##### Table of Contents



(ARDEN REALTY, INC. LOGO)   Securities and Exchange Commission Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended September 30, 2004 Commission file number 1-12193 ARDEN REALTY, INC.  Maryland
    
    95-4578533(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 11601 Wilshire Boulevard,
4th Floor
Los Angeles, California 90025-1740
(Address and zip code of principal executive offices) Registrants telephone number, including area code: (310) 966-2600 Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [   ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [   ] As of November 4, 2004 there were 65,666,375 shares of the registrants common
stock, $.01 par value, issued and outstanding.




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##### Table of Contents



ARDEN REALTY, INC.
FORM 10-Q
TABLE OF CONTENTS  
 PAGE NO.PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsConsolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003
    
    
    3Consolidated Statements of Income for the three and nine months ended September 30, 2004 and 2003 (unaudited)
    
    
    4Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (unaudited)
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    28Item 4.
    
    Controls and Procedures
    
    
    29PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    31Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    31Item 3.
    
    Defaults Upon Senior Securities
    
    
    31Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    31Item 5.
    
    Other Information
    
    
    31Item 6.
    
    Exhibits
    
    
    31SIGNATURES
    
    
    32Exhibit 31.1Exhibit 32.1




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Part I. FINANCIAL INFORMATION 
 Item 1. Financial Statements Arden Realty, Inc. 
 Consolidated Balance Sheets
 (in thousands, except per share data)
 September 30,
    
    December 31,2004
    
    2003(unaudited)AssetsInvestment in real estate:Land
    
    $
    443,626
    
    
    $
    443,517Buildings and improvements
    
    
    2,110,323
    
    
    
    2,046,734Tenant improvements and leasing commissions
    
    
    358,489
    
    
    
    331,4502,912,438
    
    
    
    2,821,701Less: accumulated depreciation and amortization
    
    
    (484,492
    )
    
    
    (436,690
    )2,427,946
    
    
    
    2,385,011Properties under development/renovation
    
    
    10,829
    
    
    
    75,627Land available for development
    
    
    23,829
    
    
    
    23,723Properties held for disposition, net
    
    
    92,519
    
    
    
    162,338Net investment in real estate
    
    
    2,555,123
    
    
    
    2,646,699Cash and cash equivalents
    
    
    15,595
    
    
    
    4,707Restricted cash
    
    
    15,765
    
    
    
    19,694Rent and other receivables, net of allowance of $3,258 and $4,041 at
September 30, 2004 and December 31, 2003, respectively
    
    
    6,282
    
    
    
    3,688Deferred rent, net of allowance of $2,032 and $2,216 at
September 30, 2004 and December 31, 2003, respectively
    
    
    43,778
    
    
    
    44,203Prepaid financing costs, expenses and other assets, net of accumulated
amortization of $12,511 and $13,781 at September 30, 2004 and
December 31,
2003, respectively
    
    
    16,895
    
    
    
    22,442Total assets
    
    $
    2,653,438
    
    
    $
    2,741,433LiabilitiesMortgage loans payable
    
    $
    377,587
    
    
    $
    557,435Mortgage loan payable  Property held for disposition
    
    
    7,270
    
    
    
    7,394Unsecured lines of credit
    
    
    136,500
    
    
    
    161,000Unsecured term loan
    
    
    125,000
    
    
    
    125,000Unsecured senior notes, net of discount
    
    
    697,438
    
    
    
    498,952Accounts payable and accrued expenses
    
    
    59,050
    
    
    
    54,317Security deposits
    
    
    23,020
    
    
    
    22,321Dividends payable
    
    
    33,118
    
    
    
    32,535Total liabilities
    
    
    1,458,983
    
    
    
    1,458,954Minority interest
    
    
    20,404
    
    
    
    72,194Stockholders EquityPreferred stock, $.01 par value, 20,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, $.01 par value, 100,000,000 shares authorized, 65,580,875 and
64,425,450 issued and outstanding at September 30, 2004 and December 31,
2003, respectively
    
    
    657
    
    
    
    646Additional paid-in capital
    
    
    1,192,049
    
    
    
    1,225,192Deferred compensation
    
    
    (13,714
    )
    
    
    (14,952
    )Accumulated other comprehensive loss
    
    
    (4,941
    )
    
    
    (601
    )Total stockholders equity
    
    
    1,174,051
    
    
    
    1,210,285Total liabilities and stockholders equity
    
    $
    2,653,438
    
    
    $
    2,741,433
 See accompanying notes to consolidated financial statements. 3




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Arden Realty, Inc. 
 Consolidated Statements of Income
 (in thousands, except per share data)
(unaudited)
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Property revenues
    
    $
    104,516
    
    
    $
    101,287
    
    
    $
    307,210
    
    
    $
    297,054Property operating expenses
    
    
    35,069
    
    
    
    33,865
    
    
    
    100,827
    
    
    
    95,45969,447
    
    
    
    67,422
    
    
    
    206,383
    
    
    
    201,595General and administrative expenses
    
    
    4,823
    
    
    
    4,391
    
    
    
    13,972
    
    
    
    11,962Interest expense
    
    
    21,517
    
    
    
    23,953
    
    
    
    66,014
    
    
    
    70,242Depreciation and amortization
    
    
    30,907
    
    
    
    29,223
    
    
    
    90,696
    
    
    
    84,586Interest and other loss (income)
    
    
    178
    
    
    
    171
    
    
    
    (153
    )
    
    
    (82
    )Income from continuing operations before
impairment on investment in securities and
minority interest
    
    
    12,022
    
    
    
    9,684
    
    
    
    35,854
    
    
    
    34,887Impairment on investment in securities
    
    
    
    
    
    
    
    
    
    
    (2,700
    )
    
    
    Minority interest
    
    
    (2,415
    )
    
    
    (1,294
    )
    
    
    (5,047
    )
    
    
    (4,063
    )Income from continuing operations
    
    
    9,607
    
    
    
    8,390
    
    
    
    28,107
    
    
    
    30,824Discontinued operations, net of minority interest
    
    
    632
    
    
    
    2,151
    
    
    
    3,291
    
    
    
    8,676Gain on sale of discontinued properties
    
    
    937
    
    
    
    
    
    
    
    7,766
    
    
    
    5,382Net income
    
    $
    11,176
    
    
    $
    10,541
    
    
    $
    39,164
    
    
    $
    44,882Basic net income per common share:Income from continuing operations
    
    $
    0.15
    
    
    $
    0.13
    
    
    $
    0.43
    
    
    $
    0.49Income from discontinued operations
    
    
    0.02
    
    
    
    0.04
    
    
    
    0.17
    
    
    
    0.22Net income per common share  basic
    
    $
    0.17
    
    
    $
    0.17
    
    
    $
    0.60
    
    
    $
    0.71Weighted average number of common shares  basic
    
    
    65,485
    
    
    
    63,635
    
    
    
    65,141
    
    
    
    63,296Diluted net income per common share:Income from continuing operations
    
    $
    0.15
    
    
    $
    0.13
    
    
    $
    0.43
    
    
    $
    0.49Income from discontinued operations
    
    
    0.02
    
    
    
    0.03
    
    
    
    0.17
    
    
    
    0.22Net income per common share  diluted
    
    $
    0.17
    
    
    $
    0.16
    
    
    $
    0.60
    
    
    $
    0.71Weighted average number of common shares  diluted
    
    
    65,892
    
    
    
    64,050
    
    
    
    65,511
    
    
    
    63,516
 See accompanying notes to consolidated financial statements. 4




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Arden Realty, Inc. 
 Consolidated Statements of Cash Flows
 (in thousands)
(unaudited)
 Nine Months EndedSeptember 30,2004
    
    2003Operating Activities:Net income
    
    $
    39,164
    
    
    $
    44,882Adjustments to reconcile net income to net cash
provided by operating activities:Minority interest, including discontinued operations
    
    
    5,346
    
    
    
    4,442Gain on sale of discontinued properties
    
    
    (7,766
    )
    
    
    (5,382
    )Impairment on investment in securities
    
    
    2,700
    
    
    
    Depreciation and amortization, including discontinued operations
    
    
    94,755
    
    
    
    90,775Amortization of loan costs
    
    
    2,911
    
    
    
    2,933Non-cash compensation expense
    
    
    2,331
    
    
    
    1,409Changes in operating assets and liabilities:Rent and other receivables
    
    
    (2,594
    )
    
    
    724Deferred rent
    
    
    (1,907
    )
    
    
    (243
    )Prepaid financing costs, expenses and other assets
    
    
    (2,066
    )
    
    
    (1,381
    )Accounts payable and accrued expenses
    
    
    3,969
    
    
    
    1,714Security deposits
    
    
    807
    
    
    
    1,499Net cash provided by operating activities
    
    
    137,650
    
    
    
    141,372Investing Activities:Improvements to commercial properties
    
    
    (70,508
    )
    
    
    (61,797
    )Proceeds from sale of properties
    
    
    77,552
    
    
    
    78,719Net cash provided by investing activities
    
    
    7,044
    
    
    
    16,922Financing Activities:Repayments of mortgage loans
    
    
    (179,972
    )
    
    
    (3,742
    )Proceeds from unsecured lines of credit
    
    
    323,500
    
    
    
    66,500Repayments of unsecured lines of credit
    
    
    (348,000
    )
    
    
    (125,087
    )Proceeds from issuance of unsecured senior notes, net of discount
    
    
    197,033
    
    
    
    Proceeds from issuance of common stock
    
    
    24,072
    
    
    
    22,780Distributions to preferred operating partnership unit holders
    
    
    (3,234
    )
    
    
    (3,234
    )Redemption of preferred operating partnership units
    
    
    (50,000
    )
    
    
    Decrease (increase) in restricted cash
    
    
    4,035
    
    
    
    (3,052
    )Distributions to minority interests
    
    
    (2,542
    )
    
    
    (2,591
    )Dividends paid
    
    
    (98,698
    )
    
    
    (95,639
    )Net cash used in financing activities
    
    
    (133,806
    )
    
    
    (144,065
    )Net increase in cash and cash equivalents
    
    
    10,888
    
    
    
    14,229Cash and cash equivalents at beginning of period
    
    
    4,707
    
    
    
    4,063Cash and cash equivalents at end of period
    
    $
    15,595
    
    
    $
    18,292Supplemental Disclosure of Cash Flow Information:Cash paid during the period for interest, net of amounts capitalized
    
    $
    66,193
    
    
    $
    72,236
 See accompanying notes to consolidated financial statements. 5




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Arden Realty, Inc. 
 Notes to Consolidated Condensed Financial Statements
 September 30, 2004
(unaudited)
 1. Description of Business The terms Arden Realty, us, we and our as used in this report
refer to Arden Realty, Inc. Through our controlling interest in Arden Realty
Limited Partnership, or the Operating Partnership, and our other subsidiaries,
we own, manage, lease, develop, renovate and acquire commercial office
properties located in Southern California. As of September 30, 2004, our
portfolio was comprised of 127 primarily suburban office properties, consisting
of 209 buildings with approximately 18.7 million net rentable square feet,
excluding one building currently under renovation. As of September 30, 2004,
our operating portfolio was 91.1% occupied. The minority interests at September 30, 2004 consist of limited
partnership interests in the Operating Partnership totaling approximately 2.5%. 2. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements include the accounts of
Arden Realty, Inc., the Operating Partnership, and our subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. We consolidate all entities for which we have controlling financial
interest as measured by a majority of the voting interest. For entities in
which the controlling financial interest is not clearly indicated by ownership
of a majority of the voting interest, we would consolidate those entities that
we control by agreement. We would also consolidate all variable interest
entities for which we were the primary beneficiary. Except for minority interests in the Operating Partnership, Arden Realty
and the Operating Partnership currently own 100% of all of our consolidated
subsidiaries and we do not have any unconsolidated investments. Interim Financial Data The accompanying consolidated condensed financial statements should be
read in conjunction with our 2003 Annual Report on Form 10-K as filed with the
Securities and Exchange Commission. The accompanying financial information
reflects all adjustments, which are, in our opinion, of a normal recurring
nature and necessary for a fair presentation of our financial position, results
of operations and cash flows for the interim periods. Interim results of
operations are not necessarily indicative of the results to be expected for the
full year. Reclassifications We classified eight properties as held for disposition during the third
quarter of 2004. Previously reported amounts in our balance sheet as of
December 31, 2003 and operating results for the three and nine months ended
September 30, 2003 were reclassified to conform with the classification of
these eight properties. 3. Property Dispositions On August 24, 2004, we sold an approximate 69,000 square foot office
property located in San Diego County for a gross sales price of approximately
$9.3 million. The net proceeds from this disposition were used to reduce the
outstanding balance on our Wells Fargo unsecured line of credit. 6




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##### Table of Contents



4. Discontinued Operations Below is a summary of our combined results of operations from the
properties disposed of or held for disposition during the periods presented.
The summary includes the results of operations before gain on sale for the
three and nine months ended September 30, 2004 and 2003, respectively (in
thousands, except number of properties): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues from rental operations
    
