| FIRST POTOMAC REALTY TRUST ITEM 1A RISK FACTORS Investing in our company involves various risks, including the risk that you might lose your entire investment |
| The following discussion concerns some of the risks associated with our business |
| These risks are interrelated, and you should treat them as a whole |
| The risks described below are not the only risks that may affect us |
| Additional risks and uncertainties not presently known to us or not identified below, may also materially and adversely affect our business, financial condition, results of operations and ability to make distributions to our shareholders |
| Risks Related to Our Business and Properties We have recently experienced rapid growth and may not be able to adapt our management and operational systems without unanticipated disruption or expense |
| We are currently experiencing a period of rapid growth |
| As a result of our rapid growth, we cannot assure you that we will be able to adapt our management, administrative, accounting and operational systems, or hire and retain sufficient operational staff to integrate properties into our portfolio or manage any future acquisitions of properties without operating disruptions or unanticipated costs |
| Our acquisitions of properties will generate additional operating expenses that we will be required to pay |
| Our growth has required, and our growth will continue to require, increased investment in management personnel, professional fees, other personnel, financial and management systems and controls and facilities, which could cause our operating margins to decline from historical levels, especially in the absence of revenue growth |
| As we acquire additional properties, we will be subject to risks associated with managing new properties, including tenant retention and mortgage default |
| Our failure to successfully integrate acquisitions into our portfolio and manage our growth could have a material adverse effect on our results of operations and financial condition |
| We are subject to the credit risk of our tenants, which may fail to make lease payments and thereby cause a significant decrease in our revenues |
| We cannot assure you that our tenants will not default on their leases and fail to make rental payments to us |
| In particular, local economic conditions and factors affecting the industries in which our tenants operate may affect our tenants’ ability to make lease payments to us |
| Moreover, we may be unable to locate a replacement tenant in a timely manner or on comparable or better terms if a tenant defaults on its lease |
| The loss of rental revenues from a number of our tenants and our inability to replace such tenants may adversely affect our profitability and our ability to meet our financial obligations |
| A majority of our tenants hold leases covering less than 10cmam000 square feet |
| The loss of rental revenues from a number of our tenants may adversely affect our profitability and our ability to meet our financial obligations |
| Loss of the US Government as a tenant could lead to a substantial decrease in our cash flow and an impairment of the value of our properties |
| The US Government accounts for 12dtta5prca of our annualized base rent as of December 31, 2005 |
| On July 31, 2002, the United States Department of Defense issued the Unified Facilities Criteria (“UFC”), which establish minimum antiterrorism standards for the design and construction of new and existing buildings leased by the departments and agencies of the Department of Defense |
| The loss of the federal government as a tenant resulting from our inability to comply with the UFC standards or for any other reason or the loss of a future significant tenant would have an adverse effect on our financial results and the value of our affected properties |
| A reduction or elimination of rent from the US Government or other significant tenants would reduce our cash flow and adversely affect our ability to make distributions to our shareholders |
| Our debt level may have a negative impact on our ability to make distributions to our shareholders and pursue our business plan |
| We have incurred indebtedness in connection with the acquisition of our properties, and we will incur new indebtedness in the future in connection with our acquisition, development and operating activities |
| 9 _________________________________________________________________ Our use of debt financing creates risks, including: • that our cash flow will be insufficient to make required payments of principal and interest; • that we will be unable to refinance some or all of our indebtedness or that any refinancing will not be on terms as favorable as those of the existing indebtedness; • that required debt payments are not reduced if the economic performance of any property declines; • that debt service obligations will reduce funds available for distribution to our shareholders and funds available for acquisitions; and • that any default on our indebtedness could result in acceleration of those obligations and possible loss of property to foreclosure |
| If the economic performance of any of our properties declines, our ability to make debt service payments would be adversely affected |
| If a property is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, we may lose that property to lender foreclosure with a resulting loss of income and asset value |
| We do not have a policy limiting the amount of debt that we may incur, although we have established 55prca to 65prca as the target range for our total debt to market capitalization |
| Accordingly, our management and board of trustees have discretion to increase the amount of our outstanding debt at any time |
| Our leverage levels may make it difficult to obtain additional financing based on our current portfolio or to refinance existing debt on favorable terms or at all |
| In addition, the terms of our revolving credit facility limit the amount of indebtedness that we may incur |
| Failure to obtain additional financing could impede our ability to grow and develop our business |
| Our leverage levels also may adversely affect the market price of our common shares if an investment in our company is perceived to be more risky than an investment in our peers |
| Our variable rate debt subjects us to interest rate risk |
| We have a revolving credit facility with KeyBank and Wells Fargo that bears interest at a variable rate on any amounts drawn on the facility |
