mature at varying dates from
April 1998 to April 2014. The Company is also obligated under a mortgage note
collateralized by the Broadmoor Austin Properties in which the Company, through
the Operating Partnership, owns an approximate 50% general partner interest in
the entity owning these Properties.  The Company's approximate 50% interest is
accounted for under the equity method of accounting.

     In addition, the Company is obligated under three loans (the "Construction
Loans") to fund the construction and development of four properties.  The
Construction Loans provide for total funding of $44.5 million, of which $10.1
million had been drawn at December 31, 1997.  The Construction Loans bear
interest at varying rates from 7.28% to 7.38% and mature at dates from August
2000 to December 2000.

     Future scheduled principal repayments of debt on real estate are as
   follows:

                                                              (in thousands)
1998............................................                 $125,500
1999............................................
2000............................................                   16,051
2001............................................                   10,000
2002............................................                    3,060
Thereafter......................................                  265,419
                                                                 --------
                                                                 $420,030/(A)/
                                                                 ========
                                                                                
     (A) The amount shown excludes the Company's approximate 50% share of the
         mortgage indebtedness which is collateralized by the Broadmoor Austin
         Properties.

     Under its loan agreements, the Company is required to satisfy various
   affirmative and negative covenants.  The Company was in compliance with these
   covenants at December 31, 1997.

(9)  ACCOUNTS PAYABLE AND OTHER LIABILITIES

     Accounts payable and other liabilities consisted of the following at
December 31, 1997 and 1996:

                                     F-17
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


                                                       (in thousands)
                                                    1997            1996
                                                    ----            ----
                                               
 Accounts payable and other liabilities  ......    $20,561         $ 7,517
 Accrued real estate taxes.....................      9,366           5,823
 Advance rent and deposits.....................      5,868           2,528
                                                   -------         -------
                                                   $35,795         $15,868
                                                   =======         =======
                                                                                
(10) DISTRIBUTION

     On December 16, 1997, the Company declared a cash distribution for the
fourth quarter of 1997 in the amount of $.40 per share, payable on January 16,
1998 to common shareholders of record on December 31, 1997. In addition, it was
determined that a distribution of $.40 per Unit would be made to the partners of
the Operating Partnership, payable on January 16, 1998. Further, on December 31,
1997, the Company declared a cash distribution in the amount of $1.60 per share,
prorated, payable on January 16, 1998, to shareholders of record on December 31,
1997 of the Company's Series A Convertible Preferred Shares. The distributions
were paid on January 16, 1998, totaling approximately $14.8 million. During the
year ended December 31, 1997, the Company declared cash distributions totaling
$47.8 million.

(11) LEASING ACTIVITIES

     The future minimum lease payments to be received by the Company as of
December 31, 1997, under non-cancelable operating leases, which expire on
various dates through 2014, are as follows:

                                                (in thousands)
Years ending December 31:                 
  1998....................................         $150,569
  1999....................................          135,564
  2000....................................          110,168
  2001....................................           85,403
  2002....................................           65,492
  Thereafter..............................          197,261
                                                   --------
                                                   $744,457
                                                   ========
                                                                                
The geographic concentration of the future minimum lease payments to be received
is detailed as follows:

                                                               (in thousands)
  LOCATION                                   
  --------                                   
  Milwaukee, WI.......................................            $ 40,503
  Dallas, TX..........................................             185,999
  Kansas City, MO.....................................               8,339
  Atlanta, GA.........................................              29,575
  Northern VA.........................................              37,891
  Baltimore, MD.......................................              23,352
  Los Angeles, CA.....................................              59,338
  Suburban Detroit, MI................................              31,207
  Chicago, IL.........................................              83,863
  Houston, TX.........................................               2,727
  Denver, CO..........................................              29,246
  Metro Washington, D.C...............................              77,807
  Suburban Philadelphia, PA...........................              71,779

                                     F-18
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED          
                             FINANCIAL STATEMENTS
                                                                  

  San Diego, CA.......................................               5,056
  Sacramento, CA......................................              39,712
  Oakland, CA.........................................              12,488 
  Phoenix, AZ.........................................               5,575
                                                                  --------
                                                                  $744,457
                                                                  ========
              
     One major tenant represented 10% of the Company's total rental income for
the period October 22, 1996 through December 31, 1996. For the year ended
December 31, 1997, all individual tenants represented less than 10% of the
Company's total rental income.