    $
    3,574
    
    
    $
    6,382
    
    
    $
    12,499
    
    
    $
    23,044Property expenses
    
    
    (1,359
    )
    
    
    (2,288
    )
    
    
    (4,850
    )
    
    
    (7,800
    )Depreciation and amortization
    
    
    (1,529
    )
    
    
    (1,882
    )
    
    
    (4,059
    )
    
    
    (6,189
    )Minority interest
    
    
    (54
    )
    
    
    (61
    )
    
    
    (299
    )
    
    
    (379
    )Discontinued operations, net of minority
interest
    
    $
    632
    
    
    $
    2,151
    
    
    $
    3,291
    
    
    $
    8,676Gain on sale of discontinued properties
    
    $
    937
    
    
    $
    
    
    
    $
    7,766
    
    
    $
    5,382Properties sold
    
    
    1
    
    
    
    5
    
    
    
    3
    
    
    
    11Properties held for sale
    
    
    8
    
    
    
    8
    
    
    
    8
    
    
    
    8
 7




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5. Outstanding Indebtedness A summary of our outstanding indebtedness as of September 30, 2004 and
December 31, 2003 is as follows: Stated AnnualInterest Rate at
    
    
    
    
    
    Number ofSeptember 30,
    
    December 31,
    
    September 30,
    
    Rate
    
    PropertiesType of Debt
    
    2004
    
    2003
    
    2004
    
    Fixed/Floating
    
    Securing Loan
    
    Maturity(in thousands)Mortgage Loans Payable:Fixed RateMortgage Financing I(1)
    
    $
    
    
    
    $
    175,000
    
    
    
    
    %
    
    
    
    
    
    
    
    
    
    
    Mortgage Financing III(2)
    
    
    133,080
    
    
    
    134,544
    
    
    
    6.74
    %
    
    Fixed
    
    
    22
    
    
    
    4/08Mortgage Financing IV(2)
    
    
    108,796
    
    
    
    109,960
    
    
    
    6.61
    %
    
    Fixed
    
    
    12
    
    
    
    4/08Mortgage Financing V(2)
    
    
    104,128
    
    
    
    105,899
    
    
    
    6.94
    %
    
    Fixed
    
    
    12
    
    
    
    4/09Mortgage Financing VI(2)
    
    
    21,412
    
    
    
    21,578
    
    
    
    7.54
    %
    
    Fixed
    
    
    3
    
    
    
    4/09Activity Business
Center(2), (3)
    
    
    7,270
    
    
    
    7,394
    
    
    
    8.85
    %
    
    Fixed
    
    
    1
    
    
    
    5/06145 South Fairfax(2)
    
    
    3,881
    
    
    
    3,912
    
    
    
    8.93
    %
    
    Fixed
    
    
    1
    
    
    
    1/27Marin Corporate Center(2)
    
    
    2,621
    
    
    
    2,724
    
    
    
    9.00
    %
    
    Fixed
    
    
    1
    
    
    
    7/15Conejo Business Center(2)
    
    
    2,567
    
    
    
    2,669
    
    
    
    8.75
    %
    
    Fixed
    
    (Note 4)
    
    
    7/15Conejo Business Center(2)
    
    
    1,102
    
    
    
    1,149
    
    
    
    7.88
    %

    
    Fixed
    
    (Note 4)
    
    
    7/15384,857
    
    
    
    564,829Unsecured Lines of Credit:Floating RateWells Fargo  $310 mm(5)
    
    
    126,500
    
    
    
    158,000
    
    
    
    3.18
    %
    
    LIBOR + 0.90% (Notes 6,7)
    
    
    
    
    
    
    4/06City National
Bank  $20 mm(5)
    
    
    10,000
    
    
    
    3,000
    
    
    
    2.69
    %
    
    (Note 8)
    
    
    
    
    
    
    8/05136,500
    
    
    
    161,000Unsecured Term Loan:Fixed RateWells Fargo  $125 mm(5)
    
    
    125,000
    
    
    
    125,000
    
    
    
    4.14
    %
    
    Fixed (Note 9)
    
    
    
    
    
    
    6/06Unsecured Senior Notes:Fixed Rate2005 Notes(10)
    
    
    199,949
    
    
    
    199,872
    
    
    
    8.88
    %
    
    Fixed
    
    
    
    
    
    
    3/052007 Notes(10)
    
    
    150,009
    
    
    
    149,907
    
    
    
    7.00
    %
    
    (Note 11)
    
    
    
    
    
    
    11/072010 Notes(10)
    
    
    49,775
    
    
    
    49,744
    
    
    
    9.15
    %
    
    Fixed
    
    
    
    
    
    
    3/102010 Notes(10)
    
    
    99,491
    
    
    
    99,429
    
    
    
    8.50
    %
    
    Fixed
    
    
    
    
    
    
    11/102011 Notes(10), (12)
    
    
    198,214
    
    
    
    
    
    
    
    5.20
    %
    
    Fixed
    
    
    
    
    
    
    9/11697,438
    
    
    
    498,952Total Debt
    
    $
    1,343,795
    
    
    $
    1,349,781
   (1)
    
    This mortgage financing was repaid in full on April 9, 2004.(2)
    
    Requires monthly payments of principal and interest.(3)
    
    This loan is secured by a property currently classified as held for
disposition.(4)
    
    Both mortgage loans are secured by the Conejo Business Center property.(5)
    
    Requires monthly payments of interest only, with outstanding principal
balance due upon maturity.(6)
    
    This line of credit also has an annual 20 basis point facility fee on the
entire $310 million commitment amount. In June 2004, we amended this line
of credit to reduce the interest rate from LIBOR + 1.00% to LIBOR + 0.90%.(7)
    
    We have entered into interest rate swap agreements that fixed the
interest rate on $50 million of the outstanding balance on this line of
credit at 3.95% through April of 2006.(8)
    
    On October 4, 2004, we amended this line of credit to reduce the interest
rate from LIBOR + 1.00% or Prime Rate  1.875% to LIBOR + 0.90% or Prime
Rate  1.975%.(9)
    
    In 2002, we entered into interest rate swap agreements that fixed the
interest rate on the entire balance of this loan. In June 2004, we amended
this loan to reduce its effective interest rate by 20 basis points. After
this amendment and after taking into effect the interest rate swap
agreements for this loan, it will have an effective interest rate of
approximately 4.14% for the remainder of 2004, 4.55% in 2005 and 4.70% in
2006.(10)
    
    Requires semi-annual interest payments only, with principal balance due
upon maturity.(11)
    
    During the fourth quarter of 2003, we entered into interest rate swap
agreements to float the interest rate on $100 million of the outstanding
balance of these notes at a rate of LIBOR + 3.1% through November of 2007.
Including these swap agreements, the effective interest rate on these
notes was approximately 5.96% as of September 30, 2004.(12)
    
    On August 18, 2004, we issued $200 million of unsecured senior notes at
an interest rate of 5.20%, maturing September 1, 2011. 8




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6. Interest Rate Swap Agreements We have entered into interest rate swap agreements to effectively convert
floating rate debt into fixed rate debt, to convert fixed rate debt to floating
rate debt and to lock the current Treasury rate in anticipation of future debt
issuances. Net amounts received or paid under these agreements are recognized
as an adjustment to interest expense when such amounts are incurred or earned.
Our objective in using interest rate swap agreements is to manage our exposure
to interest rate movements. During 2002, such agreements were used to fix the floating interest rate
associated with $50 million of the Wells Fargo unsecured line of credit and the
entire $125 million balance of the unsecured term loan. Since June of 2003, we
also entered into $150 million of forward-starting swaps that effectively fixed
the 10-year Treasury rate at an average rate of approximately 4.1% for
borrowings that occurred in 2004 to refinance some of our scheduled debt
maturities. The forward-starting interest rate swaps were entered into at
current market rates and, therefore, had no initial cost. In August 2004, we
settled the $150 million forward-starting swaps in conjunction with the
issuance of $200 million of unsecured senior notes. In October and November of 2003, we also entered into reverse interest
rate swap agreements to float $100 million of the fixed interest rate
associated with the 7.00% senior unsecured notes due in November of 2007.
Under these reverse swaps, we will receive interest at a fixed rate of 7.00%
and pay interest at a variable rate averaging the six-month LIBOR rate in arrears plus
3.10%. The interest rate swaps mature at the same time the notes are due. These
swaps qualify as fair value hedges for accounting purposes. Net semi-annual
interest payments will be recognized as increases or decreases in interest
expense. The fair value of the interest rate swaps will be recognized on our
balance sheet and the carrying value of the senior unsecured notes will be
increased or decreased by an offsetting amount. In August and September of 2004, we entered into $186 million of
forward-starting swaps that effectively fixed the 10-year Treasury rate at an
average rate of approximately 4.45% for borrowings that are anticipated to
occur in 2005 to refinance some of our scheduled debt maturities. The
forward-starting interest rate swaps were entered into at current market rates
and therefore, had no initial cost. Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities (SFAS 133), as amended and
interpreted, establishes accounting and reporting standards for derivative
instruments and for hedging activities. The accounting for changes in the fair
value of derivatives depends on the intended use of the derivative and the
resulting designation. Derivatives used to hedge the exposure to changes in
the fair value of an asset, liability, or firm commitment attributable to a
particular risk, are considered fair value hedges. Derivatives used to hedge
the exposure to variability in expected future cash flows, or other types of
forecasted transactions, are considered cash flow hedges. For derivatives designated as fair value hedges, changes in the fair value
of the derivative and the hedged item related to the hedged risk are recognized
in earnings. For derivatives designated as cash flow hedges, the effective
portion of changes in the fair value of the derivative is initially reported in
other comprehensive income (loss), outside of earnings and subsequently
recognized to earnings when the hedged transaction affects earnings. Under SFAS 133, our $175 million in floating-to-fixed swaps and our $186
million in forward-starting swaps outstanding as of September 30, 2004 are
classified as cash flow hedges with their fair value of approximately $4.6
million reported in accumulated other comprehensive income on our balance
sheet. The estimated fair value of these interest rate swap agreements are
dependent on changes in market interest rates and other market factors that
affect the value of such agreements. Consequently, the estimated current fair
value may significantly change during the term of the agreements. Any
estimated gain or loss from these agreements will be amortized into earnings as
we recognize the interest expense for the underlying floating-rate loans at the
fixed interest rate provided under our agreements in the case of the
fixed-to-floating swaps or as part of interest expense for future borrowings in
the case of the forward starting swaps. If the underlying debt related to these
swaps were to be repaid prior to maturity, we would recognize into interest
expense any unamortized gain or loss at the time of such early repayment. Under SFAS 133, our $100 million in fixed-to-floating hedges are
classified as fair value hedges with their fair value of approximately $500,000
reported in both the unsecured senior notes and other assets line items on our
balance sheet. The estimated fair value of these interest rate hedge
agreements are dependent on changes in market interest rates and other market
factors that affect the value of such agreements. Consequently, the estimated
current fair value may significantly change during the term of the agreements.
Any estimated gain or loss from these agreements will be amortized into
earnings as we recognize the interest expense for the underlying fixed-rate
loan at the floating interest rate provided under our agreements in the case of
the floating-to-fixed hedges. If the underlying debt related to these hedges
were to be repaid prior to maturity, we would recognize into interest expense
any unamortized gain or loss at the time of such early repayment. 7. Stockholders Equity and Minority Interests A common Operating Partnership unit, or common OP Unit, and a share of our
common stock have essentially the same economic characteristics as they share
equally in the total net income or loss and distributions of the Operating
Partnership. A common OP Unit may be redeemed for cash or, at the election of
the Operating Partnership, for shares of our common stock on a one-for-one
basis. Our minority interest balance included $50 million of 8.625% Series B
Cumulative Redeemable Preferred Operating Partnership Units, or Preferred OP
Units. These Preferred OP Units were issued in September of 1999. On
September 28, 2004, we redeemed the $50 million of Preferred OP Units at par
plus accrued unpaid distributions. In conjunction with this redemption, we
expensed approximately $1.1 million in original issuance costs. 9




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On September 14, 2004, we declared a quarterly dividend of $0.505 per
share to stockholders of record on September 30, 2004. For the three months
ended September 30, 2003, we declared a quarterly dividend of $0.505 per share. During the three and nine months ended September 30, 2004, we issued a
total of 67,954 and 1,091,258 common shares respectively, relating to
exercises of stock options. On August 23, 2004, we issued a total of 4,500 restricted stock awards to
several of our directors. Holders of these shares have full voting rights and
will receive any dividend but are prohibited from selling or transferring
unvested shares. The fair value on the date of the grant of these restricted
shares was $31.66. These restricted shares vest equally over three years. 8. Income (Loss) from Taxable REIT Subsidiary Beginning in the first quarter of 2004, we have reclassified for financial
presentation purposes the operating results of Nextedge, our taxable REIT
subsidiary, or TRS, from general and administrative expenses to interest and
other income (loss) in our consolidated statements of income. Nextedge provides
energy consulting services to commercial real estate owners. The following is a
breakdown of the components of interest and other income (loss) for each of the
periods presented (in thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) from TRS
    