| We may incur additional variable rate debt in the future |
| Increases in interest rates on variable rate debt would increase our interest expense, which would adversely affect net earnings and cash available for payment of our debt obligations and distributions to our shareholders |
| We compete with other parties for tenants and property acquisitions and many of these parties have substantially greater resources than we have |
| Our business strategy contemplates expansion through acquisition |
| The commercial real estate industry is highly competitive, and we compete with substantially larger companies, including substantially larger REITs, for the acquisition, development and leasing of properties |
| As a result, we may not be able or have the opportunity to make suitable investments on favorable terms in the future |
| Competition in a particular area also could adversely affect our ability to lease our properties or to increase or maintain rental rates |
| Newly developed and acquired properties may not produce the cash flow that we expect, which could adversely affect our overall financial performance |
| Over the last few years, we have focused our efforts on the acquisition and redevelopment of industrial and flex properties |
| In deciding whether to acquire or develop a particular property, we make assumptions regarding the expected future performance of that property |
| In particular, we estimate the return on our investment based on expected occupancy and rental rates |
| If our estimated return on investment proves to be inaccurate, and the property is unable to achieve the expected occupancy and rental rates, it may fail to perform as we expected in analyzing our investment |
| When we acquire a property, we often plan to reposition or redevelop that property with the goal of increasing profitability |
| Our estimate of the costs of repositioning or redeveloping an acquired property may prove to be inaccurate, which may result in our failure to meet our profitability goals |
| Additionally, we have acquired properties not fully leased, and the cash flow from existing operations may be insufficient to pay the operating expenses and debt service associated with that property until the property is more fully leased |
| If one or more of these new properties do not perform as expected or we are unable to successfully integrate new properties into our existing operations, our financial performance may be adversely affected |
| 10 _________________________________________________________________ All of our properties are located in the southern Mid-Atlantic region, making us vulnerable to changes in economic conditions in that region |
| Economic conditions in the southern Mid-Atlantic region may significantly affect the occupancy and rental rates of our properties |
| A decline in occupancy and rental rates, in turn, may significantly affect our profitability and our ability to satisfy our financial obligations |
| The economic condition of the region may depend on one or more industries and, therefore, an economic downturn in one of these industry sectors may adversely affect our performance |
| Local real estate market conditions may include a large supply of competing space, and we compete for tenants based on rental rates, attractiveness and location of a property, and quality of maintenance and management services |
| As a result of the geographic concentration of our properties, our performance, our ability to make cash distributions, and the value of our properties will depend upon economic conditions in the region, including local real estate conditions and competition |
| There can be no assurance that these markets will continue to grow or that economic conditions will remain favorable |
| If unfavorable economic conditions occur in the region, our ability to make distributions to our shareholders could be adversely affected |
| In particular, we are directly affected by decreases in federal government spending |
| Development and construction risks could adversely affect our profitability |
| We expect to develop new properties or add to existing properties in the future |
| Our renovation, redevelopment, development and related construction activities may subject us to the following risks: • we may be unable to obtain, or suffer delays in obtaining, necessary zoning, land-use, building, occupancy and other required governmental permits and authorizations, which could result in increased costs or our abandonment of these projects |
| • we may incur construction costs for a property which exceed our original estimates due to increased costs for materials or labor or other costs that we did not anticipate |
| • we may not be able to obtain financing on favorable terms, which may render us unable to proceed with our development activities |
| • we may be unable to complete construction and lease-up of a property on schedule, which could result in increased debt service expense or construction costs |
| Additionally, the time frame required for development, construction and lease-up of these properties means that we may have to wait years for a significant cash return |
| Because we are required to make cash distributions to our shareholders, if the cash flow from operations or refinancing is not sufficient, we may be forced to borrow additional money to fund such distributions |
| We may make selected acquisitions outside our current geographic market from time to time as appropriate opportunities arise |
| Our historical experience is in the southern Mid-Atlantic region, and we may not be able to operate successfully in other market areas |
| We may be exposed to a variety of risks if we choose to enter new markets |
| These risks include: • a lack of market knowledge and understanding of the local economies; • an inability to identify promising acquisition or development opportunities; • an inability to obtain construction trades people; and • an unfamiliarity with local government and permitting procedures |
| 11 _________________________________________________________________ Any of these factors could adversely affect the profitability of projects outside our current markets and limit the success of our acquisition and development strategy |
| If our acquisition and development strategy is negatively affected, the profitability, growth, and development of our business may be impeded |
| We may be unable to renew expiring leases or re-lease vacant space on a timely basis or on attractive terms, which could significantly decrease our cash flow |