(12) SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES

     In connection with the Formation Transactions, Units valued at $65.9
million were issued in exchange for the Prentiss Group's interest in the
Predecessor Company's Properties and Contracts of PPL. The net assets assumed in
the exchange totaled approximately $5.2 million. In addition, 1,879,897 Common
Shares valued at $20.00 per share were issued in exchange for certain limited
partners' interests in the Operating Partnership. Additional paid-in capital was
reduced by $.9 million of unamortized financing costs related to debt repaid
with proceeds from the IPO. In 1996, $52 million of the net proceeds of the
Company's IPO was allocated to minority interest. The remainder of the net
proceeds increased Common Shares and additional paid-in capital.

     In addition to the above transactions, the Company also acquired the
remaining 85% interest in the Park West C2 Property. The fair value of the
assets acquired totaled $43 million and liabilities assumed totaled
approximately $35 million and the resulting cash paid totaled approximately $8
million. On December 17, 1996, the Company declared a distribution totaling $7.3
million which was paid on January 17, 1997.

     During the period from October 22, 1996 through December 31, 1996, the
Company acquired eight Properties (described in Note 1) and assumed certain
assets and liabilities in the transactions. The acquisitions were recorded under
the purchase method of accounting. The fair values of the acquired assets and
liabilities recorded at the date of acquisition are as follows:

                                  (in thousands)                      
                                                              Amount     
                                                              ------
        Assets acquired                                      $121,834
        Mortgage debt assumed                                  (6,000)
        Other liabilities assumed                              (2,599)
        Other acquisition credits                                (511)
                                                             --------
          Net cash paid                                      $112,724
                                                             ======== 

     During the three months ended December 31, 1997, the Company declared cash
distributions totaling $14.8 million.  The distributions were paid January 16,
1998.

     During the year ended December 31, 1997, the Company assumed $33.9 million
of mortgage debt and $1.9 million of net liabilities in connection with the
acquisition of Properties during the period.

     During the year ended December 31, 1997, $5.0 million of the net proceeds
of the Company's Follow-on Offering, Second Follow-on Offering and the Terramics
Properties purchase were allocated to minority interest.  The remainder of the
net proceeds increased Common Shares and additional paid-in capital.

     In addition, during the year ended December 31, 1997, the Company issued
Units valued at $14.2 million in conjunction with the acquisition of the
Terramics Properties.

                                     F-19
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


(13) RELATED PARTY TRANSACTIONS

     The Company owns a 95% economic interest in the Manager which is not
consolidated in these financial statements.  The Manager incurs certain
personnel and other overhead-related expenses on behalf of the Company which is
subsequently reimbursed to the Manager.  Such expenses totaled $1.3 million and
$1.4 million for the year ended December 31, 1997 and the period October 22,
1996 through December 31, 1996, respectively.  In addition, the Company funded
certain costs of the Manager totaling approximately $10.6 million and $2.6
million during the respective periods.  The net unreimbursed cost has been
included in Other receivables (affiliates) on the balance sheet and is detailed
below:

<TABLE> 
<CAPTION> 

                                                                         (in thousands)
                                                                                         FOR THE PERIOD    
                                                          FOR THE YEAR ENDED         OCT. 22, 1996 THROUGH  
                                                             DEC. 31, 1997                DEC. 31, 1996     
                                                             -------------                -------------
<S>                                                       <C>                        <C> 
Capital funding due from affiliates.................            $ 6,359                      $2,566
Acquisition and development fees and                                                               
  commissions due to affiliates.....................             (3,737)                       (761)
Payroll and staff benefits due to affiliates........               (648)                       (257)
Other amounts due to affiliates.....................                (46)                       (202)
                                                                -------                      ------
                                                                $ 1,928                      $1,346
                                                                =======                      ====== 
</TABLE>

(14) EMPLOYEE BENEFIT PLAN (IN WHOLE DOLLARS)

     Effective October 16, 1987, the Predecessor Company adopted a 401(k)
Savings Plan (the "Plan") for its employees. Under the Plan, as amended,
employees, age 21 and older, are eligible to participate in the Plan after they
have completed one year and 1,000 hours of service. Upon formation, the Company
adopted the Plan and the terms of the Plan.

     Wages eligible for contribution to the Plan include bonuses, overtime pay
and commissions. Participants who have authorized a pre-tax contribution of 2%
or more may also elect to make an after-tax contribution of up to 8% of their
wages.

     The Company matches 25% of the first $500 contributed by its employees. The
cost to the Company for the year ended December 31, 1997 totaled $51,900. There
was no cost to the Company for this matching for the period October 22, 1996
through December 31, 1996. The cost to the Predecessor Company totaled $35,000
for the period January 1, 1996 through October 21, 1996 and $36,000 for the year
ended December 31, 1995. In addition, the Company elected to match employee
contributions with a discretionary match for the year ended December 31, 1997
which totaled $25,000.