    $
    (292
    )
    
    $
    (292
    )
    
    $
    (171
    )
    
    $
    (549
    )Interest and other income
    
    
    114
    
    
    
    121
    
    
    
    324
    
    
    
    631$
    (178
    )
    
    $
    (171
    )
    
    $
    153
    
    
    $
    82
 9. Stock Option Plan Beginning on January 1, 2003, we adopted the provisions of SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure under
which we began expensing the costs of new stock options granted to employees in
2003 in accordance with SFAS No. 123, Accounting for Stock-Based
Compensation. We used the Black-Scholes option valuation model to estimate the
fair value of the stock options granted. During the three months ended
September 30, 2004 and September 30, 2003, we expensed approximately $8,000 of
stock option based employee compensation costs. The following table reflects pro forma net income and earnings per share
had we elected to expense all options granted prior to 2003 assuming the fair
value method and using the Black-Scholes option valuation model (in thousands,
except per share amounts): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income available to common stockholders, as reported
    
    $
    11,176
    
    
    $
    10,541
    
    
    $
    39,164
    
    
    $
    44,882Stock based employee compensation costs for options granted
prior to 2003 assuming fair value method
    
    
    (24
    )
    
    
    (124
    )
    
    
    (178
    )
    
    
    (647
    )Net income available to common stockholders, as adjusted
    
    $
    11,152
    
    
    $
    10,417
    
    
    $
    38,986
    
    
    $
    44,235Earnings per share:Basic as reported
    
    $
    0.17
    
    
    $
    0.17
    
    
    $
    0.60
    
    
    $
    0.71Basic as adjusted
    
    $
    0.17
    
    
    $
    0.16
    
    
    $
    0.60
    
    
    $
    0.70Diluted as reported
    
    $
    0.17
    
    
    $
    0.16
    
    
    $
    0.60
    
    
    $
    0.71Diluted as adjusted
    
    $
    0.17
    
    
    $
    0.16
    
    
    $
    0.60
    
    
    $
    0.70
 10




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10. Comprehensive Income Comprehensive income for the three and nine months ended September 30,
2004 and 2003, respectively, consisted of net income, plus the results of
changes in value of cash flow hedges not reflected in the Consolidated
Statements of Income. The components of comprehensive income are as follows (in
thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    11,176
    
    
    $
    10,541
    
    
    $
    39,164
    
    
    $
    44,882Other comprehensive income (loss):Unrealized derivative gain (loss) on cash flow hedges
    
    
    (8,743
    )
    
    
    1,924
    
    
    
    (4,340
    )
    
    
    (985
    )Comprehensive income
    
    $
    2,433
    
    
    $
    12,465
    
    
    $
    34,824
    
    
    $
    43,897
 11. Commitments and Contingencies We are presently subject to various lawsuits, claims and proceedings
arising in the ordinary course of business, none of which if determined
unfavorably to us is expected to have a material adverse effect on our cash
flows, financial condition or results of operations. There were no material
changes in our legal proceedings during the three months ended September 30,
2004. 12. Subsequent Events On October 4, 2004, we acquired 30700 Russell Ranch Road, a 138,000 square
foot, 100% leased office property located in the Westlake Village submarket of
Los Angeles County for approximately $32.3 million. On October 11, 2004, we acquired Warner Corporate Center, a 253,000 square
foot, 97.8% leased office property located in the Woodland Hills submarket of
Los Angeles County for approximately $64.5 million. On October 11, 2004, we issued a total of 85,500 restricted stock awards
to several key executive officers and several of our directors. Holders of
these shares have full voting rights and will receive any dividend but are
prohibited from selling or transferring unvested shares. The fair value on the
date of the grant of these restricted shares was $32.66. These restricted
shares vest equally over three years. In November, 2004, we entered into $70 million of forward-starting swaps
that effectively fixed the 10-year Treasury rate at an average rate of
approximately 4.19% for borrowings that are anticipated to occur in 2005 to
refinance some of our scheduled debt maturities. 11




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Overview The following discussion relates to our unaudited consolidated financial
statements included herein, which should be read in conjunction with the
financial statements and related notes thereto included elsewhere in this Form
10-Q and in our 2003 Annual Report onForm 10-K. This form 10-Q, including the documents incorporated herein by reference,
contains forward-looking statements within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act pertaining to, among other
things, our future results of operations, cash available for distribution,
acquisitions, lease renewals, property development, property renovation,
capital requirements and general business, industry and economic conditions
applicable to us. Also, documents we subsequently file with the SEC and
incorporated herein by reference will contain forward-looking statements.
Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth below and
the matters set forth in this form 10-Q generally. We caution you, however,
that this list of factors may not be exhaustive, particularly with respect to
future filings. We are a self-administered and self-managed real estate investment trust
that owns, manages, leases, develops, renovates and acquires commercial
properties located in Southern California. We are managed by 7 senior executive
officers who have experience in the real estate industry ranging from 14 to 35
years and who collectively have an average of 19 years experience. We perform
all property and development management, accounting, finance and acquisition,
disposition activities and a majority of our leasing transactions with our
staff of approximately 300 employees. As of September 30, 2004, we were Southern Californias largest publicly
traded office landlord as measured by total net rentable square feet owned. As
of that date, our portfolio was comprised of 127 primarily suburban office
properties, consisting of 209 buildings with approximately 18.7 million net
rentable square feet excluding one building currently under renovation. As of
September 30, 2004 and December 31, 2003, our operating portfolio was 91.1% and
90.4% occupied, respectively. Business Strategy Our primary business strategy is to actively manage our portfolio to seek
to achieve gains in rental rates and occupancy, control operating expenses and
maximize income from ancillary operations and services. When market conditions
permit, we may also renovate existing or new properties or selectively develop
or acquire new properties that add value and fit strategically into our
portfolio. We may also sell existing properties and place the proceeds into
investments we believe will generate higher long-term value. We continue to seek to build a tenant base of smaller, diverse companies
that limits our exposure to any single tenant or industry. Smaller tenants
typically translate into shorter-term leases. Shorter-term leases provide
greater opportunity for renewing a substantial portion of our portfolio at
higher rental rates each year during strong markets, but create challenges to
maintain occupancy and rates when markets weaken. The average term of our
leases is 4 to 5 years, resulting in approximately 15% to 20% of our leases
expiring annually. We closely monitor our operating expenses and capital expenditures to
sustain or improve operating margins and dividend coverage. We may defer
discretionary operating expenses and capital expenditures until market
conditions improve. Impact of Economic Climate Our short and long-term liquidity, ability to refinance existing
indebtedness, ability to issue long-term debt and equity securities at
favorable rates and our dividend policy are significantly impacted by the
operating results of our properties, all of which are located in Southern
California. Our ability to lease available space and increase rates when
leases expire is largely dependent on the demand for office space in the
markets where our properties are located. The timing and extent of future changes in the national and local economy
and their effects on our properties and results of operations are difficult to
accurately predict. It is likely, however, that if national and regional
economic conditions deteriorate they would directly affect our operating
results in the future, making it more difficult for us to lease and renew
available space, to increase or maintain rental rates as leases expire and to
collect amounts due from our tenants. For additional information, see Risk
Factors  Further declines in the economic activity of Southern California will
adversely affect our operating results, - The financial condition and
solvency of our tenants may reduce our cash flow, and - Rising energy costs
and power outages in California may have an adverse effect on our operations
and revenue, in our 2003 Annual Report on Form 10-K. Critical Accounting Policies Refer to our 2003 Annual Report on Form 10-K for a discussion of our
critical accounting policies, which include, among other things, revenue
recognition, allowance for doubtful accounts and depreciation. There have been
no material changes to these policies in 2004. Off-Balance Sheet Arrangements As of September 30, 2004, we do not have any off-balance sheet
transactions, arrangements or obligations (including contingent obligations)
that have, or are reasonably likely to have a current or future material effect
on our financial condition, changes in our financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources. 12




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##### Table of Contents



RESULTS OF OPERATIONS Our financial position and operating results primarily relate to our
portfolio of commercial properties and income derived from those properties.
Therefore, the comparability of financial data from period to period will be
affected by the timing of property developments, acquisitions and dispositions. Comparison of the three months ended September 30, 2004 to the three months ended September 30, 2003
(in thousands, except number of properties and percentages) Three Months EndedSeptember 30,Percent2004
    
    2003
    
    Change
    
    ChangeTotal Portfolio:Revenue from rental operations:Scheduled cash rents
    
    $
    89,264
    
    
    $
    86,062
    
    
    $
    3,202
    
    
    
    4
    %Straight-line rents
    
    
    84
    
    
    
    109
    
    
    
    (25
    )
    
    
    (23
    )Tenant reimbursements
    
    
    5,582
    
    
    
    6,858
    
    
    
    (1,276
    )
    
    
    (19
    )Parking, net of expense
    
    
    6,273
    
    
    
    5,632
    
    
    
    641
    
    
    
    11Other rental operations
    
    
    3,313
    
    
    
    2,626
    
    
    
    687
    
    
    
    26Total revenue from rental operations
    
    
    104,516
    
    
    
    101,287
    
    
    
    3,229
    
    
    
    3Property expenses:Repairs and maintenance
    
    
    11,337
    
    
    
    10,390
    
    
    
    947
    
    
    
    9Utilities
    
    
    9,859
    
    
    
    10,312
    
    
    
    (453
    )
    
    
    (4
    )Real estate taxes
    
    
    7,599
    
    
    
    6,969
    
    
    
    630
    
    
    
    9Insurance
    
    
    1,878
    
    
    
    2,065
    
    
    
    (187
    )
    
    
    (9
    )Ground rent
    
    
    207
    
    
    
    326
    
    
    
    (119
    )
    
    
    (37
    )Administrative
    
    
    4,189
    
    
    
    3,803
    
    
    
    386
    
    
    
    10Total property expenses
    
    
    35,069
    
    
    
    33,865
    
    
    
    1,204
    
    
    
    4Property Operating Results(1)
    
    
    69,447
    
    
    
    67,422
    
    
    
    2,025
    
    
    
    3General and administrative
    
    
    4,823
    
    
    
    4,391
    
    
    
    432
    
    
    
    10Interest expense
    
    
    21,517
    
    
    
    23,953
    
    
    
    (2,436
    )
    
    
    (10
    )Depreciation and amortization
    
    
    30,907
    
    
    
    29,223
    
    
    
    1,684
    
    
    
    6Interest and other loss (income)
    
    
    178
    
    
    
    171
    
    
    
    7
    
    
    
    4Income from continuing operations before
impairment on investment in securities and
minority interest
    
    $
    12,022
    
    
    $
    9,684
    
    
    $
    2,338
    
    
    
    24
    %Discontinued operations, net of minority interest
    
    $
    632
    
    
    $
    2,151
    
    
    $
    (1,519
    )
    
    
    (71
    )%Number of Properties:Disposed of during period
    
    
    (1
    )
    
    
    Completed and placed in service during period
    
    
    
    
    
    
    In service at end of period
    
    
    127
    
    
    
    130Net Rentable Square Feet:Disposed of during period
    
    
    (70
    )
    
    
    Completed and placed in service during period
    
    
    
    
    
    
    In service at end of period
    
    
    18,726
    
    
    
    18,617Same Property Portfolio(2):Revenue from rental operations
    
    $
    104,815
    
    
    $
    104,499
    
    
    $
    316
    
    
    
    
    %Property expenses
    
    
    35,470
    
    
    
    35,077
    
    
    
    393
    
    
    
    1
    %$
    69,345
    
    
    $
    69,422
    
    
    $
    (77
    )
    
    
    
    %Straight-line rents
    
    $
    (320
    )
    
    $
    66
    
    
    $
    (386
    )
    
    
    (585
    )%Number of non-development properties
    
    
    125Number of buildings
    
    
    206Average occupancy
    
    
    90.5
    %
    
    
    89.2
    %Net rentable square feet
    
    
    18,241
   (1)
    
    Property Operating Results is commonly used by investors to
evaluate the performance of REITs, to determine trends in earnings
and to compute the fair value of properties as it is not affected
by (1) the cost of funds of the property owner or (2) the impact of
depreciation and amortization expenses as well as gains or losses
from the sale of operating real estate assets that are included in
net income computed in accordance with Generally Accepted
Accounting Principles, or GAAP. The first factor is commonly
eliminated from net income because it is specific to the particular
financing capabilities and constraints of the owner. The second
factor is commonly eliminated because it may not accurately
represent the actual change in value in real estate properties that
results from use or changes in market conditions. We believe that
eliminating these costs from net income gives investors an
additional 13