| Current tenants may not renew their leases upon the expiration of their terms |
| Alternatively, current tenants may attempt to terminate their leases prior to the expiration of their current terms |
| If non-renewals or terminations occur, we may not be able to locate qualified replacement tenants and, as a result, we would lose a significant source of revenue while remaining responsible for the payment of our obligations |
| Moreover, the terms of a renewal or new lease may be less favorable than the current lease terms |
| Any of these factors could cause a decline in lease revenue, which would have a negative impact on our profitability |
| Under some of our leases, tenants have the right to terminate prior to the scheduled expiration of the lease |
| Some of our leases for our current properties provide tenants with the right to terminate prior to the scheduled expiration of the lease |
| If a tenant terminates its lease with us prior to the expiration of the term, we may be unable to re-lease that space on as favorable terms, or at all, which could adversely affect our cash flow |
| Property owned through joint ventures, or in limited liability companies and partnerships in which we are not the sole equity holder, may limit our ability to act exclusively in our interests |
| We may make investments through partnerships, limited liability companies or joint ventures in the future |
| Partnership, limited liability company or joint venture investments may involve various risks, including the following: • our partners or joint venturers might become bankrupt (in which event we and any other remaining general partners or joint venturers would generally remain liable for the liabilities of the partnership or joint venture); • our partners, co-members or joint venturers might at any time have economic or other business interests or goals that are inconsistent with our business interests or goals; • our partners, co-members or joint venturers may be in a position to take action contrary to our instructions, requests, policies, or objectives, including our current policy with respect to maintaining our qualification as a real estate investment trust; and • agreements governing joint ventures, limited liability companies and partnerships often contain restrictions on the transfer of a joint venturer’s, member’s or partner’s interest or “buy-sell” or other provisions that may result in a purchase or sale of the interest at a disadvantageous time or on disadvantageous terms |
| Our organizational documents do not limit the amount of available funds that we may invest in partnerships, limited liability companies or joint ventures |
| The occurrence of one or more of the events described above could adversely affect our financial condition, results of operations, cash flow and ability to make distributions with respect to, and the market price of, our common shares |
| Risks Related to Our Organization and Structure Our executive officers have agreements that provide them with benefits in the event of a change in control of our company or if their employment agreement is not renewed |
| We have entered into employment agreements with our executive officers, Douglas J Donatelli, Nicholas R Smith, Barry H Bass, James H Dawson and Joel F Bonder that provide them with severance benefits if their employment ends under certain circumstances following a change in control of our company or if the executive officer resigns for “good reason” as defined in the employment agreements |
| These benefits could increase the cost to a potential acquirer of our company and thereby prevent or deter a change in control of the company that might involve a premium price for our common shares or otherwise be in the interests of our shareholders |
| 12 _________________________________________________________________ We may experience conflicts of interest with several members of our board of trustees and our executive officers relating to their ownership of units of our operating partnership |
| Our trustees and executive officers may have conflicting duties because, in their capacities as our trustees and executive officers, they have a duty to our Company, and in our capacity as general partner of our operating partnership, they have a fiduciary duty to the limited partners, and some of them are themselves limited partners |
| These conflicts of interest could lead to decisions that are not in your best interest |
| Conflicts may arise when the interests of our shareholders and the limited partners of our operating partnership diverge, particularly in circumstances in which there may be an adverse tax consequence to the limited partners, such as upon the sale of assets or the repayment of indebtedness |
| We depend on key personnel with long-standing business relationships, the loss of whom could threaten our ability to operate our business successfully |
| Our future success depends, to a significant extent, upon the continued services of our senior management team, including Douglas J Donatelli and Nicholas R Smith |
| In particular, the extent and nature of the relationships that Mr |
| Donatelli and Mr |
| Smith and the other members of our senior management team have developed in the real estate community in our markets is critically important to the success of our business |
| Although we have employment agreements with Mr |
| Smith and other key executive officers, there is no guarantee that Mr |
| Smith or these other key executive officers will remain employed with us |
| We do not maintain key person life insurance on any of our officers |
| The loss of services of one or more members of our senior management team, particularly Mr |
| Further, loss of a member of our senior management team could be negatively perceived in the capital markets, which could have an adverse effect on the market price of our common shares |
| The chairman of our board of trustees, Louis T Donatelli, has other business interests that may hinder his ability to allocate sufficient time to our operations and he and certain other of our trustees may have conflicts of interest with our company |
| Our chairman, Louis T Donatelli, has other business interests that may hinder his ability to spend adequate time on our business |
| Donatelli is also Chairman of Donatelli & Klein, Inc |
| (D&K), a real estate investment firm that focuses on the Washington, DC area |