     Participants are immediately vested in their pre-tax and after-tax
contributions, the Predecessor Company's matching contributions and earnings
thereon.

     On January 24, 1997, the Company filed a Form S-8 registering 500,000
Common Shares in connection with the Company's share purchase plan("Share
Purchase Plan"). The Share Purchase Plan enables eligible employees to purchase
shares, subject to certain restrictions, of the Company at a 15% discount to
fair market value. A total of 7,671 Common Shares were issued in accordance with
the plan during the year ended December 31, 1997. No shares were issued pursuant
to the plan during the period October 22, 1996 through December 31, 1996.

      

                                     F-20
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


(15) SHARE INCENTIVE PLAN

  Stock-Based Compensation Plans

     The Company sponsors the "Prentiss Properties Trust Trustees' Share
Incentive Plan" (the "Trustees' Automatic Grant Plan") and the "Prentiss
Properties Trust 1996 Share Incentive Plan" (the "Employees Plan")
(collectively, the "Plans"), which are stock-based incentive compensation plans
as described below. The Company applies APB Opinion 25 and related
Interpretations in accounting for the Plans. In 1995, the FASB issued FASB
Statement No. 123 "Accounting for Stock-Based Compensation" ("FAS No. 123")
which, if fully adopted by the Company, would change the methods the Company
applies in recognizing the cost of its Plans. Adoption of the cost recognition
provisions of FAS No. 123 is optional and the Company has decided not to elect
these provisions of FAS No. 123. However, pro forma disclosures as if the
Company adopted the cost recognition provisions of FAS No. 123 in 1995 are
required by FAS No. 123 and are presented below.

     Under the Plans, the Company is authorized to issue Common Shares or cash
pursuant to "Awards" granted in the form of non-qualified stock options not
intended to qualify under Section 422 of the Internal Revenue  Code of 1986, as
amended, restricted or non-restricted shares, stock appreciation rights
("SARs"), and performance shares. Awards may be granted to selected employees
and Trustees of the Company or an affiliate.  In 1996 and 1997, the Company
granted non-qualified stock options under the Plans.

The Trustees' Automatic Grant Plan

     Under the Trustees' Automatic Grant Plan, the Company grants non-qualified
stock options to Trustees automatically at specified dates.  Each Trustee in
office on October 16, 1996 was granted 10,000 non-qualified stock options.
Trustees who are later first elected or appointed to the Board are also granted
10,000 non-qualified stock options on the first day of the fiscal quarter
coinciding with or immediately following the date elected or appointed.  These
Awards vest 25% per year on each annual Board meeting following the date of
grant, commencing with the first Board meeting following the date of grant.

     In addition, commencing in 1997, on the first day of each fiscal quarter,
the Company issues to each Trustee on that date Common Shares having an
aggregate value of $2,500, based on the per share value of the Common Shares on
the date of grant.  These Common Shares shall be 100% vested at grant.

     In 1997, the Company issued a total of 50,000 non-qualified stock options
and 1,195 Common Shares to the Trustees.

The Employees' Plan

     Under the Employees' Plan, the Company is authorized to issue, in the
discretion of the Plan Administrator, Awards with respect to a maximum of
2,030,000 Common Shares.  Awards may be granted to employees of the Company or
an affiliate and Trustees who are also employees of the Company or an affiliate.
No participant may be granted, in any calendar year, Awards in the form of stock
options or SARs with respect to more than 390,000 Common Shares or restricted
share Awards for more than 50,000 Common Shares.  The Plan Administrator has
broad discretion in determining the vesting terms and other terms applicable to
Awards granted under the Plan.

     The exercise price of each option granted during 1997 and 1996 was equal to
the fair market value of the Common Shares on the date of grant.  These options
vest 33-1/3% per year on each anniversary of the date of grant, commencing with
the first anniversary of the date of grant.

     A summary of the status of the Company's stock options as of December 31,
1997 and 1996 and the changes during the year ended on those dates is presented
below:

                                     F-21
<PAGE>
 
     <TABLE>
<CAPTION>
                                                            1997                                           1996
                                          ----------------------------------------       ------------------------------------------ 
                                              # SHARES OF           WEIGHTED                # SHARES OF              WEIGHTED     
                                              UNDERLYING             AVERAGE                 UNDERLYING              AVERAGE      
                                                OPTIONS          EXERCISE PRICES                OPTIONS           EXERCISE PRICES   
                                          -------------------  -------------------       -------------------     ------------------
<S>                                       <C>                  <C>                       <C>                     <C>              
Outstanding at beginning of the year....         1,651,938            $20.82                               
Granted.................................           636,499            $25.08                   1,651,938           $20.82
Exercised...............................             9,500            $20.63                                        
Forfeited...............................            84,522            $20.86                                        
Expired.................................                                                                            
                                                ----------                                    ----------            
Outstanding at end of year..............         2,194,415            $22.06                   1,651,938           $20.82
                                                ==========                                    ==========            
Exercisable at end of year..............           525,317            $20.76                                        
                                                ==========                                    ==========            
  Weighted-average fair value...........                    $1.42                                          $1.62
                                                            =====                                          =====
</TABLE>