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measure of operating performance that, when used as an adjunct to net
income computed in accordance with GAAP, can be a useful measure of
our operating results.Property Operating Results captures trends in occupancy rates, rental
rates and operating costs. However, Property Operating Results
excludes general and administrative costs, interest expense, interest income,
depreciation and amortization expense and gains or losses from the sale of
properties, changes in value in our real estate properties that result from use or
permanent impairment to carrying costs as stipulated by GAAP, the level of
capital expenditures and leasing costs necessary to maintain the operating
performance of our properties, all of which are significant economic costs.
Therefore, Property Operating Results may fail to capture significant trends
which limits its usefulness.Property Operating Results is a non-GAAP measure of performance.
Property Operating Results is not a substitute for net income as
computed in accordance with GAAP. It excludes significant expense
components such as depreciation and amortization expense and financing
costs. This measure should be analyzed in conjunction with net income
and cash flow from operating activities as computed in accordance with
GAAP. Other companies may use different methods for calculating
Property Operating Results or similarly entitled measures and,
accordingly, our Property Operating Results may not be comparable to
similarly entitled measures reported by other companies that do not
define the measure exactly as we do.The following is a reconciliation of net income computed in accordance
with GAAP to Property Operating Results (in thousands): Three Months Ended September 30,2004
    
    2003Net income
    
    $
    11,176
    
    
    $
    10,541Add:General and administrative expense
    
    
    4,823
    
    
    
    4,391Interest expense
    
    
    21,517
    
    
    
    23,953Depreciation and amortization
    
    
    30,907
    
    
    
    29,223Minority interest
    
    
    2,415
    
    
    
    1,294Interest and other loss
    
    
    178
    
    
    
    171Less:Gain on sale of discontinued properties
    
    
    (937
    )
    
    
    Discontinued operations, net of minority interest
    
    
    (632
    )
    
    
    (2,151
    )Property Operating Results
    
    $
    69,447
    
    
    $
    67,422
  (2)
    
    Consists of non-development properties classified as part of
continuing operations and owned for the entirety of the periods
presented. VARIANCES FOR RESULTS OF OPERATIONS Our Property Operating Results for the three months ended September 30,
2004 compared to the same period in 2003 were primarily affected by our
acquisitions, dispositions and development activities since June 30, 2003. As a result of these changes within our portfolio of properties since June
30,2003, we do not believe the Property Operating Results presented above are
comparable from period to period. Therefore, in the table above, we have also
presented the Property Operating Results for our same store portfolio. Revenue from Rental Operations Revenue from rental operations increased approximately $3.2 million, or
3%, for the three months ended September 30, 2004 compared to the same period
in 2003. This increase was primarily due to our December 2003 acquisition of a 101,000 square foot office property in San
Diego County, revenues from our 6100 Center Drive development property in Los
Angeles County which was placed in service during the second quarter of 2004
and from overall occupancy gains and scheduled rent increases in our properties. Revenue from rental operations for the same store portfolio increased
approximately $0.3 million for the three months ended September 30, 2004
compared to the same period in 2003, primarily due to a 1.3% increase in
average occupancy in 2004. Property Expenses Property expenses increased approximately $1.2 million, or 4%, for the
three months ended September 30, 2004 compared to the same period in 2003.
This increase was primarily due to a property acquired in December 2003 and
the placement in service of our 6100 Center Drive development property in the second
quarter of 2004 and overall occupancy gains within our portfolio. Property expenses for the same
store portfolio increased approximately $0.4 million, or 1%, for the three
months ended September 30, 2004 compared to the same period in 2003, primarily
due to higher repairs and maintenance as a result of higher costs for
contracted services and the timing of certain projects. General and Administrative General and administrative expenses as a percentage of total revenues were
approximately 4.5% for the three months ended September 30, 2004 compared to
approximately 4.1% for the same period in 2003. The approximate $0.4 million
increase in general and administrative expenses was primarily related to higher
Section 404 implementation costs in 2004. Interest Expense Interest expense decreased approximately $2.4 million, or 10%, for the
three months ended September 30, 2004 compared to the same period in 2003. This
decrease was primarily due to a lower cost of debt in 2004 due to the permanent
refinancing of a $175 million, 7.52% mortgage financing loan earlier this year
with disposition proceeds and proceeds from the issuance of $200 million, 5.20% (5.45%
effective rate) unsecured senior notes in August 2004. 14




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##### Table of Contents



Depreciation and Amortization Depreciation and amortization expense increased by approximately $1.7
million, or 6%, for the three months ended September 30, 2004 compared to the
same period in 2003, primarily due to depreciation related to a property
acquired in December 2003 and depreciation related to capital expenditures,
tenant improvements and leasing commissions placed in service subsequent to the
second quarter of 2003. 15




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##### Table of Contents



Comparison of the nine months ended September 30, 2004 to the nine months ended September 30, 2003
(in thousands, except number of properties and percentages): Nine Months EndedSeptember 30,Percent2004
    
    2003
    
    Change
    
    ChangeTotal Portfolio:Revenue from rental operations:Scheduled cash rents
    
    $
    264,019
    
    
    $
    256,368
    
    
    $
    7,651
    
    
    
    3
    %Straight-line rents
    
    
    1,456
    
    
    
    609
    
    
    
    847
    
    
    
    139Tenant reimbursements
    
    
    15,006
    
    
    
    17,318
    
    
    
    (2,312
    )
    
    
    (13
    )Parking, net of expense
    
    
    18,027
    
    
    
    16,219
    
    
    
    1,808
    
    
    
    11Other rental operations
    
    
    8,702
    
    
    
    6,540
    
    
    
    2,162
    
    
    
    33Total revenue from rental operations
    
    
    307,210
    
    
    
    297,054
    
    
    
    10,156
    
    
    
    3Property expenses:Repairs and maintenance
    
    
    33,378
    
    
    
    30,370
    
    
    
    3,008
    
    
    
    10Utilities
    
    
    24,930
    
    
    
    25,525
    
    
    
    (595
    )
    
    
    (2
    )Real estate taxes
    
    
    22,991
    
    
    
    20,807
    
    
    
    2,184
    
    
    
    10Insurance
    
    
    5,751
    
    
    
    5,982
    
    
    
    (231
    )
    
    
    (4
    )Ground rent
    
    
    539
    
    
    
    690
    
    
    
    (151
    )
    
    
    (22
    )Administrative
    
    
    13,238
    
    
    
    12,085
    
    
    
    1,153
    
    
    
    10Total property expenses
    
    
    100,827
    
    
    
    95,459
    
    
    
    5,368
    
    
    
    6Property Operating Results(1)
    
    
    206,383
    
    
    
    201,595
    
    
    
    4,788
    
    
    
    2General and administrative
    
    
    13,972
    
    
    
    11,962
    
    
    
    2,010
    
    
    
    17Interest expense
    
    
    66,014
    
    
    
    70,242
    
    
    
    (4,228
    )
    
    
    (6
    )Depreciation and amortization
    
    
    90,696
    
    
    
    84,586
    
    
    
    6,110
    
    
    
    7Interest and other income
    
    
    (153
    )
    
    
    (82
    )
    
    
    71
    
    
    
    87Income from continuing operations before
impairment on investment in securities and
minority interest
    
    $
    35,854
    
    
    $
    34,887
    
    
    $
    967
    
    
    
    (3
    )%Discontinued operations, net of minority interest
    
    $
    3,291
    
    
    $
    8,676
    
    
    $
    (5,385
    )
    
    
    (62
    )%Number of Properties:Disposed of during period
    
    
    (3
    )
    
    
    (6
    )Completed and placed in service during period
    
    
    1
    
    
    
    In service at end of period
    
    
    127
    
    
    
    130Net Rentable Square Feet:Disposed of during period
    
    
    (365
    )
    
    
    (515
    )Completed and placed in service during period
    
    
    283
    
    
    
    In service at end of period
    
    
    18,726
    
    
    
    18,617Same Property Portfolio(2):Revenue from rental operations
    
    $
    310,072
    
    
    $
    307,055
    
    
    $
    3,017
    
    
    
    1
    %Property expenses
    
    
    101,818
    
    
    
    98,490
    
    
    
    3,328
    
    
    
    3$
    208,254
    
    
    $
    208,565
    
    
    $
    (311
    )
    
    
    
    %Straight-line rents
    
    $
    128
    
    
    $
    568
    
    
    $
    (440
    )
    
    
    (78
    )%Number of non-development properties
    
    
    125Number of buildings
    
    
    206Average occupancy
    
    
    89.9
    %
    
    
    89.2
    %Net rentable square feet
    
    
    18,241
   (1)
    
    Property Operating Results is commonly used by investors to
evaluate the performance of REITs, to determine trends in earnings
and to compute the fair value of properties as it is not affected
by (1) the cost of funds of the property owner or (2) the impact of
depreciation and amortization expenses as well as gains or losses
from the sale of operating real estate assets that are included in
net income computed in accordance with Generally Accepted
Accounting Principles, or GAAP. The first factor is commonly
eliminated from net income because it is specific to the particular
financing capabilities and constraints of the owner. The second
factor is commonly eliminated because it may not accurately
represent the actual change in value in real estate properties that
results from use or changes in market conditions. We believe that
eliminating these costs from net income gives investors an
additional measure of operating performance that, when used as an
adjunct to net income computed in accordance with GAAP, can be a
useful measure of our operating results. 16




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##### Table of Contents



Property Operating Results captures trends in occupancy rates, rental
rates and operating costs. However, Property Operating Results
excludes general and administrative costs, interest expense, interest income,
depreciation and amortization expense and gains or losses from the sale of
properties, changes in value in our real estate properties that result from use or
permanent impairment to carrying costs as stipulated by GAAP, the level of
capital expenditures and leasing costs necessary to maintain the operating
performance of our properties, all of which are significant economic costs.
Therefore, Property Operating Results may fail to capture significant
trends which limits its usefulness.Property Operating Results is a non-GAAP measure of performance.
Property Operating Results is not a substitute for net income as
computed in accordance with GAAP. It excludes significant expense
components such as depreciation and amortization expense and financing
costs. This measure should be analyzed in conjunction with net income
and cash flow from operating activities as computed in accordance with
GAAP. Other companies may use different methods for calculating
Property Operating Results or similarly entitled measures and,
accordingly, our Property Operating Results may not be comparable to
similarly entitled measures reported by other companies that do not
define the measure exactly as we do.The following is a reconciliation of net income computed in accordance
with GAAP to Property Operating Results (in thousands): Nine Months Ended September 30,2004
    
    2003Net income
    
    $
    39,164
    
    
    $
    44,882Add:General and administrative expense
    
    
    13,972
    
    
    
    11,962Interest expense
    
    
    66,014
    
    
    
    70,242Depreciation and amortization
    
    
    90,696
    
    
    
    84,586Minority interest
    
    
    5,047
    
    
    
    4,063Impairment on investment in securities
    
    
    2,700
    
    
    
    Less:Interest and other income
    
    
    (153
    )
    
    
    (82
    )Gain on sale of discontinued properties
    
    
    (7,766
    )
    
    
    (5,382
    )Discontinued operations, net of minority interest
    
    
    (3,291
    )
    
    
    (8,676
    )Property Operating Results
    
    $
    206,383
    
    
    $
    201,595
  (2)
    
    Consists of non-development properties classified as part of
continuing operations and owned for the entirety of the periods
presented. VARIANCES FOR RESULTS OF OPERATIONS Our Property Operating Results for the nine months ended September 30,
2004 compared to the same period in 2003 were primarily affected by our
acquisitions, dispositions and development activities since January 1, 2003. As a result of these changes within our portfolio of properties since
January 1,2003, we do not believe the Property Operating Results presented
above are comparable from period to period. Therefore, in the table above, we
have also presented the Property Operating Results for our same property
portfolio. Revenue from Rental Operations Revenue from rental operations increased approximately $10.2 million, or
3%, for the nine months ended September 30, 2004 compared to the same period in
2003. This increase was primarily due to our December 2003 acquisition of a 101,000 square foot office property in San Diego County,
revenues from our 6100 Center Drive development property which was placed in
service during the second quarter of 2004 and from overall occupancy gains and
scheduled rent increases in our properties. Revenue from rental operations for the same store portfolio increased
approximately $3.0 million, or 1%, for the nine months ended September 30, 2004
compared to the same period in 2003. This increase was primarily due to an
approximate $2.5 million increase in cash rents, an approximate $2.5 million
increase in other rental operations and an approximate $1.4 million increase in
parking income, all of which were partially offset by an approximate $3.0
million decrease in tenant reimbursements, and an approximate $0.4
million decrease in straight-line rents. The increase in cash rents was primarily
related to scheduled rent increases in existing leases and by the 0.7% increase
in average occupancy for these properties. The increase in other rental
operations was primarily related to higher lease termination fees in 2004 and
lower reserves for tenant receivables as a result of a reduced level of
defaults in 2004. The increase in parking income is primarily due to an
increase in occupancy in 2004 and higher special event parking in 2004. The
decrease in tenant reimbursements was primarily due to resetting of base years
for new leases in 2004. The decrease in straight-line rents was primarily due
to older leases turning over throughout our portfolio. Property Expenses Property expenses increased approximately $5.4 million, or 6%, for the
nine months ended September 30, 2004 compared to the same period in 2003. This
increase was partially due to a property acquired in December 2003 and
placing our 6100 Center Drive development property in service in the second quarter of 2004
and overall occupancy gains within our portfolio. Property expenses for the same store portfolio increased approximately
$3.3 million, or 3%, for the nine months ended September 30, 2004 compared to
the same period in 2003. This increase was primarily due to an approximate
$2.7 million increase in repairs and maintenance expense and an approximate $1.7
million increase in real estate taxes, all of which were partially offset by an
approximate $1.1 million decrease in utility expenses. Repairs and maintenance
expense increased primarily due to higher costs for contracted services and the timing
of certain projects. Real estate taxes increased primarily due to the timing of
final reassessments and property tax refunds received in 2003 for certain
properties as well as new property tax measures implemented in Los Angeles
County. Utility expenses decreased primarily due to lower than anticipated
usage in 2004, partially offset by an increase in occupancy. 17