| Donatelli continues to provide management and other services to D&K The provision of those services may reduce the time Mr |
| Donatelli is able to devote to our business |
| In addition, consistent with his fiduciary duties to the Company, Mr |
| Donatelli may compete against us outside of a specific geographic area and outside of the industrial or flex property market |
| One of our trustees, Terry L Stevens, currently serves as Vice President and Chief Financial Officer of Highwoods Properties, Inc, a fully integrated, North Carolina-based REIT that owns, leases, manages, develops, and constructs office, industrial and retail properties, some of which are located in our target markets |
| As a result, conflicts may arise when our Company and Highwoods Properties, Inc |
| compete in the same markets for properties, tenants, personnel and other services |
| Our rights and the rights of our shareholders to take action against our trustees and officers are limited, which could limit your recourse in the event of actions not in your best interests |
| Maryland law provides that a trustee has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances |
| Our amended and restated declaration of trust authorizes us to indemnify our trustees and officers for actions taken by them in those capacities to the extent permitted by Maryland law |
| In addition, our declaration of trust limits the liability of our trustees and officers for money damages, except for liability resulting from: • actual receipt of an improper benefit or profit in money, property or services; or • a final judgment based upon a finding of active and deliberate dishonesty by the trustee or officer that was material to the cause of action adjudicated |
| As a result, we and our shareholders may have more limited rights against our trustees and officers than might otherwise exist |
| Our amended and restated bylaws require us to indemnify each trustee or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made a party by reason of his or her service to us |
| In addition, we may be obligated to fund the defense costs incurred by our trustees and officers |
| 13 _________________________________________________________________ Our board of trustees may approve the issuance of preferred shares with terms that may discourage a third party from acquiring us |
| Our declaration of trust permits our board of trustees initially to issue up to 50cmam000cmam000 preferred shares, issuable in one or more classes or series |
| Our board of trustees may increase the number of preferred shares authorized by our declaration of trust without shareholder approval |
| Our board of trustees may also classify or reclassify any unissued preferred shares and establish the preferences and rights (including the right to vote, participate in earnings and to convert into securities) of any such preferred shares, which rights may be superior to those of our common shares |
| Thus, our board of trustees could authorize the issuance of preferred shares with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of the common shares might receive a premium for their shares over the then current market price of our common shares |
| Our ownership limitations may restrict business combination opportunities |
| To qualify as a REIT under the Internal Revenue Code, no more than 50prca of the value of our outstanding shares of beneficial interest may be owned, directly or under applicable attribution rules, by five or fewer individuals (as defined to include certain entities) during the last half of each taxable year (other than our first REIT taxable year) |
| To preserve our REIT qualification, our declaration of trust generally prohibits direct or indirect ownership by any person of (i) more than 8dtta75prca of the number or value of our outstanding common shares or (ii) more than 8dtta75prca of the value of our outstanding shares of all classes |
| Generally, shares owned by affiliated owners will be aggregated for purposes of the ownership limitation |
| Our declaration of trust has created a special higher ownership limitation of no more than 14dtta9prca for the group comprised of Louis T Donatelli, Douglas J Donatelli and certain related persons |
| Unless the applicable ownership limitation is waived by our board of trustees prior to transfer, any transfer of our common shares that would violate the ownership limitation will be null and void, and the intended transferee will acquire no rights in such shares |
| Common shares that would otherwise be held in violation of the ownership limit will be designated as “shares-in-trust” and transferred automatically to a trust effective on the day before the purported transfer or other event giving rise to such excess ownership |
| The beneficiary of the trust will be one or more charitable organizations named by us |
| The ownership limitation could have the effect of delaying, deterring or preventing a change in control or other transaction in which holders of common shares might receive a premium for their common shares over the then current market price or that such holders might believe to be otherwise in their best interests |
| The ownership limitation provisions also may make our common shares an unsuitable investment vehicle for any person seeking to obtain, either alone or with others as a group, ownership of (i) more than 8dtta75prca of the number or value of our outstanding common shares or (ii) more than 8dtta75prca in value of our outstanding shares of all classes |
| Our board of trustees may change our investment and operational policies and practices without a vote of our common shareholders, which limits your control of our policies and practices |
| Our major policies, including our policies and practices with respect to investments, financing, growth, debt capitalization, REIT qualification and distributions, are determined by our board of trustees |
| Although we have no present intention to do so, our board of trustees may amend or revise these and other policies from time to time without a vote of our shareholders |
| Accordingly, our shareholders will have limited control over changes in our policies |
| Our declaration of trust and bylaws do not limit the amount of indebtedness that we or our operating partnership may incur |
| If we become highly leveraged, then the resulting increase in debt service could adversely affect our ability to make payments on our outstanding indebtedness and harm our financial condition |