     The fair value of each stock option granted is estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted-
average assumptions:

                                                1997                1996
                                                ----                ----
Expected term:                                     5                   5
Expected dividend yield:                           8%                  8%
Expected volatility:                           13.11%              16.06%
Risk-free interest rate:                        6.28%               6.50%

     As of December  31, 1997, there were 2,194,415 options outstanding with a
weighted-average remaining contractual life of 9.04 years.

     Had the compensation cost for the Company's stock-based compensation plans
been determined consistent with FAS No. 123, the Company's net income and net
income per common share for 1997 would approximate the pro forma amounts below:

<TABLE>
<CAPTION>
                                                             (amounts in thousands, except per share data)

                                                      AS REPORTED         PRO FORMA         AS REPORTED         PRO FORMA
                                                        12/31/97           12/31/97           12/31/96           12/31/96
                                                       ---------          ---------          ---------          ---------
<S>                                                   <C>                 <C>               <C>                 <C> 
FAS No. 123 charge...........................                             $     894                             $     143
APB 25 charge................................
Net income...................................          $  36,921             36,027          $   4,996              4,853
Net income per Common Share-basic............               1.48               1.45                .25                .24
Net income per Common Share-diluted..........               1.46               1.42                .25                .24
</TABLE>

     The effects of applying FAS No. 123 in this pro forma disclosure are not
indicative of future amounts.  FAS No. 123 does not apply to awards prior to
1995.

(16) CAPITAL SHARES

     The Board of Trustees is authorized to provide for the issuance of
20,000,000 preferred shares ("Preferred Shares") in one or more series, to
establish the number of shares in each series and to fix the designation,
powers, preferences and rights of each such series and the qualifications,
limitations or restrictions thereof. As of December 31, 1997, 2,830,189
Preferred Shares were issued and outstanding. Each share of the Series A
Convertible Preferred Shares are convertible at the shareholder's option to one
Common Share, subject to certain adjustments, and may not be redeemed by the
Company before December 29, 2004. At December 31, 1997, all dividends then
payable on the Series A Convertible Preferred Shares had been paid.

                                     F-22
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


     The outstanding Units are redeemable at the option of the holder for a like
number of Common Shares, or at the option of the Company, the cash equivalent
thereof. Total Units outstanding at December 31, 1997, were 3,820,175.

(17) EARNINGS PER SHARE

     The Company calculates Earnings per Share in accordance with Statement of
Financial Accounting Standards ("FAS"), No. 128, "Earnings per Share" ("FAS No.
128"). FAS No. 128 requires a dual presentation of basic and diluted Earnings
per Share on the face of the income statement. Additionally, FAS No. 128
requires a reconciliation of the numerator and denominator used in computing
basic and diluted Earnings per Share.


                     (in thousands, except per share data)

Reconciliation of Earnings per Share Numerator                  YEAR ENDED
                                                               Dec. 31, 1997
                                                          --------------------
Net Income for the year ended 12/31/97                                 $36,946
Preferred Dividends                                                        (25)
                                                          --------------------
Net Income Available to Common Shareholders                            $36,921
                                                         
                                                         
Reconciliation of Earnings per Share Denominator         
                                                         
Weighted Average Common Shares Outstanding at            
  12/31/97                                                              24,930
                                                         
Basic Earnings per Share                                               $  1.48
                                                          ====================
                                                         
Dilutive Effect of Common Share Equivalents              
                                                         
Options                                                                    361
Preferred Shares                                                            16
                                                          --------------------
Total Common Share Equivalents                                             377
                                                         
Weighted Average Common Shares Outstanding                              24,930
                                                          --------------------
Weighted Average Common Shares and Common Share          
 Equivalents                                                            25,307
                                                         
                                                         
Diluted Earnings Per Share                                             $  1.46
                                                          ====================

(18) EXTRAORDINARY ITEM

     The extraordinary item represents a charge from write-offs of deferred
financing fees, in the amount of $.9 million during the year ended December 31,
1997.

(19) COMMITMENTS AND CONTINGENCIES (IN WHOLE DOLLARS)

   Legal Matters

     The Company is subject to various legal proceedings and claims that arise
in the ordinary course of business. These matters are generally covered by
insurance. Management believes that the final outcome of such 

                                     F-23
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS

matters will not have a material adverse effect on the financial position,
results of operations or liquidity of the Company.