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##### Table of Contents



General and Administrative General and administrative expenses as a percentage of total revenues were
approximately 4.5% for the nine months ended September 30, 2004 compared
to approximately 4.0% for the same period in 2003. The approximate $2.0
million increase in general and administrative expenses was primarily related
to higher personnel costs associated with annual merit increases and non-cash
compensation expense associated with restricted stock grants issued in 2004 and
2003 and higher Section 404 implementation costs in 2004. Interest Expense Interest expense decreased approximately $4.2 million, or 6%, for the nine
months ended September 30, 2004 compared to the same period in 2003. This
decrease was primarily due to a lower cost of debt in 2004 due to the permanent
refinancing of a $175 million, 7.52% mortgage financing loan earlier this year
with disposition proceeds and proceeds from the issuance of $200 million, 5.20% (5.45%
effective rate) unsecured senior notes in August 2004, partially offset by lower
capitalized interest in 2004. Capitalized interest was lower in 2004 as we
stopped capitalizing interest on our 6100 Center Drive development property in May 2003. Depreciation and Amortization Depreciation and amortization expense increased by approximately $6.1
million, or 7%, for the nine months ended September 30, 2004 compared to the
same period in 2003, primarily due to depreciation related to a property
acquired in December 2003 and depreciation related to capital expenditures,
tenant improvements and leasing commissions placed in service subsequent to the
third quarter of 2003. LIQUIDITY AND CAPITAL RESOURCES Cash Flows Cash provided by operating activities decreased by approximately $3.7
million to $137.7 million for the nine months ended September 30, 2004 compared
to $141.4 million for the same period in 2003. This decrease was primarily due
to the loss of operating cash flows from eleven properties sold since the
beginning of 2003 as part of our capital recycling program, partially offset by
the increased cash flows from a property acquired in the fourth quarter of 2003
and our 6100 Center Drive development property, which was placed in service
during the second quarter of 2004. Cash provided by investing activities decreased by approximately $9.9
million to $7.0 million for the nine months ended September 30, 2004 compared
to $16.9 million for the same period in 2003. This decrease was primarily due
to an increased level of tenant improvement and leasing commission expenditures
attributable to our higher level of occupancy in 2004. Cash used in financing activities decreased by approximately $10.3 million
to $133.8 million for the nine months ended September 30, 2004 compared to
$144.1 million for the same period in 2003. This decrease was primarily due to
the release of restricted cash associated with the payoff of our $175 million
loan in 2004 and lower net borrowings in 2004. Cash Balances, Available Borrowings and Capital Resources As of September 30, 2004, we had approximately $31.4 million in cash and
cash equivalents, including $15.8 million in restricted cash. Restricted cash
consisted of $9.7 million in interest bearing cash deposits required by four of
our mortgage loans payable and $6.1 million in cash impound accounts for real
estate taxes and insurance as required by several of our mortgage loans
payable. Our Operating Partnership has an unsecured line of credit with a total
commitment of $20 million from City National Bank. This line of credit accrues
interest at LIBOR + 1.00% or the City National Bank Prime Rate  1.875% and is
scheduled to mature in August 2005. On October 4, 2004, we amended this line of
credit to reduce the interest rate to LIBOR + 0.90% or the City National Bank Prime Rate  1.975%. As
of September 30, 2004, there was $10 million outstanding on this line of credit
and $10 million was available for additional borrowings. Our Operating Partnership also has an unsecured line of credit with a
group of banks led by Wells Fargo. In June 2004, this line of credit was
amended to reduce the interest rates by approximately 10 to 15 basis points
depending on our secured debt rating and revise certain covenants. As a result
of this amendment, this line of credit provides for borrowings up to $310
million with an option to increase the amount to $350 million and bears
interest at a rate ranging between LIBOR + 0.65% and LIBOR + 1.15% (including
an annual facility fee ranging from 0.15% to 0.40% based on the aggregate
amount of the line of credit) depending on the Operating Partnerships
unsecured debt rating. This line of credit matures in April 2006. In addition,
as long as the Operating Partnership maintains an unsecured debt rating of
BBB-/Baa3 or better, it may exercise a competitive bid option, whereby
the lenders may bid on the interest rate to be charged for up to $150 million
of the unsecured line of credit. The Operating Partnership also has the option
to convert the interest rate on this line of credit to the higher of Wells
Fargos prime rate or the Federal Funds rate plus 0.5%. As of September 30,
2004, $126.5 million was outstanding on this line of credit and $183.5 million
was available for additional borrowings. 18




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##### Table of Contents



From time to time we enter into interest rate
swaps, caps, floors and other interest rate exchange contracts to effectively manage our exposure to changes in
interest rates. We also have a capital recycling program under which
we sell existing properties and reinvest the proceeds into new acquisitions that we believe will
yield a higher long-term return on invested capital. In August 2004
we sold one property for approximately $9.3 million and used the proceeds to pay down our unsecured line of credit. In October
2004 we acquired two properties for an aggregate of approximately
$96.8 million. We expect to continue meeting our short-term liquidity and capital
requirements generally through net cash provided by operating activities and
proceeds from our unsecured lines of credit. We believe the foregoing sources
of liquidity will be sufficient to fund our short-term liquidity needs over the
next twelve months, including recurring non-revenue enhancing capital
expenditures, tenant improvements and leasing commissions. We expect to meet our long-term liquidity and capital requirements such as
scheduled principal repayments, development costs, property acquisitions, if
any, and other non-recurring capital expenditures through net cash provided by
operations, refinancing of existing indebtedness and the issuance of long-term
debt and equity securities. Debt Summary Following is a summary of scheduled principal payments for our total debt
outstanding as of September 30, 2004 (in thousands): Year
    
    Amount2004
    
    $
    1,7152005
    
    
    217,2122006
    
    
    266,101
    (1)2007
    
    
    158,6882008
    
    
    230,7272009
    
    
    112,2922010
    
    
    150,3072011
    
    
    200,5382012
    
    
    7682013
    
    
    845Thereafter
    
    
    4,602Total
    
    $
    1,343,795
   (1)
    
    Includes $126.5 million outstanding on our Wells Fargo unsecured line of
credit. 19




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##### Table of Contents



Following is certain other information related to our outstanding
indebtedness as of September 30, 2004: Unsecured and Secured Debt: Weighted
    
    WeightedAverage
    
    AverageBalance
    
    Percent
    
    Interest Rate(1)
    
    Maturity (in years)(000s)Unsecured Debt
    
    $
    958,938
    
    
    
    71
    %
    
    
    6.54
    %
    
    
    3.5Secured Debt
    
    
    384,857
    
    
    
    29
    
    
    
    7.16
    
    
    
    4.2Total Debt
    
    $
    1,343,795
    
    
    
    100
    %
    
    
    6.72
    %
    
    
    3.7
 Floating and Fixed Rate Debt: Weighted
    
    WeightedAverage
    
    AverageBalance
    
    Percent
    
    Interest Rate(1)
    
    Maturity (in years)(000s)Floating Rate
Debt(2)
    
    $
    186,500
    
    
    
    14
    %
    
    
    4.94
    %
    
    
    2.3Fixed Debt(3)
    
    
    1,157,295
    
    
    
    86
    
    
    
    7.00
    
    
    
    3.8Total Debt
    
    $
    1,343,795
    
    
    
    100
    %
    
    
    6.72
    %
    
    
    3.7
   (1)
    
    Includes amortization of prepaid financing costs.(2)
    
    Includes $100 million of fixed rate debt that has been converted to
floating rate through interest rate swap agreements.(3)
    
    Includes $175 million of floating rate debt that has been fixed through
interest rate swap agreements. Total interest incurred and the amount capitalized was as follows (in
thousands): Three Months Ended September 30,
    
    Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003Total interest incurred
    
    $
    21,777
    
    
    $
    24,129
    
    
    $
    66,628
    
    
    $
    72,568Amount capitalized
    
    
    (260
    )
    
    
    (176
    )
    
    
    (614
    )
    
    
    (2,326
    )Amount expensed
    
    $
    21,517
    
    
    $
    23,953
    
    
    $
    66,014
    
    
    $
    70,242
 Consolidated Income Available for Debt Service and Compliance with Principal Financial Covenants Consolidated Income Available for Debt Service is a non-GAAP measurement
of our performance and liquidity. Consolidated Income Available for Debt
Service is presented below because this data is used by investors and our
management as a supplemental measure to (a) evaluate our operating performance
and compare it to other real estate companies, (b) determine trends in
earnings, (c) determine our ability to service debt and (d) determine our
ability to fund future capital expenditure requirements. As discussed more
fully below, Consolidated Income Available for Debt Service is also used in
several financial covenants we are required to satisfy each quarter under the
terms of our principal debt agreements. Consolidated Income Available for Debt Service permits investors and
management to view income from our operations on an unleveraged basis before
the effects of non-cash depreciation and amortization expense. By excluding
interest expense, Consolidated Income Available for Debt Service measures our
operating performance independent of our capital structure and indebtedness
and, therefore, allows for a more meaningful comparison of our operating
performance between quarters as well as annual periods and to compare our
operating performance to that of other companies, and to more readily identify
and evaluate trends in earnings. The usefulness of Consolidated Income Available for Debt Service is
limited because it does not reflect interest expense, taxes, gains or losses on
sales of property, losses on valuations of derivatives, asset impairment
losses, cumulative effect of a change in accounting principle, extraordinary
items as defined by GAAP and depreciation and amortization costs. These costs
have been or may in the future be incurred by us, each of which affects or
could effect our operating performance and ability to finance our investments
at competitive borrowing costs, successfully maintain our REIT status, and
acquire and dispose of real estate properties at favorable prices to us. Some
of these costs also reflect changes in value in our properties that result from
use or changes in market conditions and the level of capital expenditures and
leasing costs necessary to maintain the operating performance of our
properties. Due to the significance of the net income components excluded from
Consolidated Income Available for Debt Service, this measure should not be
considered an alternative to (and should be considered in conjunction with) net
income, cash flow from operations, and other performance or liquidity measures
prescribed by GAAP. This measure should also be analyzed in conjunction with
discussions elsewhere in Managements Discussion and Analysis of Financial
Condition and Results of Operations regarding the items eliminated in the
calculation of Consolidated Income Available for Debt Service. 20




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##### Table of Contents



The reader is cautioned that Consolidated Income Available for Debt
Service, as calculated by us, may not be comparable to similar measures
reported by other companies (under names such as or similar to Consolidated
Income Available for Debt Service, EBITDA or adjusted EBITDA) that do not
define this measure exactly the same as we do. The following is a reconciliation of net cash provided by operating
activities and net income computed in accordance with GAAP to Consolidated
Income Available for Debt Service (in thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net cash provided by operating activities
    
    $
    55,115
    
    
    $
    52,725
    
    
    $
    137,650
    
    
    $
    141,372Add:Interest expense
    
    
    21,517
    
    
    
    23,953
    
    
    
    66,014
    
    
    
    70,242Less:Amortization of loan costs and fees
    
    
    (828
    )
    
    
    (1,009
    )
    
    
    (2,911
    )
    
    
    (2,933
    )Amortization of deferred compensation
    
    
    (800
    )
    
    
    (572
    )
    
    
    (2,331
    )
    
    
    (1,409
    )Changes in operating assets and liabilities:Rent and other receivables
    
    
    760
    
    
    
    189
    
    
    
    2,594
    
    
    
    (724
    )Deferred rent
    
    
    (75
    )
    
    
    332
    
    
    
    1,907
    
    
    
    243Prepaid financing costs, expenses and other assets
    
    
    (139
    )
    
    
    (2,281
    )
    