| Our declaration of trust contains provisions that make removal of our trustees difficult, which could make it difficult for our shareholders to effect changes to our management |
| Our declaration of trust provides that a trustee may only be removed upon the affirmative vote of holders of a majority of our outstanding common shares |
| Vacancies may be filled by the board of trustees |
| This requirement makes it more difficult to change our management by removing and replacing trustees |
| Our bylaws may only be amended by our board of trustees, which could limit your control of certain aspects of our corporate governance |
| Our board of trustees has the sole authority to amend our bylaws |
| Thus, the board is able to amend the bylaws in a way that may be detrimental to your interests |
| 14 _________________________________________________________________ Maryland law may discourage a third party from acquiring us |
| Maryland law provides broad discretion to our board of trustees with respect to its fiduciary duties in considering a change in control of our company, including that our board is subject to no greater level of scrutiny in considering a change in control transaction than with respect to any other act by our board |
| The Maryland Business Combination Act restricts mergers and other business combinations between our company and an interested shareholder |
| An “interested shareholder” is defined as any person who is the beneficial owner of 10prca or more of the voting power of our common shares and also includes any of our affiliates or associates that, at any time within the two year period prior to the date of a proposed merger or other business combination, was the beneficial owner of 10prca or more of our voting power |
| Additionally, the “control shares” provisions of the Maryland General Corporation Law, or MGCL, are applicable to us as if we were a corporation |
| These provisions eliminate the voting rights of shares acquired in quantities so as to constitute “control shares,” as defined under the MGCL Our amended and restated declaration of trust and/or bylaws provide that we are not bound by the Business Combination Act or the control share acquisition statute |
| However, in the case of the control share acquisition statute, our board of trustees may opt to make this statute applicable to us at any time, and may do so on a retroactive basis |
| Finally, the “unsolicited takeovers” provisions of the MGCL permit our board of trustees, without shareholder approval and regardless of what is currently provided in our declaration of trust or bylaws, to implement takeover defenses that we do not yet have |
| These provisions may have the effect of inhibiting a third party from making an acquisition proposal for our company or of delaying, deferring or preventing a change in control of our company under circumstances that otherwise could provide the holders of our common shares with the opportunity to realize a premium over the then current market price or would otherwise be in the interests of our shareholders |
| Risks Related to the Real Estate Industry Real estate investments are inherently risky, which could adversely affect our profitability and our ability to make distributions to our shareholders |
| Real estate investments are subject to varying degrees of risk |
| If we acquire or develop properties and they do not generate sufficient operating cash flow to meet operating expenses, including debt service, capital expenditures and tenant improvements, our income and ability to make distributions to our shareholders will be adversely affected |
| Income from properties may be adversely affected by: § decreases in rent and/or occupancy rates due to competition or other factors; § increases in operating costs such as real estate taxes, insurance premiums, site maintenance and utilities; § changes in interest rates and the availability of financing; and § changes in laws and governmental regulations, including those governing real estate usage, zoning and taxes |
| General economic conditions may adversely affect our financial condition and results of operations |
| Periods of economic slowdown or recession in the United States and in other countries, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults by our tenants under existing leases, which could adversely affect our financial position, results of operations, cash flow, trading price of our common shares and our ability to satisfy our debt service obligations and to make distributions to our shareholders |
| Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition |
| Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to adverse changes in the performance of such properties may be limited, thus harming our financial condition |
| The real estate market is affected by many factors that are beyond our control, including: § adverse changes in national and local economic and market conditions; § changes in interest rates and in the availability, cost and terms of debt financing; 15 _________________________________________________________________ • changes in governmental laws and regulations, fiscal policies and zoning ordinances and costs of compliance with laws and regulations, fiscal policies and ordinances; • the ongoing need for capital improvements, particularly in older buildings; • changes in operating expenses; and • civil unrest, acts of war and natural disasters, including earthquakes and floods, which may result in uninsured and underinsured losses |
| We cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us |
| We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property |
| We may be required to expend funds to correct defects or to make improvements before a property can be sold |
| We cannot assure you that we will have funds available to correct those defects or to make those improvements |
| In acquiring a property, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property |
| We may also acquire properties that are subject to a mortgage loan that may limit our ability to sell the properties prior to the loan’s maturity |
| These factors and any others that would impede our ability to respond to adverse changes in the performance of our properties could have a material adverse effect on our operating results and financial condition, as well as our ability to make distributions to our shareholders |
| The costs of compliance with or liabilities under environmental laws may harm our operating results |
