First Capital Realty Inc.
Annual Report 2005

Plain-text annual report

Location Location Location First Capital Realty Inc. Annual Report 2005 F i r s t C a p i t a l R e a l t y I n c . A n n u a l R e p o r t 2 0 0 5 F I R S T C A P I TA L R E A LT Y I N C . w w w . f i r s t c a p i t a l r e a l t y. c a H E A D O F F I C E BCE Place, TD Canada Trust Tower 161 Bay Street, Suite 2820 P.O. Box 219 Toronto, Ontario M5J 2S1 Tel: 416.504.4114 Fax: 416.941.1655 LOCATION, LOCATION, LOCATION. First Capital Realty [TSX:FCR] is Canada’s leading owner, developer and operator of neighbourhood and community supermarket-anchored shopping centres located predominantly in growing metropolitan areas. Our properties are where consumers shop for everyday life – the daily purchases that add up to hundreds of billions of dollars in North America every year. First Capital is also the second largest shareholder of Equity One (NYSE:EQY), one of the largest shopping centre REITs in the southern United States. F I N A N C I A L H I G H L I G H T S (‘000s except per share amounts) 2005 2004 Real estate investments Shareholders’ equity Revenues Net operating income Funds from operations (FFO) FFO per diluted share Dividends per share Debt to market capitalization $ 2,392,270 $ 1,831,717 $ $ $ $ $ $ 842,544 268,642 165,049 94,666 1.48 1.20 44.7% $ $ $ $ $ $ 548,493 221,502 132,818 64,664 1.42 1.17 56.4% Vancouver Edmonton Calgary S T R AT E G I CA L LY LO CAT E D Quebec City Ottawa Montreal Greater Toronto Area ANNUAL REPORT CONTENTS (1) Why Invest? (2) Achievements (3) Message to Shareholders (6) Growing Cash Flow (8) Our Major Urban Markets (10) Acquisitions (12) Development (14) Proactive Management (16) Financial Review (17) Management’s Discussion and Analysis (54) Shopping Centre Portfolio (58) Consolidated Financial Statements and Notes (82) Corporate Governance (83) Board of Directors (84) Shareholder Information WHY INVEST IN FIRST CAPITAL REALTY? FIRST CAPITAL REALTY 2005 ANNUAL REPORT • Clear and consistent long-term strategy – combination of growth and defensive approach • High quality portfolio of assets – our “private collection” • Strong financial position – recapitalized balance sheet, moderate leverage • Committed and entrepreneurial team – aligned with shareholders • 11 consecutive years of increased dividends A growth strategy applied to a stable business 137 properties totalling over 16.3 million square feet of gross leasable area DIVIDENDS ($ per share) 0 2 . 1 $ 3 2 . 1 $ 7 1 . 1 $ 4 1 . 1 $ 9 0 . 1 $ 9 9 . 0 $ 3 9 . 0 $ 9 8 . 0 $ 5 8 . 0 $ 1 8 . 0 $ 7 7 . 0 $ 7 5 . 0 $ 95 96 97 98 99 00 01 02 03 04 05 06 1 2005 ACHIEVEMENTS: GROWTH, DIVERSIFICATION, DISCIPLINE (1) We Grew Our Business We take a highly disciplined approach to growing our business through acquisitions, development and proactive management in all urban markets where we operate. Growth from these activities in 2005 generated a 21% increase in revenues and a 24% increase in net operating income. (2) We Achieved Accretive Growth Our objective is to generate absolute and accretive growth as measured by FFO and FFO per diluted share. Despite a competitive and challenging marketplace we achieved our objectives in 2005 increasing FFO by 46% to $94.7 million and FFO per diluted share by 4% to $1.48. (3) We Improved Our Financial Position Our successful growth strategy and discipline have resulted in a strong finan- cial position for First Capital. In 2005, we improved our ratio of total debt to market capitalization from 56.4% to 44.7% at December 31, 2005. (4) We Distributed More Cash to Our Shareholders We increased our dividends in 2005 and met our goal of moderately increasing dividends to shareholders while maintaining a conservative payout ratio. Regular dividends per share totalled $1.20 in 2005. 2 FIRST CAPITAL REALTY 2005 ANNUAL REPORT MESSAGE TO OUR SHAREHOLDERS We are pleased with our perform- ance in 2005. We grew our business, strengthened our balance sheet, and generated (and growing) neighbourhood solid improvements in all of our and community shopping operating metrics. More impor- centres that cater to the tantly, 2005 was another year in everyday lives of people who which the expertise of our people live within a few short kilo- and their hard work, combined metres from our properties. with the disciplined execution of our growth strategies, resulted in significant benefits for our shareholders. Our shopping centres average about 125,000 square feet in size, but each one of them plays a significant part Over the last few years we have in the life of its surrounding accomplished a great deal in what community. They serve differ- continues to be a very challenging ent demographics, different marketplace. In the real estate density characteristics, and also business, it is not an easy task to serve people of different ages, produce solid and accretive genders, cultures and back- growth while at the same time grounds. Our job, and it’s not an maintaining a conservative easy one, is to make every cus- financial position. So, was 2005 just another good year, or are we doing the right things that will allow us to con- tinue to grow and increase the value of our company going forward? Our business is not very glam- orous. We don’t own a two million square foot regional mall, a beau- tiful office tower in a prime downtown location, or a famous hotel in a ski resort surrounded by picture perfect mountains. We own, develop and operate over 137 tomer feel welcome when they come to our shopping centres to get their groceries, visit their pharmacist or the bank, get a haircut, or bring their child to get a filling at the dentist’s office. At the same time, our retail tenants operate in an extremely competitive environment, which results in a natural cap on the rents they can afford to pay. They constantly want more attractive buildings, more efficient parking lots, better access and more visible signage. In short, our tenants want the world from us, they deserve it, and they offer very little to pay for it. left to right: SYLVIE LACHANCE Executive Vice President KAREN WEAVER Chief Financial Officer and Secretary BRIAN KOZAK Vice President Western Canada DORI SEGAL President and Chief Executive Officer 3 The growth in our business comes – the powerful combination of from acquisition and development With all of these challenges, you focussed and disciplined acquisi- activities. For the properties we may well ask “Why are we in tions, proactive management and newly develop, although a compli- this business?” cated and lengthy process, it is a process we control and allows us to deliver a desirable product to our tenants with an attractive financial proposition. We pay a lot of attention to picking up well- located development sites so we end up with a favourable long- term return on our investment. The reason is quite simple. We believe all of these issues and problems present significant opportunity. The shopping centre business attracts us because it is an in-house development busi- ness. Our approach is long term, our attitude is patient, and we don’t look for short cuts. I recall someone once told me that there are no free lunches. going through a tremendous con- The bigger we get, the more chal- solidation period, a time when we lenges we face. At the same time, are busy translating experience we see more opportunities come and knowledge into quality and our way. Contrary to common On the other hand, when we efficiencies, while consistently belief, the bigger you are the acquire existing shopping centres and gradually over time, “in a easier it is to grow. one at a time, although they are magical way”, converting these very well located, we inherit a problems into attractive returns whole other set of issues that are on investment. Focussed Acquisitions At First Capital, it is second nature to us to follow three basic the result of the fragmented own- ership in our business. These centres will often have tenants that operate from outdated build- ings that have been starving for capital improvements. In these centres, tenants also have differ- ent lease agreements that are not standardized and often not drafted to our satisfaction in terms of tenant rights, exclusives and site plan issues. Putting this another way, our rules when making an acquisition mission is to harvest the fertile – location, location, location. ground of poorly managed shop- From the beginning, we realized ping centres that have lacked that everyone on our team had to capital investment for many years, be a part of this strategy, starting obsolete empty buildings, under- with the property management sized or oversized tenant space, group, through to leasing and short-term leases, high interest even to our finance people. We all rate mortgages, low loan to value keep our eyes open and ears to existing financing and tenants the ground in every market, day in in bankruptcy. To capitalize on these opportuni- ties, our strategy remains simple day out, for accretive acquisition opportunities, many of which are a very short distance from our exist- A P P LY I N G A G R OW T H S T R AT E GY TO A S TA B L E B U S I N E SS Focussed acquisition strategy Actively manage portfolio Selective development and redevelopment 4 Growing FFO Increasing equity and liquidity INCREASE SHAREHOLDER VALUE FIRST CAPITAL REALTY 2005 ANNUAL REPORT ing properties. An acquisition opportunity could be half an acre at a cost of a few hundred thou- sand dollars for the completion of an expansion for an existing or new tenant, or the purchase of a fully operating shopping centre for more than $50 million. If an opportunity is well-located, if it can be used for retail, if it has a decent return, if it has a future potential to increase cash flow or it has a strategic value, we will buy it. If it doesn’t meet these cri- teria, we will simply move on. Proactive Management Proactive management is also all about three things – people, people, people. To get a shopping centre updated to new retail formats while enhancing its returns, you need good ideas, excellent execution and a strong financial backbone. The combina- tion of these three skills is crucial as all of these activities happen while tenants and their customers continue to do business and live their lives. Sensitive municipal issues also have to be patiently dealt with given the fact they concern the day-to-day life of the community surrounding the shop- ping centre. In this respect our work is never done. Once you have transformed a shopping centre to your desired standard, you then have to work hard to maintain it at that level with ongoing improve- ments. Proactive management, therefore, is not all about real estate, it’s about people who are the stakeholders in the shopping centre. Development Being a good developer in the shopping centre business is not an option, it’s a must. While development typically generates higher returns on capital invested, although with a slightly higher risk, it also allows us to partici- pate in growth markets, provides the engine of growth for our tenants, and reduces the average age of our portfolio. In the past few years, with less than 5% of our balance sheet tied up in development assets, these devel- opment activities have delivered over 20% of our NOI growth. undergone tremendous improve- ments in the last few years. We are fortunate to have talented people who are very passionate about what they do and who also possess a high level and diversi- fied set of skills which makes First Capital what it is today. Successful development is the To these people, my fellow co- combination of three things – workers, I would like to express location, people and vision. my appreciation first and fore- A Strong Financial Position To cement the powerful combina- tion of our three-pronged real estate strategy, over the last few years we made sure that our financial structure is conservative, transparent and simple. This resulted, among other things, in most. In addition, I would like to thank our tenants and service providers for their support, our investors for their continued trust, and also our Board of Directors under the leadership of our Chairman, Chaim Katzman, for their counsel and guidance. an investment grade credit rating We will continue to focus and from DBRS last year. We are now work hard to achieve our long- in the strongest financial position term objectives, and I believe we we have ever been, and we intend are well positioned to further to continue on this path. increase value for our In summary and to answer my question on whether we are doing the right things, my conclusion is – yes we are. Going forward we will work hard to continue increasing the value of “our First Capital” which is very dear to my heart. Although we are not perfect yet, every area of our business has shareholders, tenants and business partners for a very long time to come. Dori J. Segal President and Chief Executive Officer April 6, 2006 5 G R OW I N G CA S H F LOW The following summary of our 2002 income property acquisitions demonstrates the effective execution of our focussed acquisitions and proactive management activities. G R O S S B O O K V A L U E ($ millions) G R O S S L E A S A B L E A R E A (thousands of sq. ft.) N E T O P E R A T I N G I N C O M E R U N R A T E ($ millions) A N N U A L I Z E D Y I E L D (%) 9 . 