    
    2,066
    
    
    
    1,381Accounts payable and accrued expenses
    
    
    (8,958
    )
    
    
    (5,396
    )
    
    
    (3,969
    )
    
    
    (1,714
    )Security deposits
    
    
    69
    
    
    
    (987
    )
    
    
    (807
    )
    
    
    (1,499
    )Consolidated Income Available for Debt Service
    
    $
    66,661
    
    
    $
    66,954
    
    
    $
    200,213
    
    
    $
    204,959
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net Income
    
    $
    11,176
    
    
    $
    10,541
    
    
    $
    39,164
    
    
    $
    44,882Add:Interest expense
    
    
    21,517
    
    
    
    23,953
    
    
    
    66,014
    
    
    
    70,242Depreciation and amortization
    
    
    30,907
    
    
    
    29,223
    
    
    
    90,696
    
    
    
    84,586Minority interest
    
    
    2,415
    
    
    

    1,294
    
    
    
    5,047
    
    
    
    4,063Minority interest from discontinued operations
    
    
    54
    
    
    
    61
    
    
    
    299
    
    
    
    379Depreciation from discontinued operations
    
    
    1,529
    
    
    
    1,882
    
    
    
    4,059
    
    
    
    6,189Impairment on investment in securities
    
    
    
    
    
    
    
    
    
    
    2,700
    
    
    
    Less:Gain on sale of discontinued properties
    
    
    (937
    )
    
    
    
    
    
    
    (7,766
    )
    
    
    (5,382
    )Consolidated Income Available for Debt Service
    
    $
    66,661
    
    
    $
    66,954
    
    
    $
    200,213
    
    
    $
    204,959
 Consolidated Income Available for Debt Service is also presented because
it is used in ratios contained in the principal financial covenants of the
Indenture governing our publicly traded senior unsecured notes and our Credit
Agreement with a syndicate of banks led by Wells Fargo. As of September 30,
2004, our senior unsecured notes represented approximately 52% of our total
outstanding debt and amounts outstanding under our Wells Fargo unsecured line
of credit represented approximately 9% of our total outstanding debt. The
Consolidated Income Available for Debt Service ratios and the other ratios
reported below are part of financial covenants we are required to satisfy each
fiscal quarter. We believe information about these ratios is useful to (1)
confirm that we are in compliance with the financial covenants of our principal
loan agreements, (2) evaluate our ability to service our debt, (3) evaluate our
ability to fund future capital expenditures, and (4) compare our ratios to
other real estate companies, including other REITs, that present the same
ratios. If we were to fail to satisfy these financial covenants, we would be in
default under the terms of the Indenture for the senior unsecured notes and/or
the Wells Fargo Credit Agreement. A default under those agreements could
accelerate the obligation to repay such debt and could cause us to be in
default under our other debt agreements. Depending on the circumstances
surrounding such acceleration, we might not be able to repay the debt on terms
that are favorable to us, or at all, which could have a material adverse affect
on our financial condition and our ability to raise capital in the future. 21




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The reader is cautioned that these ratios, as calculated by us, may not be
comparable to similarly entitled ratios reported by other companies that do not
calculate these ratios exactly the same as we do. These ratios should not be
considered as alternatives to the ratio of earnings to fixed charges. The following table summarizes the principal ratios contained in the
financial covenants of our senior unsecured notes and Wells Fargo unsecured
line of credit as of September 30, 2004 (in thousands, except percentage and
covenant ratio data): Net investment in real estate
    
    $
    2,555,123Cash and cash equivalents
    
    
    15,595Restricted cash
    
    
    15,765Accumulated depreciation and amortization
    
    
    484,492Total Gross Assets
    
    $
    3,070,975Gross Value of Unencumbered Assets
    
    $
    2,119,457Mortgage loans payable(1)
    
    $
    384,857Unsecured lines of credit
    
    
    136,500Unsecured term loan
    
    
    125,000Unsecured senior notes, net of discount
    
    
    697,438Total Outstanding Debt
    
    $
    1,343,795Consolidated Income Available for Debt Service(2)
    
    $
    267,791Interest incurred(2)
    
    $
    90,323Loan fee amortization(2)
    
    
    (3,545
    )Debt Service(2)
    
    $
    86,778
 Covenant Ratios
    
    Test
    
    ActualRatio of Consolidated Income Available for Debt Service to Debt Service
    
    Greater than 1.5
    
    
    3.1Ratio of Consolidated Income Available for Debt Service to interest
expense (3)
    
    Greater than 2.0
    
    
    3.2Ratio of Consolidated Income Available for Debt Service to fixed charges
(4)
    
    Greater than 1.75
    
    
    2.3Total Outstanding Debt/Total Gross Assets
    
    Less than 60%
    
    
    44
    %Secured Debt/Total Gross Assets
    
    Less than 40%
    
    
    13
    %Gross Value of Unencumbered Assets/Unsecured Debt
    
    Greater than 150%
    
    
    221
    %
   (1)
    
    Represents 9 secured loans that are secured by 53 properties in our
portfolio.(2)
    
    Represents amounts for the most recent four consecutive quarters. Loan
fee amortization excludes discount amortization on senior unsecured notes.(3)
    
    Interest expense consists of interest expense plus capitalized interest
and less amortization of loan fees and discounts.(4)
    
    Fixed charges consist of interest costs, whether expensed or
capitalized, principal payments on all debt, an amount equal to $0.3125
per quarter multiplied
by the weighted average gross leaseable square feet of the portfolio at
the end of the period and preferred unit distributions. 22




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##### Table of Contents



Funds from Operations The following table reflects the calculation of our funds from operations
for the three and nine months ended September 30, 2004 and 2003 (in thousands): Three Months Ended September 30,
    
    Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003Funds From Operations:(1)Net income
    
    $
    11,176
    
    
    $
    10,541
    
    
    $
    39,164
    
    
    $
    44,882Depreciation and minority interest from
discontinued operations
    
    
    1,583
    
    
    
    1,943
    
    
    
    4,358
    
    
    
    6,568Gain on sale of discontinued properties
    
    
    (937
    )
    
    
    
    
    
    
    (7,766
    )
    
    
    (5,382
    )Depreciation and amortization
    

    
    30,907
    
    
    
    29,223
    
    
    
    90,696
    
    
    
    84,586Minority interest
    
    
    1,340
    (2)
    
    
    1,294
    
    
    
    3,972
    (2)
    
    
    4,063Distribution on Preferred Operating
Partnership Units
    
    
    (1,078
    )(2)
    
    
    (1,078
    )
    
    
    (3,234
    )(2)
    
    
    (3,234
    )Funds From Operations(3)
    
    $
    42,991
    
    
    $
    41,923
    
    
    $
    127,190
    
    
    $
    131,483Weighted average common shares and
Operating Partnership units
outstanding  Diluted
    
    
    67,564
    
    
    
    65,740
    
    
    
    67,188
    
    
    
    65,216
   (1)
    
    We believe that funds from operations, or FFO, is a useful
supplemental measure of our operating performance. We compute FFO in
accordance with standards established by the White Paper on FFO
approved by the Board of Governors of the National Association of
Real Estate Investment Trusts, or NAREIT, in April 2002. The White
Paper defines FFO as net income or loss computed in accordance with
generally accepted accounting principles, or GAAP, excluding
extraordinary items, as defined by GAAP, and gains and losses from
sales of depreciable operating property plus real estate-related
depreciation and amortization and after adjustments for
unconsolidated partnerships and joint ventures.We believe that FFO, by excluding depreciation costs, the gains or
losses from the sale of operating real estate properties and the
extraordinary items as defined by GAAP, provides an additional
perspective on our operating results. However, because these excluded
items have a real economic effect, FFO is a limited measure of
performance.FFO captures trends in occupancy rates, rental rates and operating
costs. FFO excludes depreciation and amortization costs and it does not
capture the changes in value in our properties that result from use or
changes in market conditions or the level of capital expenditures and
leasing costs necessary to maintain the operating performance of our
properties, all of which are significant economic costs. Therefore, its
ability to measure performance is limited.Because FFO excludes significant economic components of net income
determined in accordance with GAAP, FFO should be used as an adjunct to
net income and not as an alternative to net income. FFO should also not
be used as an indicator of our financial performance, or as a substitute
for cash flow from operating activities determined in accordance with
GAAP or as a measure of our liquidity. FFO is not by itself indicative
of funds available to fund our cash needs, including our ability to pay
dividends or service our debt.FFO is used by investors to compare our performance with other REITs.
Other REITs may use different methods for calculating FFO and,
accordingly, our FFO may not be comparable to other REITs.(2)
    
    Excludes approximately $1.1 million of issuance costs expensed in
conjunction with the redemption of our Preferred Operating
Partnership Units on September 28, 2004.(3)
    
    Includes $800,000 and $572,000 in non-cash compensation expense for
the three months ended September 30, 2004 and 2003, respectively, and
approximately $2.3 million and $1.4 million in non-cash compensation
expense for the nine months ended September 30, 2004 and 2003,
respectively. 23




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##### Table of Contents



Portfolio and Lease Information The following tables set forth certain information regarding our
properties as of September 30, 2004. PORTFOLIO SUMMARY
As of September 30, 2004 Property Operating Results(1)Three Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2004Number of
    
    Number of
    
    Approximate Net
    
    (in thousands and
    
    (in thousands andLocation
    
    Properties
    
    Buildings
    
    Rentable (Sq. Ft.)
    
    unaudited)
    
    unaudited)Total
    
    % of Total
    
    Total
    
    % of Total
    
    Total
    
    % of Total
    
    Total
    
    % of Total
    
    Total
    
    % of TotalLos Angeles CountyWest(2)
    
    
    30
    
    
    
    24
    %
    
    
    32
    
    
    
    15
    %
    
    
    5,046,273
    
    
    
    27
    %
    
    $
    27,120
    
    
    
    39
    %
    
    $
    80,284
    
    
    
    39
    %North
    
    
    27
    
    
    
    21
    %
    
    
    43
    
    
    
    21
    %
    
    
    3,184,421
    
    
    
    17
    %
    
    
    11,313
    
    
    
    16
    %
    
    
    31,952
    
    
    
    15
    %South
    
    
    16
    
    
    
    12
    %
    
    
    21
    
    
    
    10
    %
    
    
    3,088,329
    
    
    
    16
    %
    
    
    9,481
    
    
    
    14
    %
    
    
    28,117
    
    
    
    14
    %Subtotal
    
    
    73
    
    
    
    57
    %
    
    
    96
    
    
    
    46
    %
    
    
    11,319,023
    
    
    
    60
    %
    
    
    47,914
    
    
    
    69
    %
    
    
    140,353
    
    
    
    68
    %Orange County
    
    
    23
    
    
    
    18
    %
    
    
    55
    
    
    
    26
    %
    
    
    3,610,875
    
    
    
    19
    %
    
    
    9,949
    
    
    
    14
    %
    
    
    31,560
    
    
    
    15
    %San Diego County
    
    
    25
    
    
    
    20
    %
    
    
    40
    
    
    
    19
    %
    
    
    2,902,252
    
    
    
    16
    %
    
    
    9,222
    
    
    
    13
    %
    
    
    27,085
    
    
    
    13
    %Ventura/Kern Counties.
    