  Environmental Matters

     The Company obtained Phase I environmental site assessments ("ESAs") for
all properties involved in the IPO. The ESAs for the industrial Properties
located in Milwaukee, Wisconsin, revealed lead contamination near the property
lines of two of the buildings and the development parcel adjacent to the site.
The ESA states that the contamination is probably the result of unauthorized
dumping of contaminated soil by the owner of a vacant lot located between the
two buildings and the development parcel. The dumping occurred prior to the
acquisition of the Milwaukee industrial Properties by the Predecessor Company.
Upon discovery of the unauthorized dumping, the Predecessor Company brought suit
against the owner of the vacant lot, the generators of the contaminated soil and
the prior owner of the Properties. The contaminated soil consists of foundry
sand which was found to contain lead in excess of acceptable trace levels.
According to the ESA, the contamination does not affect the groundwater and is
not likely to migrate or leech into adjoining land. During 1996, a settlement to
the lawsuit was finalized and was approved by the court. In accordance with the
Settlement, (i) the Operating Partnership transferred the affected areas ( a
total of approximately 1.2 acres) to the owner of the vacant lot in exchange for
$100,000 (in whole dollars) and (ii) the owner of the vacant lot and the
generators of the contaminated soil agreed to assume all responsibility for the
remediation of the contaminated soil. The court has entered a finding that the
Operating Partnership was not in the chain of title of the contaminated area. It
is management's opinion that any future outcome of this environmental matter
will not have a material impact on the financial statements.

     Certain land (the "Plant Site") in the vicinity of and underlying the Los
Angeles industrial Properties, was formerly the site of a synthetic rubber
manufacturing plant (the "Plant") owned by the United State Government and
subsequently owned or operated by numerous companies, including Shell Oil
Company ("Shell") and Dow Chemical Company ("Dow"). During the operation of the
Plant, wastes were disposed of in pits and ponds located south of the Properties
(the "Plant Site Affected Area").

     On September 25, 1997, the Company was notified that an undefined area,
which may or may not include the Los Angeles industrial Properties, associated
with the operation of the Plant would be listed on the National Properties List
(the "NPL") effective October 27, 1997. At this time, the EPA has not indicated
the precise boundaries of the NPL site. The Company is currently evaluating the
legal basis for challenging the listing. All past and present owners of the land
underlying the Los Angeles industrial Properties, including the United States
Government, Dow, Shell and the former owner, LAPCO industrial Parks ("LAPCO"),
from whom the Company purchased the Los Angeles industrial Properties, are
potentially responsible parties for the investigation and remediation of the
Plant Site. Shell has agreed to (i) indemnify and hold harmless any successor of
LAPCO, including the Company and any subsequent purchasers, tenants and lenders,
from any liability relating to clean up or remediation costs for the Plant Site
or for any contamination resulting from the Plant Site, and (ii) indemnify and
hold harmless LAPCO and any successor to LAPCO, including the Company, from any
liability arising out of any third-party tort claims for personal injury or
property damage.

     Except as noted above, the ESAs have not revealed any environmental
condition, liability or compliance concern that the Company believes have a
material adverse affect on the Company's business, assets or results of
operations, nor is the Company aware of any such condition, liability or
concern. It is possible that the ESAs relating to any one of the Properties or
the properties to be acquired do not reveal all environmental conditions,
liabilities or compliance concerns or that there are material environmental
conditions, liabilities or compliance concerns that arose at such property after
the related ESA report was completed of which the Company is otherwise unaware.

     The Company is party to several construction contracts as part of its
development activities.  The following properties are currently under
development:

                                     F-24
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


<TABLE>
<CAPTION>
                                                                                              
                                                                               
                                                                          SQUARE                                 ESTIMATED   
                      PROPERTY                    LOCATION                FOOTAGE     ESTIMATED COSTS         COMPLETION DATE   
                      --------                    --------                -------     ---------------         ---------------
                                                                                          ($000's) 
<S>                                             <C>                       <C>         <C>                     <C>
2500 Cumberland Parkway                         Atlanta, GA               145,000         $ 20,090                April 1998
The WestPoint Office Building                   Dallas, TX                149,679           19,665                April 1998
Executive Center Del Mar                        San Diego, CA             111,596           18,950                  May 1998
IBM Call Center                                 Dallas, TX                150,000           18,565                 July 1998
3130 Fairview Park Drive                        Northern Virginia         183,097           31,101             December 1998
375 N. Fairway Dr.                              Chicago, IL               136,200            6,600             December 1997(1)
5170-5270 6th Street                            Milwaukee, WI             163,200            5,900             November 1997(1)
Airworld Expansion                              Kansas City, MO           150,022            5,009                March 1998
225 N. Fairway Dr.                              Chicago, IL               111,634            5,500                March 1998
                                                                        ---------         --------
  Total Development in Process                                          1,300,428         $131,380
                                                                        =========         ========
</TABLE>

(1) Although development was completed prior to year-end, these buildings were
    in the "lease-up" stage at December 31, 1997.  Thus, projects are
    categorized as under development at December 31, 1997.