3 1 2 $ 5 . 8 6 1 $ 5 7 0 , 2 1 7 1 , 2 % 5 . 9 % 6 . 8 4 . 0 2 $ 5 . 4 1 $ 02 05 02 05 02 05 02 05 P R O P E R T Y ACT I V I T Y S U M M A R Y The following table highlights property improvements and activities since acquisition in 2002. Acquired Adjacent Site/Space Expanded Centre Renovated All/Part of Centre ✔ New Anchor or Major Tenant Expanded Space and Term of Anchor Tenant(s) ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ Property Byron Village Shopping Centre Carrefour St. Hubert Centre Commercial Beaconsfield Centre Commercial Cote St. Luc Centre Commercial Van Horne Centre Commercial Wilderton Centre Domaine Galeries Brien Galeries Normandie Midland Lawrence Plaza Place Fleury Place Pointe-aux-Trembles Place Vilamont Plaza Delson Place Viau Toys ‘R’ Us/Pier 1 Imports Village des Valeurs Westney Heights Plaza 6 LOCATION LOCATION LOCATION FIRST CAPITAL REALTY 2005 ANNUAL REPORT Centre Commercial Wilderton, Montreal, Quebec • Acquired January 2002 • At acquisition: • Population – 1 mile >60,000 residents ➤ 124,000 square feet ➤ 67.8% occupancy ➤ $9.79 average • Major tenants lease rate Metro Pharmaprix Royal Bank SAQ Liquor Store Dollarama Femme Fitness • At December 2005: ➤ 127,000 square feet ➤ 94.7% occupancy ➤ $12.67 average lease rate • Relocated, expanded, and extended leases of Pharmaprix and SAQ • Opened a new fitness centre • Renovated building facade and second floor and repaired the roof 7 FOCUSSED ON MAJOR URBAN MARKETS We target urban markets despite, and because of, their high barriers to entry. The advantage of urban retail properties is that if well-located and properly managed they typically generate sustainable returns on investments, and over time, capital appreciation. Newmarket Markham Peterborough Ajax Whitby Pickering Brampton Mississauga Cambridge Waterloo Kitchener Brantford Toronto Oakville Burlington Hamilton St. Catharines Greater Toronto Area 2000 • 14 properties • 2,500,000 square feet Greater Toronto Area 2006 • 39 properties • 5,400,000 square feet Lachenaie Repentigny Laval Boucherville Montreal Longueuil Greater Montreal Area 2000 • 4 properties • 300,000 square feet Greater Montreal Area 2006 • 32 properties • 3,200,000 square feet Beaconsfield L’Ile Perrot Chateauguay Delson Cochrane Airdrie Calgary Lethbridge Calgary/Lethbridge 2000 • 2 properties • 150,000 square feet Calgary/Lethbridge 2006 • 12 properties • 1,400,000 square feet Legend Stabilized properties Under development/expansion Expansion/development potential Development sites As at March 2006 8 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Gatineau Hull Ottawa Ottawa/Hull 2000 • 3 properties • 300,000 square feet Ottawa/Hull 2006 • 12 properties • 1,500,000 square feet Edmonton/Red Deer 2000 • 8 properties • 1,500,000 square feet Edmonton/Red Deer 2006 • 9 properties • 1,600,000 square feet Greater Vancouver Area 2000 • 0 properties • 0 square feet Greater Vancouver Area 2006 • 11 properties • 1,200,000 square feet St. Albert Edmonton Sherwood Park Red Deer North Vancouver West Vancouver Vancouver Burnaby Coquitlam Richmond Surrey Delta Langley Abbotsford Duncan, Vanc. Isld U.S.A. Quebec City 2000 • 0 properties • 0 square feet Quebec City 2006 • 4 properties • 300,000 square feet Beauport Vanier Lévis Québec Sillery Sainte-Foy Saint-Romuald Charny 9 First Capital Realty Acquisitions: INCREASING OUR PORTFOLIO We continued our acquisition activities across our target urban markets in 2005, investing approximately $493 million in Our acquisition activity in 2005 25 shopping centres that added strengthened our presence in 2.4 million square feet of gross most of our target urban leasable area to our portfolio, markets and enhanced the additional space and land overall geographic diversification parcels totalling 27.5 acres at of our portfolio. In particular, 11 existing properties, 76,000 our asset base in Western square feet of additional space at Canada grew to over four others, and the remaining $600 million or 27% of our total 50% interest at an existing annual minimum rent in 2005, up centre. We also acquired six from 23% last year. development sites totalling 115.1 acres. We take a highly disciplined approach to increasing the size This portfolio growth was and scale of our property port- accomplished through the folio. We acquire well-located completion of 46 separate shopping centres in growing transactions during the year, urban markets that are primarily almost one per week. This was a anchored by supermarkets significant amount of activity and/or drug stores. We seek considering that each opportu- acquisitions that are both opera- nity undergoes careful scrutiny tionally and financially accretive and due diligence to ensure every to the Company over the long property meets our acquisition term, also looking for benefits criteria and provides an from economies of scale, appropriate long-term return operating synergies and the on investment. strengthening of our competitive position. 10 FIRST CAPITAL REALTY 2005 ANNUAL REPORT PORTFOLIO GROWTH through ACQUISITIONS in URBAN MARKETS We acquired 25 neighbourhood and community shopping centres in 2005, all of which are anchored by a major supermarket and/or drug store chain. We strengthened our presence in the markets we operate in, and enhanced the geo- graphic diversification of our portfolio. With our Q1 2006 acquisitions, our total portfolio now consists of 137 properties amounting to over 16.3 million square feet of GLA. TOTA L I N V E S T M E N T I N P R O P E R T I E S ($ millions) Acquisitions Development and Capital Improvements 2005 Ontario Quebec British Columbia Alberta 2004 Ontario Quebec British Columbia Alberta $ $ $ 212 59 161 61 493 113 93 78 6 $ 290 $ $ $ $ 55 22 1 19 97 49 23 — 19 91 $ $ $ Total 267 81 162 80 590 162 116 78 25 $ 381 11 First Capital Realty Development: DEVELOPING OUR OPPORTUNITIES Our development and redevelop- ment expertise adds significant value to the Company and is key to the long-term success of our completed in Alberta, Ontario business. These activities deliver and Quebec. This activity high- a higher return on investment lights the national scope of our and allow First Capital Realty to portfolio, and the capabilities of better participate in growth our development professionals markets and enhance our rela- across the country. tionships with our tenants. At year end, we had six projects For the year ended December 31, under development and more 2005, we brought on-line over than 15 others under various 339,000 square feet of new gross planning, expansion and rede- leasable area at 19 properties velopment stages. Our inventory throughout the portfolio. During of land assets and development the year we also invested projects totalled 238 acres at $97 million in our ongoing December 31, 2005, with the development and redevelopment potential to add approximately projects, including improve- 2.9 million square feet of GLA to ments to our existing shopping the portfolio, about one-third of centre portfolio. We believe we which we currently plan to com- invest more in our properties plete by the end of 2007. This than most other landlords, extensive pipeline of develop- ensuring our portfolio remains ment opportunities provides attractive to quality retailers First Capital with significant and their customers, and organic growth despite the com- enhancing our long-term petitive acquisition market for competitive position. shopping centres. Development activity in 2005 occurred in all of our urban markets, with major projects 12 FIRST CAPITAL REALTY 2005 ANNUAL REPORT DEVELOPMENT— the w ay to PARTICIPATE in GROWTH MARKETS We invested $97 million in our development, redevelopment and improvement activities in 2005, and added 339,000 square feet of brand new, high quality and modern retail space to our growing portfolio. During the year we also invested $61 million in new land sites and land parcels adjacent to existing centres. Our current inventory of land assets and develop- ment projects will continue to provide us with growth and higher returns on invested capital. 2 0 0 5 D E V E LO P M E N T S Property Name Location Gross Leasable Area Major Anchors Royal Oak Calgary, AB 61,000 sq. ft. Home Outfitters, Mexx, Royal Bank Tillsonburg Town Centre Tillsonburg, ON 60,000 sq. ft. Canadian Tire Strandherd Crossing Ottawa, ON 50,000 sq. ft. Shoppers Drug Mart, Royal Bank Sherwood Towne Square Edmonton, AB 30,000 sq. ft. Michael’s, Royal Bank Red Deer Village Red Deer, AB 22,000 sq. ft. Shoppers Drug Mart, Rogers Video 3434 Lawrence Place Bordeaux Toronto, ON 17,000 sq. ft. Mark’s Work Wearhouse Gatineau, QC 16,000 sq. ft. Marche Frais, Cuisine De La Mer Lapointe Les Galeries de Lanaudiere Lachenaie, QC 14,000 sq. ft. Tommy Hilfiger, TD Canada Trust Wellington Corners London, ON 13,000 sq. ft. Montana’s Harwood Plaza Ajax, ON 10,000 sq. ft. The Bargain Shop Other pads and expansions Total 46,000 sq. ft. 339,000 sq. ft. 13 First Capital Realty Proactive Management: MANAGING OUR PROPERTIES Our property management and leasing activities have generated tangible benefits for First Capital as well as our tenants First Capital has proven its and their customers. Over the ability to add value to its last three years the combination properties through proactive of improving portfolio occupancy management. This essential and higher average rents has element of our growth strategy resulted in steady and increas- results in value enhancements ing same property net operating and property upgrades aimed at income. In 2005, same property providing consumers with the NOI grew 2.6% while occupancy best possible shopping experi- for the total portfolio improved ence. Specifically, we strive to to 95.0% at the end of 2005 from create and maintain the highest 94.1% at the beginning of the standards in such elements as year. These increases are parking, lighting, signage, further demonstrations of the facades, landscape and access strength and quality of our points. Knowledgeable and sophisticated retailers seek to position themselves in the best located, best operated and most visible and accessible locations. Our proactive management approach ensures our properties remain attractive to these quality retailers and their cus- tomers over the long term. property portfolio. Another key element of our success is our leasing activity and our strong relationships with national, regional and local tenants. During 2005, leasing activities resulted in net new leasing totalling 490,000 square feet, including development coming on-line and renewal leasing of 594,000 square feet completed at a 4.9% increase over the expiring rental rates. 