| Our operating expenses could be higher than anticipated due to the cost of complying with existing or future environmental laws and regulations |
| An owner of real property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property |
| We may face liability regardless of: • our knowledge of the contamination; • the timing of the contamination; • the cause of the contamination; or • the party responsible for the contamination of the property |
| There may be environmental problems associated with our properties of which we are unaware |
| Some of our properties contain, or may have contained in the past, underground tanks for the storage of petroleum-based or waste products that could create a potential for release of hazardous substances |
| If environmental contamination exists on our properties, we could become subject to strict, joint and several liability for the contamination by virtue of our ownership interest |
| The presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs, thus harming our financial condition |
| In addition, although our leases generally require our tenants to operate in compliance with all applicable laws and to indemnify us against any environmental liabilities arising from a tenant’s activities on the property, we could nonetheless be subject to strict liability by virtue of our ownership interest for environmental liabilities created by our tenants, and we cannot be sure that our tenants would satisfy their indemnification obligations under the applicable sales agreement or lease |
| The discovery of material environmental liabilities attached to our properties could have a material adverse effect on our results of operations and financial condition and our ability to make distributions to our shareholders |
| Our properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem |
| When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time |
| Some molds may produce airborne toxins or 16 _________________________________________________________________ irritants |
| Concern about indoor exposure to mold has been increasing as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions |
| As a result, the presence of significant mold at any of our properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property |
| In addition, the presence of significant mold could expose us to liability from our tenants, employees of our tenants and others if property damage or health concerns arise |
| Compliance with the Americans with Disabilities Act and fire, safety and other regulations may require us to make unintended expenditures that adversely impact our ability to make distributions to our shareholders |
| All of our properties are required to comply with the Americans with Disabilities Act, or the ADA The ADA has separate compliance requirements for “public accommodations” and “commercial facilities,” but generally requires that buildings be made accessible to people with disabilities |
| Compliance with the ADA requirements could require removal of access barriers and non-compliance could result in imposition of fines by the US Government or an award of damages to private litigants, or both |
| While the tenants to whom we lease properties are obligated by law to comply with the ADA provisions, and typically under our leases are obligated to cover costs associated with compliance, if required changes involve greater expenditures than anticipated, or if the changes must be made on a more accelerated basis than anticipated, the ability of these tenants to cover costs could be adversely affected and we could be required to expend our own funds to comply with the provisions of the ADA, which could adversely affect our results of operations and financial condition and our ability to make distributions to shareholders |
| In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and bodies and become applicable to our properties |
| We may be required to make substantial capital expenditures to comply with those requirements and these expenditures could have a material adverse effect on our ability to make distributions to our shareholders |
| An uninsured loss or a loss that exceeds the policies on our properties could subject us to lost capital or revenue on those properties |
| Under the terms and conditions of the leases currently in force on our properties, tenants generally are required to indemnify and hold us harmless from liabilities resulting from injury to persons, air, water, land or property, on or off the premises, due to activities conducted on the properties, except for claims arising from the negligence or intentional misconduct of us or our agents |
| Additionally, tenants are generally required, at the tenant’s expense, to obtain and keep in full force during the term of the lease, liability and full replacement value property damage insurance policies |
| Our largest tenant, the federal government is not required to maintain property insurance at all |
| We have obtained comprehensive liability, casualty, flood and rental loss insurance policies on our properties |
| All of these policies may involve substantial deductibles and certain exclusions |
| In addition, we cannot assure you that our tenants will properly maintain their insurance policies or have the ability to pay the deductibles |
| Should a loss occur that is uninsured or in an amount exceeding the combined aggregate limits for the policies noted above, or in the event of a loss that is subject to a substantial deductible under an insurance policy, we could lose all or part of our capital invested in, and anticipated revenue from, one or more of the properties, which could have a material adverse effect on our operating results and financial condition, as well as our ability to make distributions to our shareholders |
| Terrorist attacks, such as the attacks that occurred in New York and Washington, DC on September 11, 2001, and other acts of violence or war may affect any market on which our common shares trade, the markets in which we operate, our operations and our profitability |
| Terrorist attacks may negatively affect our operations |
| These attacks or armed conflicts may directly impact the value of our properties through damage, destruction, loss or increased security costs |
| The terrorism insurance that we obtain may not be sufficient to cover loss for damages to our properties as a result of terrorist attacks |
| In addition, certain losses resulting from these types of events are uninsurable and others would not be covered by our current terrorism insurance |