(20) RECENTLY ISSUED ACCOUNTING STANDARDS

     In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income"
and FAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information."

     FAS No. 130 establishes standards for reporting comprehensive income by
showing changes in the amounts of those items that affect comprehensive income
on the face of the financial statements.  FAS No. 130 does not require a
specific format for the financial statement in which comprehensive income is
reported, but does require that an amount representing total comprehensive
income be reported in that statement.  FAS No. 130 is effective for fiscal years
beginning after December 15, 1997 and requires reclassification of earlier
financial statements for comparative purposes.  The Company believes that upon
implementation, FAS No. 130 will not have a material impact on the financial
statements of the Company.

     FAS No. 131 requires disclosure of segment data in an entity's annual
financial statements and selected segment information in their quarterly report
to shareholders.  FAS No. 131 also requires entity-wide disclosures about the
products and services an entity provides, the material countries in which it
holds assets and reports revenues, and its major customers.  FAS No. 131
supersedes FAS No. 14, "Financial Reporting for Segments of a Business
Enterprise," and is effective for fiscal years beginning after December 15,
1997.  The Company believes that upon implementation, FAS No. 131 will not have
a material impact on the financial statements of the Company.

                                     F-25
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


(21) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

     The following scheduled is a summary of the quarterly results of operations
for the year ended December 31, 1997 and the period October 22, 1996 to December
31, 1996:

<TABLE>
<CAPTION>
                                                           (amounts in thousands, except per share data)
                                                      FIRST       SECOND      THIRD       FOURTH
                                                     QUARTER     QUARTER     QUARTER     QUARTER       TOTAL
                                                    ----------  ----------  ----------  ----------  -----------
<S>                                                 <C>         <C>         <C>         <C>         <C>
Year Ended December 31, 1997
Revenue...........................................     $22,654     $29,778     $35,580     $43,716     $131,728
Income from Operations............................       8,379      10,171      11,414      12,454       42,418
Net Income........................................       7,080       9,147      10,116      10,603       36,946
Net Income per Common Share-basic.................        0.35        0.37        0.38        0.38         1.48
Net income per Common Share-diluted...............        0.35        0.37        0.38        0.36         1.46

                                                                                          FOURTH
                                                                                         QUARTER       TOTAL
                                                                                        ----------  -----------
Period October 22, 1996 to December 31, 1996
Revenue...........................................                                         $13,787     $ 13,787
Income from Operations............................                                           5,840        5,840
Net Income........................................                                           4,996        4,996
Net Income per Common Share-basic.................                                            0.25         0.25
Net income per Common Share-diluted...............                                            0.25         0.25
</TABLE>

(22) PRO FORMA FINANCIAL INFORMATION (UNAUDITED)

     Due to the impact of the Follow-on Offerings and the Properties
acquired during 1997, the 1997 historical results of operations are not
indicative of future results of operations.  The following Pro Forma Condensed
Statements of Income for the years ended December 31, 1997 and 1996 are
presented as if the IPO and related formation transactions, Follow-on Offerings
and property acquisitions had occurred at January 1, 1996, and therefore include
pro forma information.  The pro forma information is based upon historical
information and does not purport to present what actual results would have been
had such transactions, in fact, occurred at January 1, 1996, or to project
results for any future period.

<TABLE>
<CAPTION>
                                                             (in thousands, except per share data)
                                                                     YEARS ENDED DECEMBER 31,
                                                                     ------------------------
                                                                   1997                   1996
                                                                   ----                   ----
<S>                                                              <C>                   <C>
Total revenues.....................................              $200,979              $187,316
Property operating and maintenance.................                46,556                46,537
Real estate taxes..................................                20,363                18,789
General and administrative.........................                 3,185                 2,615
Personnel costs, net...............................                 3,658                 2,704
Interest expense...................................                40,787                40,787
Amortization of deferred financing costs...........                   848                   848
Depreciation and amortization......................                33,200                33,200
Equity in joint venture and unconsolidated
 subsidiaries......................................                 5,515                 6,040
                                                                 --------              --------
Income before minority interest....................                57,897                47,876
Minority interest..................................                (6,399)               (5,308)
                                                                 --------              --------
Net income.........................................                51,498                42,568
Preferred dividends................................                (4,528)               (4,528)