14 FIRST CAPITAL REALTY 2005 ANNUAL REPORT QUALITY PROPERTIES attr act QUALITY RETAILERS Our proactive property management and leasing activities in 2005 generated a solid improvement in occupancy to 95% and increased average rents by 3.3% to $13.61 per square foot, resulting in growth in same property net operating income of 2.6%. With our ongoing development activities, prop- erty expansions and our focus on constantly improving and updating our centres, we will continue to work on improving these operating metrics. TO P 3 0 T E N A N T S 1 Sobeys 2 Loblaws 3 Metro 11 Royal Bank 21 Future Shop 12 H.Y. Louie Group 22 Blockbuster 13 Save-On-Foods 23 SAQ 4 Canadian Tire 14 Rogers 24 Dollarama 5 Zellers 15 Reitmans Group 25 Pharma Plus 6 Shoppers Drug Mart 16 Scotiabank 26 Forzani Group 7 Canada Safeway 17 Winners / HomeSense 27 Cara Operations 8 Wal-Mart 18 Tim Hortons / Wendy’s 28 Toys ’R’ Us 9 TD Canada Trust 19 LCBO 29 Bank of Montreal 10 CIBC 20 Staples 30 Michael’s Arts & Crafts 15 First Capital Realty Financial Review: FINANCIAL STRENGTH Operating Highlights • Revenue increased 21% to $268.6 million • Net operating income increased 24% to $165 million • Invested $590 million in acqui- sitions, development activities and property improvements • Added 2.7 million square feet of gross leasable area • Funds from operations increased 46% to $94.7 million • FFO per diluted share increased 4% to $1.48 • Average rent per occupied square foot grew 3.3% to $13.61 Sustainable Cash Flow • 124 of 137 properties are supermarket and/or drug store- anchored • Top 30 tenants provide 56.5% of annual rents, 77% of which are backed by investment grade credit ratings • Occupancy has increased from 94.1% to 95% • Same property net operating income increased 2.6% • Debt to market capitalization improved to 44.7% from 56.4% • Debt to gross total assets improved to 53.8% from 64.1% 47% of total annual rents are from tenants with investment grade credit ratings R E V E N U E S ($ millions) N E T O P E R A T I N G I N C O M E ($ millions) D E B T T O M A R K E T C A P I T A L I Z A T I O N (%) T O T A L A S S E T S ($ millions) 9 6 2 $ 2 2 2 $ 8 5 1 $ 3 3 1 $ 6 9 $ 5 6 1 $ % 7 6 9 6 4 , 2 $ % 6 5 % 5 4 4 9 8 , 1 $ 2 4 5 , 1 $ 03 04 05 03 04 05 03 04 05 03 04 05 16 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S FIRST CAPITAL REALTY 2005 ANNUAL REPORT I N D E X Disclosures Business Overview and Strategy Operations Results of Operations Capital Structure and Liquidity Quarterly Analysis Outlook Events Subsequent to December 31, 2005 Summary of Significant Accounting Estimates and Policies Summary of Changes to Significant Accounting Policies Risks and Uncertainties (18) (18) (23) (31) (37) (43) (45) (45) (46) (48) (50) 17 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S D I S C LO S U R E S This Management’s Discussion and Analysis (“MD&A”) of results of operations and financial condition should be read in conjunction with First Capital Realty Inc.’s (“First Capital Realty” or the “Company”) audited consolidated financial statements for the years ended December 31, 2005 and 2004 and the accompanying notes. Additional information about the Company, including the Annual Information Form is on SEDAR at www.sedar.com. The information in this MD&A is based on information available to management as of March 10, 2006. Cautionary Statement Regarding Forward-Looking Statements Certain statements included in this MD&A constitute forward-looking statements, including those identified by the expressions “anticipate”, “believe”, “plan”, “estimate”, “expect”, “intend” and similar expressions to the extent they relate to the Company or its management. The forward- looking statements are not historical facts but reflect the Company’s current expectations regarding future results or events and are based on information currently available to management. Management believes that the expectations reflected in forward-looking statements are based upon reasonable assumptions; however, management can give no assurance that actual results will be consistent with these forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations, including the matters discussed under “Risk Management” and in other sections of this MD&A. Factors that could cause actual results or events to differ materially from those expressed or implied by forward-looking statements, include, but are not limited to, general economic conditions, the availability of new competitive supply of retail properties which may become available either through construction or sublease, First Capital Realty’s ability to maintain occupancy and to lease or re-lease space at current or anticipated rents, tenant bankruptcies, financial difficulties and defaults, changes in interest rates, changes in operating costs, First Capital Realty’s ability to obtain insurance coverage at a reasonable cost and the availability of financing. These forward-looking statements are made as of March 10, 2006. The accounting principles that the financial data has been prepared in accordance with is Canadian Generally Accepted Accounting Principles (“GAAP”) and all amounts are in Canadian dollars, unless otherwise noted. B U S I N E S S OV E R V I E W A N D S T R AT E GY First Capital Realty Inc. (TSX:FCR) is Canada’s leading owner, developer and operator of supermarket-anchored neighbourhood and community shopping centres located predominantly in growing metropolitan areas. The Company also invests in the United States through its holdings in Equity One, Inc. (NYSE:EQY) (“Equity One”), an owner, developer and operator of neighbourhood and community shopping centres located in high growth markets in the southern United States and the Boston, Massachusetts metropolitan area. First Capital Realty was incorporated in November 1993 and conducts its business directly and through subsidiaries. First Capital Realty’s primary objective is the creation of value over the long term by generating sustainable cash flow and capital appreciation of its shopping centre portfolio. This 18 FIRST CAPITAL REALTY 2005 ANNUAL REPORT objective is achieved through a focussed and disciplined acquisition strategy, by undertaking selective development and redevelopment activities and by proactive management of the existing shopping centre portfolio. The Company’s portfolio of income-producing shopping centres at December 31, 2005 consisted of interests in 15.7 million square feet of gross leasable area in 133 properties including six under development, 123 of which were supermarket and/or drug store-anchored. These shopping centres average 122,000 square feet in size (2004 – 125,000 square feet) and have an average net book value of $128 per square foot (2004 – $125 per square foot). The Company operates in key urban markets in the four largest provincial economies in Canada as summarized in the following chart: December 31 2005 Gross 2004 Gross Percent Number of Leasable Area Percent Number of Leasable Area Occupied Properties(1) (000s sq. ft.) Occupied Properties (000s sq. ft.) Ontario 95.7% Quebec 94.2% 93.9% Alberta British Columbia 96.6% 90.2% Other 95.0% Total 53 47 18 11 4 133 7,275 4,388 2,688 1,174 187 15,712 94.4% 94.5% 92.2% 96.5% 88.9% 94.1% (1) Includes four properties currently under development with no GLA. 43 40 14 3 4 104 6,086 4,064 2,218 472 184 13,024 The Company targets specific urban markets with stable and/or growing populations despite, and because of, the high barriers to entry. The Company intends to continue to operate primarily in and around growing urban markets including Toronto, Montreal, Calgary, Vancouver, Ottawa, Edmonton and Quebec City. Management believes that urban retail properties typically will generate sustainable returns on investment, and over time, capital appreciation. The Company seeks to achieve critical mass in its markets to generate economies of scale and operating synergies. The Company targets well-located properties that management expects will attract quality tenants with long lease terms. These quality tenants provide consumers with daily necessities including both products and services. In management’s view, such tenants are somewhat less sensitive to economic cycles due to the high component of consumer non-discretionary spending for such products and services and are desirable tenants for the Company’s type of properties. One measure of the quality of tenants is their credit-worthiness. At December 31, 2005, the Company’s top 30 tenants represented 56.5% of the Company’s annualized minimum rents and 58.3% of the gross leasable area in the Company’s portfolio. A total of 77% of those rents are from tenants who have investment grade credit ratings and who represent many of Canada’s leading supermarket operators, drug store chains, discount retailers, banks and other familiar shopping destinations. Furthermore, 47% of total annualized minimum rents are from tenants who have investment grade credit ratings. The Company intends to grow through acquisitions, selective development and proactive management of the portfolio. Acquisitions increase the size and enhance the quality of the portfolio. Management seeks to acquire well-located neighbourhood and community shopping 19 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued centres in the Company’s target urban markets that it believes will provide an appropriate return on investment over the long term. In addition to one-off property transactions, management will look for strategic or portfolio acquisitions, in both existing markets and markets where the Company may not yet have a significant presence. During 2005, the Company acquired interests in 25 properties (2004 – 21 properties) which are consistent with the Company’s investment and growth strategies. Through these acquisitions, the Company expanded its presence in its target urban markets in Canada and thus continues to generate greater economies of scale. The Company also pursues selective development and redevelopment activities, either alone or with joint-venture partners, in order to actively participate in growth markets and to achieve a better return on its portfolio. Investments in development and redevelopment activities generally comprise approximately 5% of the Company’s total assets at any given time. Typically new centres are developed after obtaining anchor tenant lease commitments. The Company strategically manages all development activities to reduce development risks. In 2005, the Company completed the development of 339,000 square feet of gross leasable area of which 328,000 square feet was occupied (2004 – 550,000 square feet of which 512,000 square feet was occupied). First Capital Realty is actively developing properties in its major markets across Canada, generating growth in markets where accretive acquisitions are often difficult to find. The Company views proactive management of the existing portfolio as an important part of its strategy. Proactive management encompasses continued investment in properties to ensure they remain attractive to quality retail tenants and their customers over the long term. Specifically, management strives to create and maintain the highest standards in lighting, parking, access and general appearance of our properties. The Company’s proactive management strategies have contributed to continued improvement in occupancy levels and average lease rates throughout the portfolio. During 2005, the Company completed the full internalization of its development, leasing, legal, construction management and tenant co-ordination functions, thereby internalizing all important value creation activities. These capabilities are located in each of the Company’s offices in Toronto, Montreal and Calgary in order to effectively serve the major urban markets where First Capital Realty operates. Our property management joint venture, FCB, a retail tenant services partnership of First Capital Realty and Brookfield LePage Johnson Controls Facility Management Services “BLJC” provides basic property management services to our properties. Effective with the implementation of this joint venture on April 1, 2005, First Capital Realty terminated its third- party property management agreement. This change in the delivery of property management services has positively impacted the quality of service the Company’s tenants receive, and over time may result in a more efficient cost structure for our tenants. First Capital Realty owns a 60% economic interest in FCB and jointly controls FCB along with BLJC. The full internalization of the value creation activities and property management services also has resulted in First Capital Realty being able to leverage all of its knowledge and expertise 20 FIRST CAPITAL REALTY 2005 ANNUAL REPORT within the Company, which will provide a higher ability to deliver on strategic plans and foster stronger relationships with key outside stakeholders in the acquisition, development and tenant communities. The Company also owns 13.3 million shares (2004 – 12.7 million shares) or approximately 17.8% (2004 – 17.5%) of Equity One, Inc., the assets of which are similar to those of the Company, and at December 31, 2005 comprised 192 properties totalling 19.7 million square feet (December 31, 2004 – 188 properties totalling 19.9 million square feet). At December 31, 2005, the Company had interests in 325 properties totalling approximately 35.4 million square feet of gross leasable area which include properties held through its investment in Equity One (December 31, 2004 – 292 properties totalling 32.9 million square feet). Company Key Performance Measures There are many factors that contribute to the successful operations of First Capital Realty’s business including rental rates, renewal rates, occupancy, tenant quality, availability of properties that meet our acquisition criteria, financing rates, tenant inducements, maintenance and general capital expenditures, development costs and the economic environment in our markets. The Company quantifies the collective results of these factors into the two key measures: funds from operations per diluted share and the overall leverage level. Funds from Operations per Diluted Share A key objective is to generate absolute and accretive growth as measured by funds from operations per diluted share through execution of the business strategy. Overall Leverage Level Another important objective is to continue to maintain financial discipline and ensure sustainability of cash flows through our debt to total market capitalization ratio which is targetted to range from 45% to 60%, subject to market conditions and opportunities and taking into consideration the total asset value of the Company. 