| Additional terrorism insurance may not be available at a reasonable price or at all |
| The United States may enter into armed conflicts in the future |
| The consequences of any armed conflicts are unpredictable, and we may not be able to foresee events that could have an adverse effect on our business |
| Any of these events could result in increased volatility in or damage to the United States and worldwide financial markets and economy |
| They also could result in a continuation of the current economic uncertainty in the United States or abroad |
| Adverse economic conditions could affect the ability of our tenants to pay rent, which could have a material adverse effect on our operating results and financial condition, as well as our ability to make distributions to our shareholders, and may result in volatility in the market price for our common shares |
| 17 _________________________________________________________________ Tax Risks of our Business and Structure If we fail to remain qualified as a REIT for federal income tax purposes, we will not be able to deduct our distributions, and our income will be subject to taxation |
| We elected to be taxed as a REIT under the Internal Revenue Code commencing with our short taxable year ended December 31, 2003, which affords us significant tax advantages |
| The requirements for qualification as a REIT, however, are complex and our management has limited experience in operating a REIT If we fail to meet these requirements and do not qualify for certain relief provisions, our distributions to our shareholders will not be deductible by us and we will be subject to a corporate level tax on our taxable income |
| This would substantially reduce our cash available to make distributions to our shareholders |
| In addition, incurring corporate income tax liability might cause us to borrow funds, liquidate some of our investments or take other steps that could negatively affect our operating results |
| Moreover, if our REIT status is terminated because of our failure to meet a REIT qualification requirement or if we voluntarily revoke our election, unless relief provisions applicable to certain REIT qualification failures apply, we would be disqualified from electing treatment as a REIT for the four taxable years following the year in which REIT status is lost |
| Distribution requirements relating to qualification as a REIT for federal income tax purposes limit our flexibility in executing our business plan |
| Our business plan contemplates growth through acquisitions |
| To qualify and maintain our status as a REIT for federal income tax purposes, we generally are required to distribute to our shareholders at least 90prca of our REIT taxable income each year |
| REIT taxable income is determined without regard to the deduction for dividends paid and by excluding net capital gains |
| We are also required to pay tax at regular corporate rates to the extent that we distribute less than 100prca of our taxable income (including net capital gains) each year |
| In addition, we are required to pay a 4prca nondeductible excise tax on the amount, if any, by which certain distributions we pay with respect to any calendar year are less than the sum of 85prca of our ordinary income for that calendar year, 95prca of our capital gain net income for the calendar year and any amount of our income that was not distributed in prior years |
| We have distributed, and intend to distribute, to our shareholders all or substantially all of our taxable REIT income each year in order to comply with the distribution requirements of the Internal Revenue Code and to avoid federal income tax and the 4prca nondeductible excise tax |
| Our distribution requirements limit our ability to fund acquisitions and capital expenditures through retained earnings |
| Thus, our ability to grow through acquisitions will be limited if we are unable to obtain debt or equity financing |
| In addition, differences in timing between the receipt of income and the payment of expenses in arriving at REIT taxable income and the effect of required debt amortization payments could require us to borrow funds to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT Moreover, even if we maintain our status as a REIT, the net income of the taxable REIT subsidiaries owned by our operating partnership will be subject to federal, state and local income taxes at regular corporate rates |
| Our disposal of properties may have negative implications, including unfavorable tax consequences |
| If we make a sale of a property directly or through an entity that is treated as a partnership or a disregarded entity, for federal income tax purposes, and it is deemed to be a sale of dealer property or inventory, the sale may be deemed to be a “prohibited transaction” under federal tax laws applicable to REITs, in which case our gain, or our share of the gain, from the sale would be subject to a 100prca penalty tax |
| If we believe that a sale of a property might be treated as a prohibited transaction, we may dispose of that property through a taxable REIT subsidiary, in which case the gain from the sale would be subject to corporate income tax but not the 100prca prohibited transaction tax |
| We cannot assure you, however, that the Internal Revenue Service will not assert successfully that sales of properties that we make directly or through an entity that is treated as a partnership or a disregarded entity, for federal income tax purposes, rather than through a taxable REIT subsidiary, are sales of dealer property or inventory, in which case the 100prca penalty tax would apply |
| We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our securities |
| At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended |
| Any of those new laws or interpretations may take effect retroactively and could adversely affect us or the market price of our securities |
| 18 _________________________________________________________________ If we or our predecessor entity failed to qualify as an S corporation for any of our tax years prior to our initial public offering, we may fail to qualify as a REIT To qualify as a REIT, we may not have at the close of any year undistributed “earnings and profits” accumulated in any non-REIT year, including undistributed “earnings and profits” accumulated in any non-REIT year for which we or our predecessor, First Potomac Realty Investment Trust, Inc, did not qualify as an S corporation |