</TABLE> 

                                     F-26
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


<TABLE> 
<S>                                                              <C>                   <C>
Net income attributable to common
    shareholders...................................                46,970                38,040
Net income per Common Share -
    basic..........................................              $   1.42              $   1.15
                                                                 ========              ========
Net income per Common Share -
    diluted........................................              $   1.40              $   1.13
                                                                 ========              ========
</TABLE>

(23) SUBSEQUENT EVENTS

     On January 9, 1998, the Company acquired a single Class "A" office Property
containing 141,139 square feet located in the suburban Philadelphia,
Pennsylvania, area.  The purchase price of the Property, excluding closing
costs, totaled approximately $13.8 million.

     On January 13, 1998, the Company acquired six industrial Properties
containing 382,234 square feet located in the San Jose, California, area.  The
purchase price of the Properties, excluding closing costs, totaled approximately
$26.6 million.

     On January 30, 1998, the Company acquired a single Class "A" office
Property containing 234,222 square feet located in Denver, Colorado.  The
purchase price of the Property, excluding closing costs, totaled approximately
$31.0 million.

     On February 2, 1998, the Company closed a direct private placement of
1,100,000 Common Shares with an affiliate of Union Bank of Switzerland ("UBS").
The Common Shares were priced at  a gross price of $27.00 per share based on the
market price of the Company's Common Shares on the day the transaction was
consummated. In a separate transaction, Prentiss Properties Trust entered into a
forward agreement dated February 2, 1998, with UBS-LB (the "UBS Forward
Agreement"). The maturity date of the UBS Forward Agreement is February 2, 1999,
subject to acceleration as described more fully below.

     The UBS Forward Agreement generally provides that if the market price of a
common share on the maturity date is less than $27 (the "Forward Price") the
Company must pay UBS-LB the difference multiplied by 1,100,000. Similarly, if
the market price of a Common Share is above the Forward Price, UBS-LB must pay
us the difference in Common Shares. If the Company chooses not to, or if the
Company cannot, settle in freely tradable Common Shares, the Company must
repurchase the 1,100,000 shares at the Forward Price in cash. Over the life of
the UBS Forward Agreement, the Forward Price will be increased by LIBOR plus 135
basis points, minus any dividends received on the Common Shares.

     To secure the Company's obligations under the UBS Forward Agreement, the
UBS Forward Agreement provides for quarterly payments of collateral equal to
1,100,000 times 105% of the amount by which the market price of a common share
is below the Forward Price. The collateral may be in the form of cash, letters
of credit or freely tradable Common Shares.

     Although maturity date of the UBS Forward Agreement is February 2, 1999; if
the closing price of the Common Shares falls below $16.40 for a period of three
consecutive trading days, or if the market value of the Company's Common Shares
(excluding operating partnership units) declines to or below $600,000,000, UBS-
LB has the right to force a complete settlement under the UBS Forward Agreement
(if the closing price of the Common Shares falls below $18.50 for a period of
three consecutive trading days, UBS-LB has the right to force a settlement with
respect to 67% of the Transaction). UBS-LB also has the right to force a
complete settlement under the UBS Forward Agreement if the Company:

                                     F-27
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


     .  is in default with respect to certain financial covenants under the UBS
        Forward Agreement,
     .  is in default under its credit facility with a syndicate of lenders or
        any other unsecured lending agreement, or
     .  fail to post sufficient cash collateral.

     On February 3, 1998, the Company reached an agreement to refinance the
$140 million loan collateralized by the Broadmoor Austin Properties.  The new
loan agreement, signed with an affiliate of Lehman Brothers Inc., is a non-
recourse loan with an interest rate of 7.04%, a term of 13 years and is
collateralized by the Broadmoor Austin Properties.  The borrower under the loan
is Broadmoor Austin Associates, a joint venture between Prentiss Properties and
IBM, in which Prentiss Properties owns an approximate 50% interest.

     On February 3, 1998, the Company reached an agreement to refinance of the
$10 million loan collateralized by the Walnut Glen Tower Property.  The new loan
agreement, for total funds of $35 million, is for seven years with an option to
extend for one additional year at a fixed rate of 6.92%.  The existing $10
million loan had a rate of 7.50%.

     On February 5, 1998, the Company acquired 50 Class "A" office/industrial
flex Properties containing 1,162,000 square feet located in the San Diego,
California, area.  The purchase price of the Properties, excluding estimated
closing costs, totaled approximately $89.5 million.