2005 Performance Compared to Objectives The Company’s objectives for 2005 were to: • Increase the size of the Company’s income-producing portfolio while maintaining and enhancing asset quality; and, • Increase the funds from operations through increased rental rates and portfolio occupancy, expansion and development activities. The Company believes it has met or exceeded all of its 2005 objectives. Key financial and operating metrics which provide measures of performance are outlined on the Summary Consolidated Information and Highlights table: 21 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Summary Consolidated Information and Highlights (thousands of dollars, except per share amounts) 2005 2004 (1) (2) 2003 (1) (2) Operation Information Gross leasable area (sq. ft.) Number of properties Development land acreage owned Portfolio occupancy Rate per occupied square foot Financial Information Gross real property investments Total real estate investments Total assets Mortgages, credit facilities and debentures payable Convertible debentures payable Shareholders’ equity Net operating income – Canada (4) Net income Net income per share Net income per diluted share Equity One Dividends received from Equity One (Cdn$) US$ Dividends from Equity One US$ average exchange on dividends Debt to market capitalization (5) Debt to gross total assets (5) Dividends per common share – regular – special Dividends Dividends reinvested by shareholders (6) Funds from Operations 15,712,000 133(3) 238 95.0% 13.61 $ 13,024,000 104 139 94.1% 13.17 $ 10,708,000 82 89 93.1% 12.66 $ $ 2,274,818 $ 2,392,270 $ 2,469,288 $ 1,685,277 $ 1,831,717 $ 1,893,597 $ 1,306,888 $ 1,496,133 $ 1,541,580 $ 1,397,040 $ 96,990 $ 842,544 $ 165,049 29,196 $ 0.72 $ 0.50 $ $ 1,002,965 247,736 $ 548,493 $ 132,818 $ 17,887 $ 0.46 $ 0.45 $ $ $ $ $ $ 18,221 15,207 1.20 44.7% 53.8% 1.20 0.20 87,617 45,200 $ $ $ $ $ 18,671 14,249 1.31 56.4% 64.1% 1.17 — 54,771 — $ $ $ $ $ $ $ $ $ $ $ $ 786,301 335,656 349,672 96,201 22,149 0.91 0.86 19,033 13,001 1.46 67.2% 72.2% 1.14 — 30,507 — Funds from operations (7) Funds from operations per diluted share Weighted average diluted shares – FFO 94,666 $ $ 1.48 63,995,995 $ $ 64,664 1.42 45,652,868 (1) Refer to the 2005 MD&A for discussion and analysis relating to the two years ended December 31, 2005 and 2004 and to the 2004 MD&A for discussion and analysis for the two years ended December 31, 2004 and 2003. (2) Comparative figures have been restated to reflect the change in accounting standards with respect to convertible debentures which is further described in the notes to the 2005 consolidated financial statements. (3) Includes four properties currently under development with no GLA. (4) Net operating income is a non Generally Accepted Accounting Principles (“GAAP”) measure of operating performance. See definition on page 32. (5) Calculated in accordance with the Series A unsecured debenture indenture. (6) Includes $16 million of dividends payable at December 31, 2005 that were reinvested in January 2006. (7) Funds from operations is a measure of operating performance that is not defined by GAAP. See page 31 for an explanation and reconciliation of funds from operations to net income. The definition of funds from operations changed effective January 1, 2004. 22 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Summary Consolidated Information Highlights • Gross real property investments increased by 35% over 2004 • The leverage of the Company as measured by debt to total market capitalization improved to 44.7% at December 31, 2005 from 56.4% at December 31, 2004 • Net operating income increased by 24% over 2004 • Funds from operations per diluted share increased by 4% over 2004 • Regular dividends increased to $1.20 per share compared to $1.17 per share in 2004 O P E R AT I O N S Investments in Real Estate The Company’s total investment in its acquisition, development and portfolio improvement activities over the last two years is summarized as follows: ($ millions) Gross real property investments, January 1 Acquisition of income-producing properties Acquisition of additional space and land parcels adjacent to existing properties Acquisition of land sites for development Active development and portfolio improvement Other Gross real property investments, December 31 2005 1,685 407 36 37 97 13 2,275 $ $ $ $ 2004 1,307 262 11 17 91 (3) 1,685 The Company’s operations are comprised of acquisitions of income-producing properties, acquisitions of additional space and land parcels at or adjacent to existing income properties, acquisitions of land sites for future development, development of square footage at our centres and leasing of income-producing properties and properties under development. These operations for 2005 and 2004, along with the Company’s interest in Equity One are discussed below. Income-Producing Properties In 2005, the Company acquired interests in 25 income-producing shopping centres, comprising 2.4 million square feet, for $401.9 million compared with the acquisition of 21 income- producing shopping centres, comprising 1.9 million square feet for $262 million in 2004. Of these properties, 19 were anchored by supermarkets and three were anchored by drug stores. In addition, nine of the supermarket-anchored centres also included drug stores as additional anchors. These acquisitions are in and around the Company’s targetted urban markets and demonstrate the Company’s continuing focus on these urban markets. The acquisitions are summarized in the following table. 23 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Property Name City Province Anchored Anchored (square feet) ($ millions) Supermarket- Drug Store- Leasable Area Cost Gross Acquisition Grimsby Square Shopping Centre Hooper Building Pemberton Plaza Kingsland Plaza Broadmoor Grimsby Sherbrooke Vancouver Calgary ON QC BC AB Richmond London Airdrie Kitchener Langley BC Shopping Centre ON Adelaide Shoppers AB Towerlane Mall ON Fairway Plaza BC Langley Mall BC Harbour Front Centre Vancouver QC Place Michelet BC 1331 Main Street Uplands Common AB Carrefour des Forges Drummondville QC College Square (1) ON BC Langley Crossing Bowmanville Mall ON Chartwell Shopping Ottawa Langley Bowmanville Montreal Vancouver Lethbridge Centre Toronto Terra Nova Shopping Centre Richmond Galeries des Chesnaye Lachenaie Burlingwood Shopping Centre Coronation Mall Loblaws Plaza Lakeview Plaza Verdun Shoppers Total (1) 50% interest Burlington Duncan Ottawa Calgary Montreal ON BC QC ON BC ON AB QC ✔ ✔ ✔ — ✔ — ✔ ✔ ✔ — ✔ — ✔ ✔ ✔ — ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ — 19 ✔ ✔ — ✔ — ✔ ✔ — — — — — — — ✔ — ✔ ✔ — ✔ ✔ — — ✔ ✔ 12 126,000 92,000 78,000 45,000 43,000 19,000 170,000 169,000 132,000 127,000 59,000 55,000 53,000 50,000 388,000 129,000 115,000 $ 13.1 11.4 19.1 9.0 14.5 5.6 20.1 40.5 13.6 34.3 13.5 5.7 11.1 7.3 39.3 29.1 13.6 85,000 19.0 73,000 57,000 24.7 7.1 46,000 58,000 106,000 64,000 19,000 9.5 11.1 15.9 11.1 2.7 2,358,000 $ 401.9 In addition, the Company acquired the remaining 50% interest in Northfield Centre, Waterloo, Ontario for $5.2 million. Additional Space and Adjacent Land Parcels In 2005 the Company acquired additional space in four existing shopping centres and 11 land parcels at or adjacent to existing properties adding 76,000 square feet of gross leasable area and 27.5 acres of commercial land. Total expenditures on these additional interests and land parcels amounted to $36.2 million. These acquisitions are set out in the following table. 24 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Property Name City Province Acres (square feet) ($ millions) Gross Acquisition Leasable Area Cost Promenades Lévis Brantford Mall Steeple Hill Shopping Centre Towerlane Mall Pemberton Plaza Carrefour des Forges Grimsby Square Shopping Centre Grimsby Toronto 1071 King Street West Windsor University Mall Delson Plaza Delson Toronto Chartwell Shopping Centre Carrefour St-David (1) Quebec City King Liberty Village Toronto Grimsby Square Shopping Centre Grimsby Place Seigneuriale QC Lévis ON Brantford ON Pickering AB Airdrie Vancouver BC Drummondville QC ON ON ON QC ON QC ON ON (La Belle Province) Quebec City QC Total 3.5 0.3 0.3 — — 1.0 0.2 — 9.5 1.0 3.9 6.2 1.0 0.6 — $ — — 38,000 8,000 — — 27,000 — — — — — — 2.4 0.3 0.2 4.0 3.4 0.4 0.4 3.8 1.6 0.4 4.9 2.6 9.8 1.1 — 27.5 3,000 76,000 0.9 $ 36.2 (1) To be combined with Carrefour St-David land development site in table below. Land Sites for Development The Company also invested $36.7 million in the acquisition of six land sites comprising 115.1 acres of commercial land for future development as set out in the table below. Property Name City Province North Oakville Land Morningside Crossing Carrefour du Plateau-Grives(2) Bow Valley Crossing (1)(2) Carrefour St-David Jericho Centre Total (1) 50% interest (2) Acquired prior to zoning process Oakville Toronto Hull Calgary Quebec City Langley ON ON QC AB QC BC Acres 7.7 13.4 32.9 48.4 10.5 2.2 115.1 Acquisition Cost ($ millions) $ 7.0 13.0 6.7 4.4 4.0 1.6 $ 36.7 Impact of 2005 Acquisitions on Continuing Operations Management takes a highly disciplined approach to increasing the size and scale of the Company’s property portfolio. Management seeks acquisitions that are both operationally and financially accretive to the Company over the long term, also looking for benefits from economies of scale and operating synergies and strengthening of the Company’s competitive position in its target urban markets. As well, the Company also looks to enhance the geographic diversification of the portfolio. Management believes that the 2005 acquisitions are in-line with the business strategy and will support achievement of the Company’s objectives. 25 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued 2004 Acquisitions In 2004, First Capital Realty expanded its portfolio through various acquisitions as set out below. Income-Producing Properties The Company acquired interests in 21 income-producing shopping centres, comprising 1.9 million square feet for $262 million. Of these properties, 19 were anchored by supermarkets and two were anchored by drug stores. Nine of the supermarket-anchored centres also included drug stores as additional anchors. These acquisitions are in and around our targetted urban markets and demonstrate the Company’s focus on these urban markets, including our initial acquisitions in Vancouver and Quebec City, two markets where the Company did not previously have a presence. Property Name City Province Anchored Anchored (square feet) ($ millions) Supermarket- Drug Store- Leasable Area Cost Gross Acquisition West Oaks Mall(1) Appleby Mall Scott 72 Centre Promenades Lévis Carrefour Soumande Norfolk Mall Plaza Don Quichotte York Mills Gardens Place Pierre Boucher Place des Cormiers King Liberty Village Carrefour Don Quichotte Abbotsford Burlington Delta Lévis Quebec City Tillsonburg Ile Perrot Toronto Longueuil Sept-Iles Toronto BC ON BC QC QC ON QC ON QC QC ON Ile-Perrot Laval Plaza Laval Elysee Merchandise Building Toronto Place de la Colline Place Seigneuriale Place Provencher Place du Commerce IGA Tremblant Time Marketplace Eastview QC QC ON QC Chicoutimi QC Quebec City QC Montreal Montreal QC Mont Tremblant QC BC Vancouver AB Red Deer ✔ ✔ — ✔ ✔ (2) ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ ✔ — ✔ ✔ ✔ ✔ 19 ✔ ✔ ✔ — — — — ✔ ✔ — — ✔ ✔ — ✔ — ✔ ✔ — ✔ — 11 270,000 173,000 163,000 141,000 107,000 100,000 99,000 90,000 88,000 75,000 73,000 72,000 63,000 52,000 52,000 50,000 46,000 40,000 38,000 38,000 34,000 1,864,000 $ 29.8 26.5 34.6 4.1 6.8 5.0 14.6 38.3 8.3 4.8 16.7 9.0 7.7 8.0 5.9 4.6 6.7 6.1 4.5 13.2 6.4 $ 261.6 (1) 50% interest (2) Development subsequent to initial acquisition has added a supermarket of 32,000 square feet. 26 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Additional Interests and Adjacent Land Parcels The Company acquired an additional interest in an existing shopping centre and six land parcels at or adjacent to existing properties for expansion. Total expenditures on these additional interests and land parcels amounted to $10.8 million for 16,000 square feet of retail space and 8.6 acres of commercial land for future development. Gross Acquisition Leasable Area Cost Property Name City Province Acres (square feet) ($ millions) Ambassador Plaza Carrefour Soumande Brantford Mall Steeplehill Shopping Centre King Liberty Village Maple Grove Village Carrefour St. Hubert Total Windsor Quebec City Brantford Pickering Toronto Oakville Longueuil ON QC ON ON ON ON QC — 3.0 1.8 1.3 1.0 