| Although we believe that we and our predecessor corporation qualified as an S corporation for federal income tax purposes for all tax years prior to our initial public offering, if it is determined that we did not so qualify, we will not qualify as a REIT Any such failure to qualify may also prevent us from qualifying as a REIT for any of the following four tax years |
| If First Potomac Management, Inc |
| failed to qualify as an S corporation during any of its tax years, we may be responsible for any entity level taxes due |
| On February 28, 2006, the Company entered into and closed under an Agreement and Plan of Merger with First Potomac Management, Inc, a Delaware S corporation (“FPM, Inc |
| ”) owned solely by the Company’s Chairman, Louis T Donatelli, four members of senior management, Douglas J Donatelli, Nicholas R Smith, James H Dawson and Barry H Bass, and a former member of senior management, Kyung Rhee (“Merger Agreement”) |
| merged into the Company in a merger under Section 368(a) of the Code (the “Merger”) |
| qualified as an S corporation for federal and state income tax purposes since its incorporation in 1997, the Company may be responsible for any entity level taxes due if FPM, Inc |
| did not qualify at any time as an S corporation |
| shareholders have severally indemnified the Company against any such loss, however, in the event one or more of the shareholders is unable to fulfill its indemnification obligation, the Company may not be reimbursed for a portion of the taxes |
| Risks Related to an Investment in Our Common Shares Our common shares trade in a limited market which could hinder your ability to sell our common shares |
| Our equity market capitalization places us at the low end of market capitalization among all REITs |
| Because of our small market capitalization, many of our investors are individuals |
| Our common shares experience limited trading volume; relatively, many investors may not be interested in owning our common shares because of the inability to acquire or sell a substantial block of our common shares at one time |
| This illiquidity could have an adverse effect on the market price of our common shares |
| In addition, a shareholder may not be able to borrow funds using our common shares as collateral because lenders may be unwilling to accept the pledge of common shares having such a limited market |
| Any substantial sale of our common shares could have a material adverse effect on the market price of our common shares |
| The market price and trading volume of our common shares may be volatile |
| The market price of our common shares may become highly volatile and be subject to wide fluctuations |
| In addition, the trading volume in our common shares may fluctuate and cause significant price variations to occur |
| Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common shares include: § actual or anticipated declines in our quarterly operating results or distributions; § reductions in our funds from operations; § increases in market interest rates that lead purchasers of our securities to demand a higher dividend yield; § changes in market valuations of similar companies; § adverse market reaction to any increased indebtedness we incur in the future; § additions or departures of key management personnel; § actions by institutional shareholders; § speculation in the press or investment community; and § general market and economic conditions |
| 19 _________________________________________________________________ Broad market fluctuations could negatively impact the market price of our common shares |
| In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many companies that have been unrelated to these companies’ operating performances |
| These broad market fluctuations could reduce the market price of our common shares |
| Furthermore, our operating results and prospects may be below the expectations of investors or may be lower than those of companies with comparable market capitalizations, which could lead to a material decline in the market price of our common shares |
| An increase in market interest rates may have an adverse effect on the market price of our common shares |
| One of the factors that investors may consider in deciding whether to buy or sell our common shares is our distribution rate as a percentage of our share price, relative to market interest rates |
| If market interest rates increase, prospective investors may desire a higher distribution rate on our common shares or seek securities paying higher dividends or interest |
| The market price of our common shares likely will be based primarily on the earnings that we derive from rental income with respect to our properties and our related distributions to shareholders, and not from the underlying appraised value of the properties themselves |
| As a result, interest rate fluctuations and capital market conditions can affect the market price of our common shares |
| For instance, if interest rates rise without an increase in our distribution rate, the market price of our common shares could decrease because potential investors may require a higher yield on our common shares as market rates on interest-bearing securities, such as bonds, rise |
| In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and make distributions to our shareholders |
| Shares eligible for future sale may have adverse effects on our share price |
| We cannot predict the effect, if any, of future sales of common shares, or the availability of shares for future sales, on the market price of our common shares |
| Sales of substantial amounts of common shares, including up to approximately 2cmam000cmam000 common shares issuable upon (i) the redemption of units of our operating partnership, and (ii) exercise of options, or the perception that these sales could occur, may adversely affect prevailing market prices for our common shares and impede our ability to raise capital |
| We also may issue from time to time additional common shares or preferred shares or units of our operating partnership in connection with the acquisition of properties, and we may grant demand or piggyback registration rights in connection with these issuances |
| Sales of substantial amounts of securities or the perception that these sales could occur may adversely affect the prevailing market price for our common shares |
| In addition, the sale of these shares could impair our ability to raise capital through a sale of additional equity securities |