     In connection with the IPO, certain entities affiliated with the Company
(PDO Three, Inc.; Prentiss O'Hare Illinois, Inc.; Prentiss Property Acquisition,
Inc.; and Prentiss Properties Holding, Inc. [the "Merged Entities"]) received
Units in exchange for assets contributed to the Operating Partnership.  In
February of 1998, (i) the Merged Entities distributed 113,500 Units to certain
employees of the Merged Entities (the "Merged Entity Employees"), (ii) the
Company issued 2,432,541 Common Shares in exchange for all of the capital stock
of the Merged Entities to the owners of the Merged Entities (the "Merged Entity
Owners"), and (iii) the Merged Entity Employees redeemed their 113,500 Units in
exchange for an equal number of Common Shares.  The Company 

                                     F-28
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


agreed to file with the SEC a Registration Statement, with respect to the resale
of the Common Shares by the Merged Entity Owners and Merged Entity Employees.

     On February 12, 1998, the Company closed two direct placements of
registered Common Shares resulting in net proceeds of approximately $47 million.
The Company placed 1,816,006 Common Shares of beneficial interest at $27.25 per
share.  The Common Shares were underwritten/sold in two separate transactions by
Prudential Securities Incorporated ("Prudential") and Salomon Smith Barney.
Prudential underwrote 922,676 Common Shares and Salomon Smith Barney underwrote
893,330 Common Shares.  The proceeds will be used for future real estate
acquisitions.

     On February 18, 1998, the Company closed a direct placement of registered
Common Shares resulting in net proceeds of approximately $30.9 million.  The
Company placed 1,198,157 Common Shares of beneficial interest at $27.13 per
share.  The registered Common Shares were underwritten by AG Edwards.  The
proceeds will be used for future real estate acquisitions.

                                     F-29
<PAGE>
 
                           PRENTISS PROPERTIES TRUST
                            AND PREDECESSOR COMPANY
                      NOTES TO CONSOLIDATED AND COMBINED
                             FINANCIAL STATEMENTS


  REAL ESTATE AND ACCUMULATED DEPRECIATION

                             (DOLLARS IN THOUSANDS)

A summary of activity for real estate and accumulated depreciation is as
follows:

<TABLE>
<CAPTION>
                                                                 1997            1996           1995
                                                              ----------       --------       --------
<S>                                                           <C>              <C>            <C>
Real estate:
 Balance at beginning of year......................           $  501,035       $153,148       $151,673
   Additions to and Improvement of Real estate.....              609,781        347,887          1,475
                                                              ----------       --------       --------
  Balance at end of year...........................           $1,110,816       $501,035       $153,148
                                                              ==========       ========       ========
Accumulated depreciation:
  Balance at beginning of year.....................               18,507         11,780          7,307
  Depreciation expense.............................               17,636          6,727          4,473
                                                              ----------       --------       --------
    Balance at end of year.........................           $   36,143       $ 18,507       $ 11,780
                                                              ==========       ========       ========
</TABLE>
                                                                                
                                     F-30

<PAGE>
                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                 PRENTISS PROPERTIES TRUST



                                 By:     /s/ Thomas P. Simon
                                    ----------------------------------
                                             Thomas P. Simon
                                             Vice President
Date:     January 25, 1999 

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

                Date                                     Signature
                ----                                     ---------

          January 25, 1999                        /s/ Michael V. Prentiss
                                            ------------------------------------
                                                    Michael V. Prentiss
                                                  Chief Executive Officer
                                             Chairman of the Board and Trustee

          January 25, 1999                          /s/ Thomas F. August
                                            ------------------------------------
                                                      Thomas F. August
                                               President and Chief Operating
                                                      Officer Trustee

          January 25, 1999                           /s/ Mark R. Doran
                                            ------------------------------------
                                                       Mark R. Doran
                                                  Chief Financial Officer

          January 25, 1999                          /s/ Thomas P. Simon
                                            ------------------------------------
                                                      Thomas P. Simon
                                                       Vice President

          January 25, 1999                        
                                            ------------------------------------
                                                    Thomas J. Hynes, Jr.
                                                          Trustee

          January 25, 1999                         /s/ Barry J.C. Parker
                                            ------------------------------------
                                                     Barry J.C. Parker
                                                          Trustee

          January 25, 1999                     /s/ Dr. Leonard M. Riggs, Jr.
                                            ------------------------------------
                                                 Dr. Leonard M. Riggs, Jr.
                                                          Trustee

          January 25, 1999                        /s/ Ronald G. Steinhart
                                            ------------------------------------
                                                    Ronald G. Steinhart
                                                          Trustee

          January 25, 1999                         /s/ Lawrence A. Wilson
                                            ------------------------------------
                                                     Lawrence A. Wilson
                                                          Trustee