1.0 0.5 8.6 16,000 — — — — — — 16,000 $ 1.6 2.8 0.5 0.9 3.2 0.9 0.9 $ 10.8 2004 Land Sites for Development The Company also invested $17.2 million in the acquisition of six land sites comprising 54.3 acres of commercial land for future development as set out below. Acquisition Cost Property Name City Province Acres ($ millions) Charlemagne Strandherd Crossing Carrefour du Versant Clairfields St. Charles Shoppers Waterloo Total Charlemagne Ottawa Gatineau Guelph Kirkland Waterloo QC ON QC ON QC ON 22.3 10.5 9.0 8.5 3.0 1.0 54.3 $ 3.8 5.8 1.3 4.1 1.0 1.2 $ 17.2 2005 Development Activities Development is completed on a selective basis based on opportunities in the markets where the Company operates. Development activities are strategically managed to reduce risks and properties are developed after obtaining anchor lease commitments. In 2005, the Company developed 339,000 square feet of retail space in the following shopping centres: 27 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Property Name City Province Square Feet Major Anchors Royal Oak Calgary Tillsonburg Town Centre Strandherd Crossing Tillsonburg Ottawa Sherwood Towne Square Red Deer Village Edmonton Red Deer 3434 Lawrence Place Bordeaux Les Galeries de Lanaudiere Wellington Corners Harwood Plaza Other pads and expansions Total Toronto Gatineau Lachenaie London Ajax AB ON ON AB AB ON QC QC ON ON 61,000 60,000 50,000 30,000 22,000 17,000 16,000 14,000 13,000 10,000 46,000 339,000 Home Outfitters, Mexx, Royal Bank Canadian Tire Shoppers Drug Mart, Royal Bank Michael’s, Royal Bank Shoppers Drug Mart, Rogers Video Mark’s Work Wearhouse Marche Frais, Cuisine De La Mer Lapointe Tommy Hilfiger, TD Canada Trust Montana’s The Bargain Shop The 2005 development of 339,000 square feet compares with 550,000 square feet completed in 2004. Of the 339,000 square feet completed, 328,000 square feet is occupied at December 31, 2005 at an average rate of $18.33 per square foot. These successfully completed development projects illustrate the potential future value of investments in on-going development initiatives that are not yet generating income, but are expected to contribute significantly to the growth of the Company. At December 31, 2005, the Company owned 238 acres of land sites and parcels available for future development compared with 139 acres in 2004. This inventory provides the Company with opportunities for growth throughout its existing portfolio. Number of Sites/Properties Acres Properties under development Square footage under development in existing properties Land parcels adjacent to/part of existing properties Land sites held for future development Total 6 7 34 10 57 — — 87 151 238 Developable Square Feet 503,000 76,550 942,950 1,429,000 2,951,500 In 2005, the Company invested a total of $97 million in its active development projects as well as in certain improvements to its existing shopping centre portfolio. In addition to the properties under development at December 31, 2005, the Company has a number of shopping centres under redevelopment or expansion. The expected costs of completing planned and approved projects, including tenant inducements, total approximately $72 million. In the management of its development and expansion program, the Company utilizes dedicated internal professional staff. Direct and incremental costs of development, including applicable salaries and other direct costs of internal staff are capitalized to the cost of the development. 28 FIRST CAPITAL REALTY 2005 ANNUAL REPORT 2004 Development Activities In 2004, the Company developed 550,000 square feet of retail space in the following shopping centres: Property Name City Province Square Feet Anchors Calgary AB 142,000 Sobeys, London Drugs Royal Oak Les Galeries de Lanaudiere Sherwood Towne Square Lachenaie Edmonton Brooklin Towne Centre Whitby Strandherd Crossing Carrefour Soumande Carrefour du Versant Parkway Centre Delta Centre 3434 Lawrence Shoppers Waterloo Brampton Corners Wellington Corners Plaza Delson Other pads and expansions Ottawa Quebec City Gatineau Peterborough Cambridge Toronto Waterloo Brampton London Montreal QC AB ON ON QC QC ON ON ON ON ON ON QC 71,000 48,000 45,000 40,000 32,000 32,000 26,000 22,000 20,000 15,000 11,000 10,000 8,000 28,000 550,000 Dollar Max, Old Navy HomeSense, Mark’s Work Wearhouse Shoppers Drug Mart, Bank of Nova Scotia Loeb (Metro) Le Fruiterie Familiprix, Dollarama Winners, SportMart Shoppers Home Health Care, Dollarama Staples Shoppers Drug Mart Buck or Two Shoppers Home Health Care SAQ Of the 550,000 square feet completed, 512,000 square feet was occupied at December 31, 2004 at an average rate of $16.97 per square foot. At December 31, 2004, the Company had 139 acres of land sites and parcels available for development. This inventory provides the Company with opportunities for growth throughout its existing portfolio. Number of Sites/Properties Acres Properties under development Square footage under development in existing properties Land parcels adjacent to/part of existing properties Land sites held for future development 4 11 28 6 49 — — 56 83 139 Developable Square Feet 219,000 116,400 618,250 710,000 1,663,650 The Company invested a total of $91 million in its active development projects as well as in certain improvements to its existing shopping centre portfolio. The Company also had a number of shopping centres under redevelopment or expansion at December 31, 2004. The costs to complete planned and approved projects including tenant inducements totalled approximately $40 million. 29 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Leasing In 2005, net new leasing, including new space coming on-line totalled 490,000 square feet compared to 599,000 square feet in 2004. This net new leasing will generate additional annual minimum rent of approximately $6.0 million as compared to $7.9 million in 2004. Lease renewals on 594,000 square feet were completed in 2005, as compared to 410,000 square feet of space in 2004. The 2005 renewals will generate additional annual minimum rent 4.9% greater than the expiring rent which compares to 2004 renewals of 2.4%. With the impact of leasing during the year in the existing portfolio and development projects, new acquisitions and increases from contractual rent steps, the average rate per occupied square foot increased to $13.61 at December 31, 2005 as compared with $13.17 at December 31, 2004. The occupancy level of the portfolio, including properties currently under redevelopment, was 95.0% of total gross leasable area as at December 31, 2005 as compared with 94.1% at December 31, 2004. New leases, and to a lesser extent, renewal leasing, require investments of capital for tenant installation costs which typically include tenant allowances and other leasing costs. Equity One Equity One is a United States Real Estate Investment Trust (“REIT”) traded on the New York Stock Exchange (“NYSE”) under the ticker symbol EQY, that acquires, develops and operates community and neighbourhood shopping centres located predominantly in high growth markets in the southern United States and the Boston, Massachusetts metropolitan area. Similar to the Company, Equity One’s shopping centres are primarily anchored by supermarkets or other daily necessity oriented retailers such as drug stores or discount retail stores. Equity One Property Portfolio At December 31, 2005, Equity One owned 192 properties (2004 –188 properties) totalling 19.7 million square feet (2004 – 19.9 million square feet) located primarily in metropolitan areas of 11 states (2004 – 12 states) in the southern United States and the Boston, Massachusetts area. The portfolio is comprised of 125 supermarket-anchored shopping centres (2004 – 133), seven drug store-anchored shopping centres (2004 – eight), 49 other retail anchored shopping centres (2004 – 40), six development parcels (2004 – four) and five non-retail properties (2004 – three) as well as a non-controlling interest in one unconsolidated joint venture. The investment in Equity One provides the Company with both geographic and property rental revenue diversification in growing urban markets in the United States. Seventy-six percent of the total square footage owned by Equity One is located in Florida, Texas, and Georgia with the balance of the properties in nine other states. Additionally, all of Equity One’s top ten tenants are represented by U.S.-based corporations that are distinct from the Company’s top ten tenants. Information concerning Equity One is based on publicly available information and documents filed with the U.S. Securities and Exchange Commission. Analysis of Investment in Equity One The book value and market value of the Company’s investment in Equity One amount to $212 million and $359 million (2004 – $204 million and $364 million), respectively, at December 31, 2005, using the year-end exchange rate of $1.16 (2004 – $1.20). First Capital 30 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Realty through its wholly-owned U.S. subsidiaries owned 13.3 million shares of Equity One as of December 31, 2005 (2004 – 12.7 million shares). First Capital Realty’s investment in Equity One originated from an exchange of the Company’s U.S. shopping centre business for shares in Equity One in September 2001, which at the time had a book value of US$120 million. Since that time, Equity One has grown significantly, and the Company’s investment has increased from additional investments in shares. At December 31, 2005, the Equity One shares had a market value of US$308 million or US$23.12 per share. Equity One has paid dividends for 31 consecutive quarters, providing the Company with a source of stable cash income. During 2005, First Capital Realty reinvested a portion of these dividends into additional stock purchases through the Equity One dividend reinvestment and stock purchase plan, and the Company may continue to undertake such reinvestments or additional purchases in the future. At December 31, 2005, the Company has leveraged its investment in Equity One with the majority of the shares held as security for US$133 million of debt. R E S U LT S O F O P E R AT I O N S Funds from Operations In management’s view, funds from operations (“FFO”) is a commonly accepted and meaningful indicator of financial performance in the real estate industry. First Capital Realty believes that financial analysts, investors and stockholders are better served when the clear presentation of comparable period operating results generated from FFO disclosure supplements Canadian generally accepted accounting principles (“GAAP”) disclosure. The Company’s method of calculating FFO may be different from methods used by other corporations or REITs and accordingly, may not be comparable to such other corporations or REITs. FFO is presented to assist investors in analyzing the Company’s performance. FFO: (i) does not represent cash flow from operating activities as defined by GAAP (ii) is not indicative of cash available to fund all liquidity requirements, including payment of dividends and capital for growth and (iii) should not be considered as an alternative to net income (which is determined in accordance with GAAP) for the purpose of evaluating operating performance. (thousands of dollars) Net income for the year Add (deduct): Amortization of shopping centres, deferred costs and intangible assets Gain on disposition of real estate and investments Equity income from Equity One Funds from operations from Equity One Dilution gain on investment in Equity One Future income taxes Funds from operations 2005 2004 $ 29,196 $ 17,887 47,816 (202) (17,475) 26,275 — 9,056 94,666 $ 35,136 (1,163) (18,228) 25,923 (3,201) 8,310 64,664 $ Funds from Operations – RealPac Recommendations First Capital Realty calculates FFO in accordance with the recommendations of the Real Property Association of Canada (“RealPac”), formerly known as the Canadian Institute of Public and Private Real Estate Companies (“CIPPREC”). The definition is meant to standardize the calculation and disclosure of FFO across real estate entities in Canada, and is modelled on 31 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued the definition adopted by the National Association of Real Estate Investment Trusts (“NAREIT”) in the United States. The new method of calculation differs from the Company’s historical calculation, and was adopted by First Capital Realty on January 1, 2005 and applied retroactively. Funds from Operations per Diluted Share Funds from operations per diluted common share totalled $1.48 for the year ended December 31, 2005 compared to $1.42 in 2004. The increase in FFO per share was due primarily to growth in net operating income. The positive impacts from growth in net operating income were partially offset by a 40.2% increase in the weighted average