    
    6
    
    
    
    5
    %
    
    
    17
    
    
    
    8
    %
    
    
    794,892
    
    
    
    4
    %
    
    
    2,362
    
    
    
    4
    %
    
    
    7,380
    
    
    
    4
    %Subtotal
    
    
    127
    
    
    
    100
    %
    
    
    208
    
    
    
    99
    %
    
    
    18,627,042
    
    
    
    99
    %
    
    $
    69,447
    
    
    
    100
    %
    
    $
    206,378
    
    
    
    100
    %Renovation
Building(3)
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1
    %
    
    
    99,119
    
    
    
    1
    %
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    Total
    
    
    127
    
    
    
    100
    %
    
    
    209
    
    
    
    100
    %
    
    
    18,726,161
    
    
    
    100
    %
    
    $
    69,447
    
    
    
    100
    %
    
    $
    206,383
    
    
    
    100
    %
   (1)
    
    Excludes the operating results of two properties sold during the
first quarter of 2004 and one property currently classified as held
for disposition. The operating results for these properties are
reported as part of discontinued operations in our quarterly and year
to date operating results.(2)
    
    Includes a retail property with approximately 37,000 net rentable
square feet.(3)
    
    Comprised of one building in a business park containing a total of
four buildings. After completion of the renovation, the total square
footage of this building will expand to 130,000 square feet. PORTFOLIO OCCUPANCY AND IN-PLACE RENTS
As of September 30, 2004 Annualized Base RentPer Leased Square Foot(1)Percent
    
    Percent
    
    Portfolio
    
    Full ServiceLocation
    
    Occupied
    
    Leased
    
    Total
    
    Gross Leases(2)Los Angeles CountyWest
    
    
    93.4
    %
    
    
    95.0
    %
    
    $
    27.77
    
    
    $
    27.79North
    
    
    91.8
    %
    
    
    92.7
    %
    
    
    21.94
    
    
    
    22.75South
    
    
    86.3
    %
    
    
    89.0
    %
    
    
    19.14
    
    
    
    20.21Subtotal/Weighted Average
    
    
    91.0
    %
    
    
    92.7
    %
    
    $
    23.87
    
    
    $
    24.59Orange County
    
    
    89.8
    %
    
    
    90.7
    %
    
    
    18.82
    
    
    
    22.02San Diego County
    
    
    91.9
    %
    
    
    93.3
    %
    
    
    19.52
    
    
    
    24.04Ventura/Kern Counties
    
    
    94.8
    %
    
    
    95.4
    %
    
    
    18.95
    
    
    
    19.52Subtotal/Weighted Average
    
    
    91.1
    %
    
    
    92.5
    %
    
    $
    22.01
    
    
    $
    23.90Renovation Building
    
    
    
    
    
    
    100.0
    %
    
    
    17.40
    
    
    
    Total/Weighted Average
    
    
    90.4
    %
    
    
    92.6
    %
    
    $
    21.98
    
    
    $
    23.90
   (1)
    
    Based on monthly contractual base rent under existing leases as of
September 30, 2004, multiplied by 12 and divided by leased net
rentable square feet; for those leases where rent has not yet
commenced or which are in a free rent period, the first month in
which rent is to be received is used to determine annualized base
rent.(2)
    
    Excludes 32 properties and approximately 3.5 million square feet
under triple net and modified gross leases. 24




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##### Table of Contents



TEN LARGEST TENANTS
As of September 30, 2004 Weighted
    
    Percentage of
    
    Percentage ofAverage
    
    Aggregate
    
    AggregateRemaining
    
    Portfolio
    
    Portfolio
    
    
    
    
    
    AnnualizedNumber of
    
    Lease Term
    
    Leased
    
    Annualized
    
    Net Rentable
    
    Base RentTenant
    
    Locations
    
    in Months
    
    Square Feet
    
    Base Rent(1)
    
    Square Feet
    
    (in thousands)Vivendi Universal
    
    
    2
    
    
    
    67
    
    
    
    1.34
    %
    
    
    2.10
    %
    
    
    231,681
    
    
    $
    7,980State of California
    
    
    22
    
    
    
    46
    
    
    
    2.01
    %
    
    
    1.97
    %
    
    
    345,750
    
    
    
    7,460University of Phoenix
    
    
    6
    
    
    
    43
    
    
    
    0.96
    %
    
    
    0.98
    %
    
    
    166,195
    
    
    
    3,719Ceridian Corporation
    
    
    2
    
    
    
    67
    
    
    
    0.89
    %
    
    
    0.98
    %
    
    
    152,612
    
    
    
    3,706Atlantic Richfield
    
    
    1
    
    
    
    24
    
    
    
    0.83
    %
    
    
    0.91
    %
    
    
    143,885
    
    
    
    3,453Pepperdine University
    
    
    1
    
    
    
    170
    
    
    
    0.66
    %
    
    
    0.84
    %
    
    
    113,488
    
    
    
    3,173Westfield Corporation
    
    
    1
    
    
    
    94
    
    
    
    0.61
    %
    
    
    0.77
    %
    
    
    106,011
    
    
    
    2,939Haight, Brown & Bonesteel, LLP
    
    
    2
    
    
    
    80
    
    
    
    0.37
    %
    
    
    0.72
    %
    
    
    63,262
    
    
    
    2,737State Compensation Insurance Fund
    
    
    1
    
    
    
    42
    
    
    
    0.66
    %
    
    
    0.70
    %
    
    
    113,513
    
    
    
    2,656Walt Disney Pictures and Television
    
    
    1
    
    
    
    46
    
    
    
    0.67
    %
    
    
    0.68
    %
    
    
    114,922
    
    
    
    2,588Total/Weighted Average(2)
    
    
    39
    
    
    
    62
    
    
    
    9.00
    %
    
    
    10.65
    %
    
    
    1,551,319
    
    
    $
    40,411
   (1)
    
    Annualized base rent is calculated as monthly contractual base rent
under existing leases as of September 30, 2004 multiplied by 12; for
those leases where rent has not yet commenced or which are in a free
rent period, the first month in which rent is to be received is used
to determine annualized base rent.  (2)
    
    The weighted average calculation is based on net rentable square
footage leased by each tenant. 25




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##### Table of Contents



LEASING ACTIVITY Three Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2004Net Absorption (square feet)
    
    
    214,954
    
    
    
    207,006Gross New Leasing Activity (square feet)
    
    
    525,901
    
    
    
    1,545,257Gross Renewal Leasing Activity (square feet)
    
    
    834,258
    
    
    
    2,292,651Retention Rate
    
    
    75.1
    %
    
    
    63.8
    %Cash Rent Growth(1):Expiring Rate
    
    $
    22.10
    
    
    $
    22.69New / Renewed Rate
    
    $
    20.09
    
    
    $
    20.55Decrease
    
    
    (9
    )%
    
    
    (9
    )%GAAP Rent Growth(2):Expiring Rate
    
    $
    21.28
    
    
    $
    21.86New / Renewed Rate
    
    $
    21.58
    
    
    $
    22.05Increase
    
    
    1
    %
    
    
    1
    %Weighted
Average Lease Term in Months - New
    
    
    52
    
    
    
    54Weighted
Average Lease Term in Months - Renewal
    
    
    53
    
    
    
    46Tenant Improvements and Commissions (per square foot):New(3)
    
    $
    20.34
    
    
    $
    20.75Renewal
    
    $
    7.97
    
    
    $
    8.57Capital Expenditures (per square foot):Recurring
    
    $
    0.07
    
    
    $
    0.20Non-recurring
    
    $
    0.01
    
    
    $
    0.05
   (1)
    
    Represents the difference between initial market rents on new and
renewed leases as compared to the expiring cash rents on the same
space.(2)
    
    Represents cash rent growth adjusted for straight-line rents.(3)
    
    Excludes development/renovation space. 26




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##### Table of Contents



PORTFOLIO DIVERSIFICATION
As of September 30, 2004 Percentage ofOccupied
    
    TotalNAICS
    
    Square
    
    OccupiedNorth American Industrial Classification System Description
    
    Code
    
    Feet
    
    PortfolioProfessional, Scientific, and Technical Services
    
    
    541
    
    
    
    4,407,923
    
    
    
    25.99
    %Finance and Insurance
    
    
    521-525
    
    
    
    2,900,060
    
    
    
    17.10
    %Information
    
    
    511-519
    
    
    
    1,783,652
    
    
    
    10.52
    %Manufacturing
    
    
    311-339
    
    
    
    1,340,619
    
    
    
    7.90
    %Health Care and Social Assistance
    
    
    621-624
    
    
    
    1,174,910
    
    
    
    6.93
    %Administrative and Support and Waste Management and Remediation Services
    
    
    561-562
    
    
    
    775,572
    
    
    
    4.57
    %Public Administration
    
    
    921-928
    
    
    
    701,043
    
    
    
    4.13
    %Educational Services
    
    
    611
    
    
    
    739,252
    
    
    
    4.36
    %Real Estate, Rental and Leasing
    
    
    531-533
    
    
    
    717,164
    
    
    
    4.23
    %Wholesale Trade
    
    
    423-425
    
    
    
    553,648
    
    
    
    3.26
    %Transportation and Warehousing
    
    
    481-493
    
    
    
    381,397
    
    
    
    2.25
    %Arts, Entertainment, and Recreation
    
    
    711-713
    
    
    
    298,088
    
    
    
    1.76
    %Construction
    
    
    236-238
    
    
    
    312,155
    
    
    
    1.84
    %Other Services (except Public Administration)
    
    
    811-814
    
    
    
    291,908
    
    
    
    1.72
    %Accommodation and Food Services
    
    
    721-722
    
    
    
    171,792
    
    
    
    1.01
    %Retail Trade
    
    
    441-454
    
    
    
    125,453
    
    
    
    0.74
    %Mining
    
    
    211-213
    
    
    
    57,337
    
    
    
    0.34
    %Management of Companies and Enterprises
    
    
    551
    
    
    
    28,305
    
    
    
    0.17
    %Utilities
    
    
    221
    
    
    
    8,975
    
    
    
    0.05
    %Agriculture, Forestry, Fishing and Hunting
    
    
    111-115
    
    
    
    6,261
    
    
    
    0.04
    %Other - Uncategorized
    
    
    
    
    
    
    184,839
    
    
    
    1.09
    %16,960,353
    
    
    
    100.00
    %
 27




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##### Table of Contents



LEASE EXPIRATIONS - ANNUAL
As of September 30, 2004 Q4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2009 and2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterLos Angeles County:West
    
    Expiring SF(1)
    
    
    141,404
    
    
    
    653,654
    
    
    
    554,995
    
    
    
    643,646
    
    
    
    524,846
    
    
    
    2,226,263% of Leased SF(2)
    
    
    0.82
    %
    
    
    3.79
    %
    
    
    3.22
    %
    
    
    3.73
    %
    
    
    3.05
    %
    
    
    12.92
    %Rent per SF(3)
    
    $
    29.19
    
    
    $
    27.71
    
    
    $
    28.78
    
    
    $
    28.88
    
    
    $
    30.09
    
    
    $
    32.88North
    
    Expiring SF(1)
    
    
    166,913
    
    
    
    448,748
    
    
    
    484,791
    
    
    
    513,301
    
    
    
    603,566
    
    
    
    676,319% of Leased SF(2)
    
    
    0.97
    %
    
    
    2.61
    %
    
    
    2.81
    %
    
    
    2.98
    %
    
    
    3.50
    %
    
    
    3.92
    %Rent per SF(3)
    
    $
    18.11
    
    
    $
    23.20
    
    
    $
    24.08
    
    
    $
    22.72
    
    
    $
    24.61
    
    
    $
    22.88South
    
    Expiring SF(1)
    
    
    56,359
    
    
    
    545,202
    
    
    
    313,415
    
    
    
    301,662
    
    
    
    410,172
    
    
    
    1,094,017% of Leased SF(2)
    
    
    0.33
    %
    
    
    3.16
    %
    
    
    1.82
    %
    
    
    1.75
    %

    
    
    2.38
    %
    
    
    6.35
    %Rent per SF(3)
    
    $
    21.22
    
    
    $
    19.27
    
    
    $
    22.30
    
    
    $
    22.13
    
    
    $
    21.72
    
    
    $
    18.87Subtotal -
Los Angeles County
    
    Expiring SF(1)
    
    
    364,676
    
    
    
    1,647,604
    
    
    
    1,353,201
    
    
    
    1,458,609
    
    
    
    1,538,584
    
    
    
    3,996,599% of Leased SF(2)
    
    
    2.12
    %
    
    
    9.56
    %
    
    
    7.85
    %
    
    
    8.46
    %
    
    
    8.93
    %
    
    
    23.19
    %Rent per SF(3)
    
    $
    22.89
    
    
    $
    23.69
    
    
    $
    25.60
    
    
    $
    25.32
    
    
    $
    25.71
    
    
    $
    27.35Orange County
    
    Expiring SF(1)
    
    
    235,966
    
    
    
    597,590
    
    
    
    652,253
    
    
    
    572,286
    
    
    
    350,597
    
    
    
    770,418% of Leased SF(2)
    
    
    1.37
    %
    
    
    3.46
    %
    
    
    3.79
    %
    
    
    3.32
    %
    
    
    2.04
    %
    
    
    4.47
    %Rent per SF(3)
    
    $
    13.96
    
    
    $
    20.42
    
    
    $
    20.94
    
    
    $
    18.35
    
    

    $
    20.25
    
    
    $
    22.27San Diego County
    
    Expiring SF(1)
    
    
    100,862
    
    
    
    623,035
    
    
    
    422,547
    
    
    
    261,773
    
    
    
    270,894
    
    
    
    921,888% of Leased SF(2)
    
    
    0.58
    %
    
    
    3.62
    %
    
    
    2.45
    %
    
    
    1.52
    %
    
    
    1.57
    %
    
    
    5.35
    %Rent per SF(3)
    
    $
    13.85
    
    
    $
    18.79
    
    
    $
    23.33
    
    
    $
    23.06
    
    
    $
    25.17
    
    
    $
    23.54All Others
    
    Expiring SF(1)
    
    
    60,224
    
    
    
    182,026
    
    
    
    185,445
    
    
    
    57,330
    
    
    
    76,526
    
    
    
    192,452% of Leased SF(2)
    
    
    0.35
    %
    
    
    1.06
    %
    
    
    1.08
    %
    
    
    0.34
    %
    
    
    0.44
    %
    
    
    1.12
    %Rent per SF(3)
    