number of diluted common shares and the strengthening of the Canadian dollar compared to the prior year. Net Operating Income Net operating income is defined as a property rental revenue less property operating costs (see note 21 to the consolidated financial statements). In management’s opinion, net operating income is useful in analyzing the operating performance of the Company’s shopping centre portfolio. Net operating income is not a measure defined by GAAP and there is no standard definition of net operating income. Accordingly, net operating income may not be comparable with similar measures presented by other entities. Net operating income should not be construed as an alternative to net income or cash flow from operating activities determined in accordance with GAAP. (thousands of dollars) 2005 2004 Same property 2004 Acquisitions 2005 Acquisitions Development and redevelopment Straight-line rent Market rent adjustments Lease termination, sold properties and other non-recurring amounts Net operating income $ 101,821 21,504 14,847 21,581 2,985 1,130 $ 99,280 12,832 — 16,413 2,881 289 1,181 $ 165,049 1,123 132,818 $ Net operating income (“NOI”) represents non-GAAP information and may not be comparable to measures used by other issuers. Net operating income increased in 2005 by $32 million to $165 million. Same property NOI (includes properties where the Company’s ownership and investment are substantially the same in the two calendar years) grew by 2.6% or $2.5 million during the year. Properties which were acquired during 2004 contributed an additional $21.5 million to NOI in 2005 with the increase arising primarily from a full year of ownership versus a partial year and to a lesser degree from leasing on the properties. Properties acquired in 2005 contributed $14.9 million to NOI, which contribution management expects will increase in 2006 when the properties will have been owned for a full year. NOI from properties which are currently or have undergone substantial development or redevelopment at some point during 2004 or 2005 was $21.6 million in 2005. This represents an increase of $5.2 million in NOI over 2004 due to development and redevelopment activities, net of temporary reductions in NOI while the properties were undergoing development. In the normal course of operations the Company receives payments from tenants as compensation for the cancellation of leases. In 2005, the Company received lease cancellation 32 FIRST CAPITAL REALTY 2005 ANNUAL REPORT payments of $0.5 million or 0.2% of total property revenues as compared to $1.7 million or 0.8% of total property revenues in 2004. Lease termination income was lower in 2005 due partially to a one-time lease termination payment of $0.6 million received from a single tenant in 2004. Lease termination income has ranged from 0.3% to 2% of total property revenues over the past five years. The ratio of net operating income to gross rental revenues in 2005 of 62.3% reflects the inclusion of straight-line rents, market rent adjustments, lease termination fees and non- recurring amounts of $5.3 million included in NOI. Excluding these items, the NOI margin is approximately 61.6%. Similarly, the 2004 ratio of net operating income to gross property revenues of 61.8% reflects the inclusion of lease termination fees, market rent adjustments and other non-recurring amounts of $4.3 million in NOI. Excluding these items, the NOI margin was approximately 61.0%. Overall, the NOI margin has been stable over the past three years as the Company’s portfolio has grown and expanded in new markets. Management, in measuring the Company’s performance, does not distinguish or group its Canadian operations on a geographical or any other basis. Accordingly, the Company has a single reportable Canadian segment for disclosure purposes in accordance with Canadian GAAP. Equity Income from Equity One The Company’s share of Equity One’s net earnings, adjusted to Canadian GAAP, net of a provision for future tax on the undistributed earnings of Equity One, is recorded as equity income. The $0.8 million decrease in the equity income is primarily due to a decrease in Equity One’s gains on property dispositions in 2005. As a result of the Company increasing the number of Equity One shares owned, and Equity One increasing its dividend rate during the year, the total dividends received by the Company on its investment in 2005 were US$15.2 million as compared to US$14.2 million in 2004. Interest and Other Income (thousands of dollars) Interest and other income Gain on disposition of property and securities Dividend income on marketable securities Total 2005 2,551 291 960 3,802 $ $ 2004 6,409 — 71 6,480 $ $ The Company earns interest income from funds invested in three types of investments: advances made to the Company’s development partners; short-term cash deposits; and an investment in a portfolio of short-term mortgages, other receivables and investments in marketable securities. The decline in interest and other income is due to the receipt of income in 2004 from certain high-yield cash flow participation loans, in which the Company had a non-recourse interest including approximately $2.7 million which was non-recurring. The participation loans and other related income and cash flow payment were substantially realized in 2004 and no longer contribute significantly to the Company’s results. Gain on Disposition of Real Estate and Investments Periodically, the Company will dispose of certain assets which do not meet the long-term investment criteria of the Company. In 2004, the Company sold its Leduc Towne Square property of 50,000 square feet in Leduc, Alberta and a land parcel held in a joint venture. 33 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Interest Expense (thousands of dollars) Mortgages and credit facilities Secured by Canadian properties Secured by investment in Equity One Debentures and convertible debentures Total interest expense 2005 2004 $ $ 60,299 7,557 67,856 12,476 80,332 $ $ 47,482 4,980 52,462 27,796 80,258 The increase in interest expense on mortgages and credit facilities in 2005 was a result of an increase in the gross debt required to fund the growth of the property portfolio. This was largely offset by the redemption of the Company’s convertible debentures during 2004 and 2005. While gross debt has increased, the Company’s ratio of debt to gross total assets has declined from 64.1% at December 31, 2004 to 53.8% at December 31, 2005. Interest Expense on Mortgages and Credit Facilities – Canada (thousands of dollars) Interest expense Interest capitalized Interest paid in excess of implicit interest on assumed mortgages Total Canadian mortgage and credit facilities interest paid 2005 2004 $ $ 60,299 5,830 1,710 67,839 $ $ 47,482 4,499 327 52,308 The increase of $15.5 million in interest paid on Canadian mortgages and credit facilities in 2005 over 2004 primarily results from increased borrowing by the Company to fund acquisitions and development activities. The effect of an increase in gross debt was partially offset by a decrease in the weighted average interest rate on the Company’s Canadian fixed rate borrowings, from 6.8% at December 31, 2004 to 6.5% at December 31, 2005 as rates on new financings are lower than those on existing debt. The interest capitalized to properties under development in 2005 increased over 2004 as a result of increased development activity and investments. Interest Expense on U.S. Credit Facilities – Secured by Investment in Equity One (thousands of dollars) Ending debt balance – December 31 (US$) Interest expense (US$) Average exchange rate Interest expense (Cdn$) 2005 2004 $ 132,941 6,261 $ 1.21 $ 7,557 $ $ $ $ $ 85,713 3,832 1.30 4,980 Measured in U.S. currency, the interest expense on the U.S. facilities has increased by 63% in 2005 from 2004 as a result of the higher debt balance and a higher average interest rate. The change in the U.S. exchange rate during 2005 has partially offset this increase, resulting in a 52% increase in interest expense measured in Canadian currency. The Company uses U.S. dollar-denominated debt to finance its U.S. dollar investment. 34 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Interest on Debentures and Convertible Debentures (thousands of dollars) Interest expense on convertible debentures Interest expense on debentures Total debenture interest expense Implicit interest rate in excess of coupon on convertible debentures Change in accrued interest Less: interest paid in common shares of the Company Cash interest paid 2005 2004 $ $ 9,766 2,710 12,476 (1,438) 1,984 (10,465) 2,557 $ $ 27,796 — 27,796 (3,953) 3,200 (19,137) 7,906 During 2005 and 2004, the Company redeemed all of its Series B, C, and D convertible debentures resulting in a significant decrease in interest expense from convertible debentures. On June 21, 2005, the Company issued $100 million of 5.08% senior unsecured debentures, maturing on June 21, 2012. Interest is payable semi-annually. On December 19, 2005, the Company issued $100 million of 5.5% convertible unsecured subordinated debentures due September 30, 2017. Interest is payable semi-annually on March 31 and September 30. In 2005, 543,547 (2004 – 1,177,143) common shares were issued to pay interest to holders of convertible debentures. Corporate Expenses (thousands of dollars) Salaries, wages and benefits Non-cash compensation Other general and administrative costs Capital taxes, net of recoveries from tenants Capitalized expenses Total corporate expenses 2005 2004 $ $ 10,626 1,532 5,954 1,442 (5,182) 14,372 $ $ 6,380 960 3,887 1,362 (950) 11,639 Total corporate expenses have increased to $14.4 million in 2005 from $11.6 million in 2004. Salaries, wages and benefits have increased as a result of portfolio growth and related staffing levels including the full internalization of development, leasing, legal, construction management and tenant co-ordination. In addition, corporate expenses include costs for all other real estate activities and for general corporate purposes and net capital taxes. Non-cash compensation is recognized over the vesting period of options, restricted share units and deferred share units. These items are considered part of the total compensation for directors, senior management, key employees and select service providers to the Company. Due to the grants of options and share units during 2005, the non-cash compensation expense has increased from the prior year. Options and share units are designed to align the holders’ interests with the long-term interests of the Company and its shareholders. Other general and administrative costs have increased with the Company’s growth and in response to the increasing costs of compliance with the regulatory environment for public companies. In addition, there was an increase in the net pre-acquisition costs incurred in the investigation of real estate assets which were ultimately not acquired by the Company. The Company manages all of its acquisitions, development and redevelopment and leasing activities internally. Certain internal costs directly related to development and initial leasing 35 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued of the properties, including salaries and related costs, are capitalized in accordance with GAAP, to land and shopping centres under development as incurred. Direct and incremental costs associated with internal leasing staff are capitalized to deferred leasing costs and amortized over the lives of the related leases. Amounts capitalized to real estate investments and deferred leasing costs during 2005 totalled $5.2 million, compared to $1.0 million in 2004. The increase in capitalized costs was due to the full internalization of these activities com- mencing in the fourth quarter of 2004 and subsequent operations during the full year in 2005. Despite the factors which have increased these expenses in 2005, corporate expenses as a percentage of gross rental revenue have remained constant at 5.4%. Amortization (thousands of dollars) Shopping centres Tenant inducements and leasing fees Intangible assets Deferred financing fees Other Total amortization 2005 2004 $ $ 36,854 8,467 2,495 2,096 409 50,321 $ $ 29,194 4,447 1,495 2,724 196 38,056 Amortization of shopping centre properties increased to $37 million in 2005 from $29 million in 2004. The increase is due to the amortization of newly acquired properties and developments coming on-line. The amortization of intangible assets arises from the allocation of a portion of the purchase price on acquisitions subsequent to September 12, 2003 to lease origination costs and customer relationships. The increase is also due to acquisitions and new developments coming on-line. Amortization of tenant inducements and leasing fees increased as a result of the growing portfolio. In addition to inducements incurred directly by the Company, changes to accounting for acquisitions in 2004 had the effect of increasing the Company’s deferred charges. Deferred financing costs are commitment fees and other costs incurred in connection with debt financing, and are amortized over the term of the related financing. The decrease in 2005 over 2004 is primarily due to the redemption of the convertible debentures during 2004 and 2005. Income and Other Taxes (thousands of dollars) Canadian federal large corporations tax United States current income taxes and other Future income taxes Total 2005 2004 $ $ 1,631 2,436 9,056 13,123 $ $ 2,150 2,656 8,310 13,116 The Company has estimated tax-loss carry-forwards for Canadian income tax purposes of approximately $42 million available to reduce future Canadian taxable income. The total income tax expense has decreased compared to 2004 due to one-time tax effects of the convertible debenture redemptions. 36 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Net Income (thousands of dollars) Net income Net income per diluted share 2005 2004 $ $ 29,196 0.50 $ $ 17,887 0.45 Net income for the year ended December 31, 2005 was $29.2 million, or $0.72 per basic share and $0.50 per diluted share, compared to $17.9 million, or $0.46 per basic share and $0.45 per diluted share, in 2004. The increase in net income results primarily from an increase in net operating income from properties due to acquisitions and development coming on-line, partially offset by increased amortization and corporate expenses. The effect on earnings per share of the increase in net income is partially offset by a 51% increase in diluted shares outstanding. CA P I TA L S T R U CT U R E A N D L I Q U I D I T Y The real estate business is capital-intensive by nature. The Company’s capital structure is key to financing growth and providing cash dividends to shareholders over the long term. In the real estate industry, financial leverage is used to enhance rates of return on invested capital. Management believes that First Capital Realty’s blend of debt, convertible debentures and equity in its capital base provides stability and reduces risks while generating an acceptable return on investment, taking into account the long-term business objectives of the Company. In May 2005, the Company received an investment grade credit rating from the Dominion Bond Rating Service Limited (“DBRS”). DBRS is a credit rating agency that provides ratings of debt securities for commercial entities. Credit ratings provide investors with an assessment of potential risk that borrowers will not fulfill their obligations with respect to both principal and interest payments. Ratings generally range from the highest credit quality (generally AAA) to very speculative (generally C). The credit rating provided to the Company was BBB (low) with a stable trend relating to the Series A unsecured debentures and is generally an indication of adequate credit quality as defined by DBRS. 37 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued (thousands of dollars) 2005 2004 Mortgages and credit facilities – Canada Credit facilities – U.S. Mortgages and credit facilities Unsecured debentures payable Convertible debentures payable Equity component of convertible debentures Other Convertible debentures principal Share capital Warrants Options and share units Cumulative currency translation Contributed surplus Deficit Equity component of convertible debentures Total shareholders’ equity Total capital employed $ 1,142,430 154,610 1,297,040 100,000 96,990 3,015 (5) 100,000 1,022,701 472 3,004 (14,577) 19,513 (191,584) 839,529 3,015 842,544 $ 2,339,584 $ 899,939 103,026 1,002,965 — 247,736 16,517 (2,552) 261,701 673,660 711 1,273 (13,347) 2,842 (133,163) 531,976 16,517 548,493 $ 1,813,159 Mortgages and Credit Facilities As at December 31, 2005, mortgages and credit facilities increased primarily due to the acquisition of shopping centres and refinancing activities during the year. The weighted average interest rate on fixed rate mortgages and credit facilities was 6.5% at December 31, 2005 compared to 6.8% at December 31, 2004. (thousands of dollars) Canada U.S. 2005 Total 2004 Total Fixed rate Floating rate $ 1,080,239 62,191 $ 1,142,430 $ 63,965 90,645 $ 154,610 $ 1,144,204 152,836 $ 1,297,040 $ 880,277 122,688 $ 1,002,965 At December 31, 2005, 88% of the outstanding mortgage and credit facility liabilities bore interest at fixed interest rates which is consistent with 2004. The fixed mortgage rates provide an effective matching for rental income from leases which typically have fixed terms ranging from five to ten years and incremental contractual rent steps during the term of the lease. In Canada, the Company had fixed rate mortgages outstanding as at December 31, 2005 in the aggregate amount of $1,080.2 million as compared to $838.2 million at the end of 2004. The increase in the outstanding balance is the net result of $76.8 million in repayments and $318.8 million in new financing, primarily from financing on acquisitions and refinancing on existing properties. The average remaining term of the mortgages outstanding has declined from 7.2 years at December 31, 2004 to 6.4 years at December 31, 2005. This decline is due to the passage of time and the assumption of mortgages with short remaining terms, offset in part by longer terms on new financings. 38 FIRST CAPITAL REALTY 2005 ANNUAL REPORT The floating rate financing is secured by certain of the Company’s shopping centres and development assets and is being used primarily to finance acquisition, development and redevelopment activities. As these projects are completed, management intends to arrange long-term financing. The U.S. dollar-denominated credit facilities totalling Cdn$154.6 million are used to finance the Company’s investment in Equity One and reduce the Company’s exposure to fluctuations in foreign currency exchange rates. The debt service requirements of these credit facilities are funded by the cash flow generated by the dividends from Equity One. The outstanding U.S. credit facilities increased from US$85.7 million at December 31, 2004 to US$132.9 million at December 31, 2005. On July 12, 2005, the Company increased the amount of its U.S. loan secured by the Equity One shares to US$120 million and extended the maturity to July 2010. The Company’s objective is to manage its long-term debt by staggering maturity dates in order to mitigate against short-term volatility in the debt markets. At December 31, 2005, the Company had mortgages and credit facilities aggregating $77.1 million coming due in 2006, of which $17.3 million are mortgages at an average interest rate of 7.36% and $34.5 million is the scheduled amortization of principal balances during the year. The remaining $25.3 million of debt maturing in 2006 is represented by credit facilities. As the Company intends to renew its bank credit facilities prior to their maturity dates and foresees no difficulty in doing so, cash payment of the outstanding credit facilities is not expected to be required. Subsequent to December 31, 2005, the Company refinanced US$15 million of short-term U.S. credit facilities extending the maturity to 2010, with an option to further extend to 2011. Series A Unsecured Debentures On June 21, 2005, the Company issued $100 million principal amount of 5.08% senior unsecured debentures, with a maturity date of June 21, 2012. DBRS has provided First Capital Realty with a credit rating of BBB (low) with a stable trend relating to the debentures. The proceeds of the June 21, 2005 offering were used to repay the Company’s credit facilities to fund acquisitions and development activities and for general corporate purposes. Debt Maturity Profile (thousands of dollars) Credit Facilities Debentures Credit Facilities Total Mortgages and Unsecured U.S. 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Thereafter $ 53,352 201,498 80,557 68,437 83,734 80,402 107,024 140,962 186,249 107,248 32,967 $ 1,142,430 $ — — — — — — 100,000 — — — — $ 100,000 $ 23,773 6,978 6,978 6,978 109,903 — — — — — — $ 154,610 $ 77,125 208,476 87,535 75,415 193,637 80,402 207,024 140,962 186,249 107,248 32,967 $ 1,397,040 % Due 5.5 14.9 6.3 5.4 13.8 5.8 14.8 10.1 13.3 7.7 2.4 100.0 39 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued The Company is liable for minimum land-lease payments of $0.6 million on certain of its properties in each year from 2006 to 2010 and $6.9 million thereafter. Total minimum land lease payments are $9.9 million. The leases expire between 2023 and 2039. Convertible Debentures (thousands of dollars) Interest Rate 2005 2004 Coupon Implicit Principal Liability Equity Principal Liability Equity 5.50% 7.00% 7.25% 5.97% 8.25% 9.60% $ 100,000 $ 96,990 $ — — — — $ 100,000 $ 96,990 $ — $ — $ 3,015 $ 99,999 — — 161,702 — 8,238 8,279 3,015 $ 261,701 $ 247,736 $ 16,517 96,595 151,141 On December 19, 2005, the Company issued $100 million of 5.50% convertible unsecured subordinated debentures (“5.50% debentures”) due September 30, 2017. The debentures require interest payable semi-annually on March 31 and September 30. Holders of the 5.50% debentures have the right to convert them into common shares at a share price of $27.00 through to December 31, 2011 and $28.00 thereafter to maturity. The Company may redeem the 5.50% debentures on or after December 31, 2009, but prior to January 1, 2012, provided the average trading price of the common shares for the 20 consecutive trading days ending five days prior to the redemption or maturity date is at 125% of the conversion price. The Company may redeem the 5.50% debentures after January 1, 2012 but prior to maturity at a price equal to the principal plus accrued interest. The Company has the option of repaying the 5.50% debentures on redemption by way of the issuance of common shares at 97% of a weighted average trading price of the Company’s common stock. The Company also has the option of paying the semi-annual interest through the issue of common shares. It is the current intention of First Capital Realty to satisfy its obligations to pay principal and interest on its 5.50% convertible unsecured subordinated debentures by issuing common shares. On September 30, 2005, the Company redeemed the outstanding $100 million principal amount of the 7.0% convertible debentures with the issuance of 4,995,205 shares. Prior to the redemption date, holders of $0.045 million principal amount of the 7.0% convertible debentures converted their debentures in accordance with the terms and conditions of the trust indenture. The early redemption of the 7.0% convertible debentures resulted in a non- cash gain of $0.2 million and an increase in contributed surplus of $8.2 million. On March 31, 2005, the Company redeemed the outstanding $161.7 million principal amount of the 7.25% convertible debentures with the issuance of 8,411,386 shares. Prior to the redemption date, holders of $0.035 million principal amount of 7.25% convertible debentures converted their debentures in accordance with the terms and conditions of the trust indenture. The early redemption of the 7.25% convertible debentures resulted in a non-cash gain of $0.8 million and an increase in contributed surplus of $8.4 million. On August 30, 2004, the Company redeemed in cash the outstanding $35.1 million principal amount of the 7.875% convertible debentures. Prior to the redemption date, holders of $62.4 million principal amount of 7.875% convertible debentures converted their debentures into 3,797,212 common shares at a conversion price of $16.43 in accordance with the terms and conditions of the trust indenture. 