    $
    18.40
    
    
    $
    20.07
    
    
    $
    20.52
    
    
    $
    19.89
    
    
    $
    21.46
    
    
    $
    18.81Total Portfolio
    
    Expiring SF(1)
    
    
    761,728
    
    
    
    3,050,255
    
    
    
    2,613,446
    
    
    
    2,349,998
    
    
    
    2,236,601
    
    
    
    5,881,357% of Leased SF(2)
    
    
    4.42
    %
    
    
    17.70
    %
    
    
    15.17
    %
    
    
    13.64
    %
    
    
    12.98
    %
    
    
    34.13
    %Rent per SF(3)
    
    $
    18.57
    
    
    $
    21.83
    
    
    $
    23.71
    
    
    $
    23.24
    
    
    $
    24.64
    
    
    $
    25.81
  (1)
    
    Represents the rentable square footage of expiring leases. For
2004, represents expirations from October 1, 2004 through December
31, 2004, not including month-to-month tenants.  (2)
    
    Percentage of total rentable square footage expiring during the
period.  (3)
    
    Represents annualized ending cash rents of expiring leases. QUARTERLY LEASE EXPIRATIONS - 2005
As of September 30, 2004 Q1-05
    
    Q2-05
    
    Q3-05
    
    Q4-05Los Angeles County:West
    
    Expiring SF(1)
    
    
    135,165
    
    
    
    144,443
    
    
    
    142,915
    
    
    
    231,131% of Leased SF(2)
    
    
    0.78
    %
    
    
    0.84
    %
    
    
    0.83
    %
    
    
    1.34
    %Rent per SF(3)
    
    $
    27.04
    
    
    $
    27.21
    
    
    $
    29.59
    
    
    
    27.26North
    
    Expiring SF(1)
    
    
    68,800
    
    
    
    98,343
    
    
    
    159,122
    
    
    
    122,483% of Leased SF(2)
    
    
    0.40
    %
    
    
    0.57
    %
    
    
    0.93
    %
    
    
    0.71
    %Rent per SF(3)
    
    $
    23.30
    
    
    $
    23.83
    
    
    $
    22.44
    
    
    
    23.63South
    
    Expiring SF(1)
    
    
    163,261
    
    
    
    205,272
    
    
    
    84,915
    
    
    
    91,754% of Leased SF(2)
    
    
    0.95
    %
    
    
    1.19
    %
    
    
    0.49
    %
    
    
    0.53
    %Rent per SF(3)
    
    $
    18.40
    
    
    $
    18.56
    
    
    $
    20.36
    
    
    $
    21.42Subtotal -
Los Angeles County
    
    Expiring SF(1)
    
    
    367,226
    
    
    
    448,058
    
    
    
    386,952
    
    
    
    445,368% of Leased SF(2)
    
    
    2.13
    %
    
    
    2.60
    %
    
    
    2.25
    %
    
    
    2.58
    %Rent per SF(3)
    
    $
    22.50
    
    
    $
    22.50
    
    
    $
    24.63
    
    
    
    25.06Orange County
    
    Expiring SF(1)
    
    
    149,596
    
    
    
    164,941
    
    
    
    142,123
    
    
    
    140,930% of Leased SF(2)
    
    
    0.87
    %
    
    
    0.96
    %
    
    
    0.82
    %
    
    
    0.81
    %Rent per SF(3)
    
    $
    18.91
    
    
    $
    18.82
    
    
    $
    22.82
    
    
    
    21.48San Diego County
    
    Expiring SF(1)
    
    
    151,735
    
    
    
    102,294
    
    
    
    174,740
    
    
    
    194,266% of Leased SF(2)
    
    
    0.88
    %
    
    
    0.59
    %
    
    
    1.02
    %
    
    
    1.13
    %Rent per SF(3)
    
    $
    22.24
    
    
    $
    21.11
    
    
    $
    19.66
    
    
    
    14.09All Others
    
    Expiring SF(1)
    
    
    43,419
    
    
    
    21,347
    
    
    
    52,747
    
    
    
    64,513% of Leased SF(2)
    
    
    0.25
    %
    
    
    0.12
    %
    
    
    0.31
    %
    
    
    0.38
    %Rent per SF(3)
    
    $
    19.49
    
    
    $
    18.20
    
    
    $
    19.94
    
    
    $
    21.19Total Portfolio
    
    Expiring SF(1)
    
    
    711,976
    
    
    
    736,640
    
    
    
    756,562
    
    
    
    845,077% of Leased SF(2)
    
    
    4.13
    %
    
    
    4.27
    %
    
    
    4.40
    %
    
    
    4.90
    %Rent per SF(3)
    
    $
    21.51
    
    
    $
    21.36
    
    
    $
    22.81
    
    
    $
    21.65
   (1)
    
    Represents the square footage of expiring leases, not including
month-to-month tenants.(2)
    
    Percentage of total rentable square footage expiring during the
period.(3)
    
    Represents annualized ending cash rents of expiring leases. 28




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##### Table of Contents



RENOVATION SUMMARY
As of September 30, 2004 EstimatedYear 1StabilizedCosts
    
    
    
    
    
    
    
    
    
    Estimated
    
    Cash Property
    
    Estimated
    
    EstimatedIncurred
    
    Estimated
    
    Percent
    
    Construction
    
    Operating
    
    Year 1
    
    Year 1Square
    
    To Date
    
    Total Cost
    
    Leased at
    
    Completion
    
    Results
    
    Annual
    
    AnnualBuilding
    
    Feet
    
    (in thousands)
    
    (in thousands)
    
    11/3/04
    
    Date
    
    (in thousands)
    
    Cash Yield
    
    GAAP Yield22745 Savi Ranch
Parkway
    
    
    130,000
    
    
    $
    2,189
    
    
    $
    9,244
    
    
    
    100
    %
    
    4th Qtr 2004
    
    $
    1,881
    
    
    
    10.0
    %
    
    
    11.7
    %
   (1)
    
    Estimated Year 1 Annual GAAP Yield includes an adjustment for
straight-line rents. In addition, we have preliminary architectural designs completed for
additional build-to-suit projects at the Howard Hughes Center totaling
approximately 475,000 net rentable square feet of office space. We also have
construction entitlements at the Howard Hughes Center for up to 600 hotel
rooms. Build-to-suit projects consist of properties constructed to the tenants
specifications in return for the tenants long-term commitment to the property.
We do not intend to commence construction on any additional build-to-suit or
multi-tenant projects at the Howard Hughes Center until development plans and
budgets are finalized with terms allowing us to achieve yields commensurate
with the projects development risk. In addition to our development at the Howard Hughes Center, we have
completed preliminary designs and are marketing an approximate 170,000 square
foot build-to-suit office building at our Long Beach Airport Business Park.
Also, as part of our Gateway Towers acquisition in August 2002, we acquired a
5-acre developable land parcel in Torrance, California that we intend to market
for a build-to-suit office building. We currently do not intend to commence
construction on these projects until build-to-suit tenant leases are signed
with terms allowing us to achieve yields commensurate with the projects
development risk. We expect to finance our development/renovation activities over the next
24 months through net cash provided by operating activities, proceeds from
asset sales, proceeds from our unsecured lines of credit or other secured
borrowings. 
 Item 3. Quantitative and Qualitative Disclosure about Market Risk Market risk is the exposure or loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices.
The primary market risk to which we are exposed is interest rate risk, which is
sensitive to many factors, including governmental monetary and tax policies,
domestic and international economic and political considerations and other
factors that are beyond our control. Interest Rate Risk In order to modify and manage the interest characteristics of our
outstanding debt and limit the effects of interest rates on our operations, we
use a variety of financial instruments, including interest rate swaps, caps,
floors and other interest rate exchange contracts. The use of these types of
instruments to hedge our exposure to changes in interest rates carries
additional risks such as counter-party credit risk. We do not enter into any
transactions for speculative or trading purposes. During 2002, we entered into
interest rate swap agreements fixing the interest rates on variable debt with
notional amounts totaling $175.0 million. During 2003, we entered into $150
million of forward-starting swap agreements fixing the 10-year Treasury rate
for borrowings that occurred in 2004 to refinance some of our scheduled debt
maturities. In August 2004, we settled the $150 million of forward-starting
swaps in conjunction with the issuance of $200 million of unsecured senior
notes. In October and November of 2003, we also entered into reverse interest
rate swap agreements to float $100 million of the fixed interest rate
associated with the 7.00% senior unsecured notes due in November 2007. In
August and September of 2004, we entered into $186 million forward-starting
swaps that effectively fixed the 10-year Treasury rate at an average rate of
approximately 4.45% for borrowings that are anticipated to occur in 2005 to
refinance some of our scheduled debt maturities. Some of our future earnings, cash flows and fair values relating to
financial instruments are dependent upon prevailing market rates of interest,
such as LIBOR. Based on interest rates and outstanding balances as of
September 30, 2004, a 1% increase in interest rates on our $186.5 million of
floating rate debt would decrease annual future earnings and cash flows by
approximately $1.9 million and would not have an impact on the fair value of
the floating rate debt. Conversely, a 1% decrease in interest rates on our
$186.5 million of floating rate debt would increase annual future earnings and
cash flows by approximately $1.9 million and would not have an impact on the
fair value of the floating rate debt. The weighted average interest rate on
our floating debt as of September 30, 2004 was 4.94%. Our fixed rate debt totaled $1,157.3 million as of September 30, 2004 with
a weighted average interest rate of 7.00% and a total fair value of
approximately $1,190.6 million. A 1% decrease in interest rates would increase
the fair value of our fixed rate debt by approximately $39.3 million and would
not have an impact on future earnings and cash flows. A 1% increase in
interest rates would decrease the fair value of our fixed rated debt by
approximately $37.1 million and would not have an impact on future earnings and
cash flows. These amounts are determined by considering the impact of hypothetical
interest rates on our borrowing cost. These analyses do not consider the
effects of the reduced level of overall economic activity that could exist in
that environment. Further, in the event of a change of this magnitude, we
would consider taking actions to further mitigate our exposure to the change.
Due to the uncertainty of the specific actions that would be taken and their
possible effects, however, this sensitivity analysis assumes no changes in our
capital structure. 29




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##### Table of Contents



Item 4. Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and our
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, our management was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. Our disclosure
controls and procedures are designed to provide a reasonable level of assurance
of reaching our desired disclosure control objectives. Also, we have an
investment in an unconsolidated entity. Because we do not control or manage
this entity, our disclosure controls and procedures with respect to such entity
is necessarily substantially more limited than those we maintain with respect
to our consolidated subsidiaries. As required by SEC Rule 13a-15(b), we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of the end of
the third quarter of 2004 covered by this report. Based on the foregoing, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective and were operating at the
reasonable assurance level. There has been no change in our internal controls over financial reporting
during our most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting. 30




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##### Table of Contents



Part II            OTHER INFORMATION 
 Item 1. Legal Proceedings We are presently subject to various lawsuits, claims and proceedings
arising in the ordinary course of business, none of which if determined
unfavorably to us is expected to have a material adverse effect on our cash
flows, financial condition or results of operations. There were no material
changes in our legal proceedings during the three months ended September 30,
2004. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  None 
 Item 3. Defaults Upon Senior Securities  None 
 Item 4. Submission of Matters to a Vote of Security Holders 
 Item 5. Other Information  None 
 Item 6. Exhibits (a) Exhibits 10.46*
    
    Second Amended and Restated Agreement of Limited Partnership of Arden Realty Limited
Partnership, dated September 7, 1999, filed as an exhibit to Arden Realtys quarterly
report on Form 10-Q filed with the Commission on November 15, 1999.10.47*
    
    Admission of New Partners and Amendment to Limited Partnership Agreement entered into
as of the 20th day of December, 2000, by and between Arden Realty Limited Partnership
and the persons identified as the New Partners therein, filed as an exhibit to
Arden Realty Limited Partnerships annual report on Form 10-K filed with the
Commission on March 30, 2001.10.48*
    
    Second Amendment to Limited Partnership Agreement entered into as of September 13,
2003, by Arden Realty Limited Partnership, filed as an exhibit to Arden Realty
Limited Partnerships quarterly report on Form 10-Q filed with the Commission on
November 13, 2003.31.1
    
    Officers certifications pursuant to Rule 13a-14(a) or Rule 15d-14(a).32.1
    
    Officers certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)
   (*)
    
    Incorporated by reference.(1)
    
    In accordance with SEC Release No. 33-8212, the following
exhibit is being furnished, and is not being filed as part of this
Report or as a separate disclosure document, and is not being
incorporated by reference into any Securities Act of 1933
registration statement. 31




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. ARDEN REALTY, INC.Date: November 5, 2004
    
    By:
    
    /s/ Andrew J. SobelAndrew J. SobelExecutive Vice President - Strategic Planningand OperationsDate: November 5, 2004
    
    By:
    
    /s/ Richard S. DavisRichard S. DavisSenior Vice President andChief Financial Officer
 32