40 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Accounting for the early redemption of the 7.875% convertible debentures resulted in a non- cash debt settlement expense of $0.9 million and contributed surplus of $2.8 million. In 2005, 543,547 (2004 – 1,177,143) common shares were issued to pay interest to holders of convertible debentures. A change in GAAP, effective January 1, 2005 resulted in changes to the recorded liability and equity components of the Company’s convertible debentures. See Summary of Changes to Significant Accounting Policies. Shareholders’ Equity Shareholders’ equity amounted to $843 million as at December 31, 2005, as compared to $548 million at the end of 2004. Shareholders’ equity as at December 31, 2005 included $3.0 million (2004 – $16.5 million) representing the equity component of convertible debentures as discussed above. As at December 31, 2005, the Company had 70,645,834 (2004 – 51,659,583) issued and outstanding common shares with a stated capital of $1,022.7 million (2004 – $673.7 million). During fiscal 2005, a total of 18,986,251 common shares were issued as follows: 543,547 shares for interest payments on convertible debentures; 2,700,000 shares in connection with a public offering; 13,410,006 common shares in connection with the redemption and conversion of convertible debentures and 900,956 shares from the exercise of common share options and warrants and 1,431,742 common shares under the Company’s new dividend reinvestment plan (“DRIP”). The Company adopted a “DRIP” in May 2005 enabling Canadian resident shareholders who hold at least 500 common shares to reinvest cash dividends into additional common shares to be purchased through the Company’s transfer agent directly from the Company without charge. Shareholders who elect to participate in the DRIP reinvest in additional common shares at a discount of 2% of the weighted average trading price of the common shares on the TSX for the five consecutive trading days preceding the dividend payment date. Shareholders’ equity as at December 31, 2005 included a negative cumulative, unrealized currency translation adjustment in the amount of $14.6 million (2004 – $13.3 million). This amount represents the difference between the U.S. dollar exchange rate in effect at the date of the acquisition of the Company’s U.S. net assets, and the U.S. dollar exchange rate as at December 31, 2005 and 2004, respectively. The U.S. dollar exchange rate in effect at December 31, 2005 decreased to US$1.00 = Cdn$1.16 from the exchange rate at December 31, 2004 of US$1.00 = Cdn$1.20. The impact of the decrease in the foreign exchange rate on the net assets held in the United States resulted in a $1.2 million change in the unrealized currency translation adjustment. Shareholders’ equity as at December 31, 2005 included a deficit of $191.6 million (2004 – $133.2 million). The Company has historically paid dividends at levels consistent with general industry practice and are based on cash flow from operations as opposed to net income. 41 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Share Purchase Options As of December 31, 2005, the Company issued and had outstanding 1,145,105 share purchase options, with an average exercise price of $17.46. The options are exercisable by the holder at any time after vesting. The options have been issued at various times pursuant to the Company’s stock option plan to the employees, officers and directors of the Company and third-party service providers. The options granted permit the holder to acquire shares at an exercise price equal to the market price of such shares at the date the option is granted. The objective of granting options is to encourage the holder to acquire an ownership interest in the Company over a period of time which acts as a financial incentive for the holder to consider the long-term interests of the Company and its shareholders. If all options outstanding at December 31, 2005 were exercised, 1,145,105 shares would be issued and the Company would receive proceeds of approximately $20.0 million. Liquidity The Company’s primary sources of capital are cash generated from Canadian property operations, dividends from Equity One, credit facilities, mortgage financing and refinancings and equity issues. Primary uses of capital include acquisitions, development projects, debt principal repayments, payment of dividends to shareholders, capital improvements and the funding of leasing costs. Cash and cash equivalents were $5.3 million at December 31, 2005 (2004 – $4.9 million). At December 31, 2005, the Company had undrawn credit facilities totalling $157.7 million and had approved credit facilities totalling $275 million of which $226.5 million were available based on security provided to the banks. The Company also had unencumbered assets with a book value of approximately $73.6 million. Management believes that it has sufficient resources to meet its operational and investing requirements in the near and longer term. The Company currently uses secured mortgages and credit facilities, unsecured debentures, convertible debentures and equity issues to finance its growth. The actual level and type of future borrowings will be determined based on prevailing interest rates, various costs of debt and equity capital, debt market conditions and our general view of the required leverage in the business. Dividends The Company has maintained a policy of paying regular quarterly dividends to common shareholders since it commenced operations as a public company in 1994. Dividends are set taking into consideration the Company’s capital requirements, its alternative sources of capital and common industry cash distribution practices. In 2005, the Company paid regular dividends of $1.20 per common share (2004 – $1.17 per common share) and a special dividend of $0.20 per share in March 2005. The regular dividends as a percent of Funds from Operations per share are approximately 81% in 2005 compared to approximately 82% in 2004. The Company is currently paying a quarterly dividend of $0.30 per common share. The annual dividend has grown at a compound rate of approximately 5% since the Company commenced paying dividends in 1994. Dividends declared totalled $87.6 million for the four quarters of 2005. Following the establishment of the DRIP effective for the second quarter, $45.2 million of the $59.9 million in dividends were reinvested by shareholders pursuant to the DRIP in common shares. 42 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Q U A R T E R LY A N A LY S I S ($000s except per share and other data) Q4 Q3 Q2 Q1 2005 Property rental revenue Property rental expense Net operating income Net income Net income/share Net income/share diluted Weighted average diluted shares outstanding – EPS Funds from operations Funds from operations/share diluted $ Weighted average diluted 70,936 25,676 45,260 7,626 0.11 0.11 $ $ 70,235 26,864 43,371 8,740 0.26 0.14 $ $ 63,403 23,769 39,634 6,479 0.10 0.10 60,266 23,482 36,784 6,351 0.27 0.10 $ $ $ $ 68,893,289 26,889 0.38 69,758,875 25,379 0.39 $ 64,327,921 23,102 0.36 $ 61,283,912 19,296 0.35 $ shares outstanding – FFO Dividend Total assets Total mortgages and credit facilities Shareholders’ equity 71,311,303 0.30 $ 2,469,288 1,297,040 842,544 65,355,568 0.30 $ 2,389,404 1,331,505 836,464 64,327,921 0.30 $ 2,214,076 1,167,915 732,714 54,730,436 $ 0.30(1) 2,007,137 1,054,492 741,998 Other Data Number of properties Gross leasable area Occupancy % 133 15,712,000 95.0% 128 15,377,000 94.7% 118 14,420,000 94.7% 110 13,511,000 93.9% (1) Excludes special dividend of $0.20 paid to shareholders of record on March 29, 2005. ($000s except per share and other data) Property rental revenue Property rental expense Net operating income Net income Net income/share Net income/share diluted Weighted average diluted shares outstanding – EPS Funds from operations Funds from operations/share diluted $ Weighted average diluted Q4 59,543 23,441 36,102 6,030 0.12 0.12 $ $ $ $ 2004 $ $ Q3 54,412 19,155 35,257 5,385 0.17 0.15 Q2 Q1 52,613 20,701 31,912 3,534 0.08 0.08 48,454 18,907 29,547 2,938 0.08 0.08 $ $ 51,977,136 19,016 0.37 50,970,595 16,714 0.35 $ 43,366,400 15,802 0.36 $ 39,098,047 13,132 0.34 $ shares outstanding – FFO Dividend Total assets Total mortgages and credit facilities Shareholders’ equity $ 51,977,136 0.30 1,893,597 1,002,965 548,493 $ 47,723,521 0.29 1,835,578 975,538 553,928 $ 43,366,400 0.29 1,779,647 918,485 452,431 39,098,047 0.29 $ 1,654,257 829,412 429,174 Other Data Number of properties Gross leasable area Occupancy % 104 13,024,000 94.1% 103 12,692,000 93.7% 101 12,489,000 93.8% 93 11,698,000 93.3% 43 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued The growth over the eight quarters in 2004 and 2005 in property, rental revenue, property expenses and net operating income is primarily due to acquisitions, development coming on-line and leasing activity. Refer to the MD&A and the Quarterly Financial Statements for discussion and analysis relating to the four quarters in 2004 and the first three quarters in 2005. A discussion of the fourth quarter of 2005 follows. Q4 2005 Operations and Results During the fourth quarter of 2005, the Company acquired interests in four income-producing shopping centres in Ontario, Alberta, British Columbia and Quebec. The aggregate acquisition amount of $40.8 million, including closing costs, was funded in cash. The Company also invested $19.3 million in acquiring additional space and four land parcels at or adjacent to existing properties adding 3,000 square feet of gross leasable area and 11.7 acres of expansion land to the portfolio. In the fourth quarter of 2005, 104,000 square feet of newly developed space came on-line in the following shopping centres: Property Name City Province Square Feet Major Anchors Gross Leasable Area Harwood Red Deer Village Royal Oak Place Bordeaux Others Ajax Red Deer Calgary Gatineau ON AB AB QC The Bargain Shop Shoppers Drug Mart Home Outfitters Marche Frais 10,000 16,000 39,000 13,000 26,000 104,000 The 104,000 square feet of space developed and brought on-line during the quarter was leased at an average rate of $16.64 per square foot. In addition to acquisitions of income-producing properties and development assets, the Company invested $36.3 million during the fourth quarter in its active development projects as well as in certain improvements to existing properties. Leasing activity in the fourth quarter of 2005 resulted in net new leasing of 152,000 square feet, including development projects coming on-line, and renewal leasing of 138,000 square feet. The average rate per occupied square foot at December 31, 2005 increased to $13.61 from $13.56 at September 30, 2005. Portfolio occupancy at December 31, 2005 increased to 95.0% from 94.7% at September 30, 2005. Properties acquired during the fourth quarter had an average lease rate per square foot of $12.28, and occupancy of 98%. FFO per diluted share was $0.38 in the fourth quarter of 2005 compared to $0.37 in the fourth quarter of 2004. The increase was due primarily to the Company’s property acquisitions and development projects coming on-line partially offset by an increase of 37% in the weighted average diluted number of shares outstanding. Net operating income increased to $45.3 million from $36.1 million in the fourth quarter of 2004. The increase was due to $6.9 million from 2005 acquisitions, $0.2 million from the incremental impact of acquisitions made in 2004, $1.9 million from properties under development and same property income growth of $0.5 million or 2.0%. 44 FIRST CAPITAL REALTY 2005 ANNUAL REPORT O U T LO O K In 2005, First Capital Realty made significant progress in meeting or exceeding all of its stated goals and objectives. The Company grew the business and generated solid increases in funds from operations while finishing the year with a stronger balance sheet and a larger public float of common shares. For 2006, the Company’s objectives are: • to increase the size of the Company’s income-producing portfolio through acquisition and development while maintaining and enhancing asset quality; • to increase the cash flow from operations through increased rental rates and portfolio occupancy; • to continue to grow the business while maintaining a responsible and prudent leverage ratio; and • to further increase the market capitalization and public float of the Company. First Capital Realty has a focussed and clear strategy for managing and growing its business, and management believes the Company is well positioned to continue to deliver increased value to investors over the long term. Focussed acquisitions, proactive management of its assets, aggressive leasing efforts and successful development initiatives should result in increased net operating income and continued strength in the occupancy of the Company’s existing portfolio. The Company’s superior locations and well maintained properties should continue to attract and retain tenants that provide customers with daily necessities. The acquisition environment remains extremely competitive. Nevertheless, the Company will continue to acquire properties that are well located and of high quality where they add strategic value and/or operating synergies provided they will be accretive to FFO over the long term. Development and redevelopment activities will continue to provide the Company with opportunities to participate in growth markets and once completed, generate higher returns on investment. With respect to acquisitions of both income-producing and development properties, the Company will continue to focus on maintaining the sustainability and growth potential of rental income to ensure that among other things, refinancing risk is minimized. This is particularly important in the current environment with decreasing capitalization rates resulting from increasing real estate prices. Overall, management is confident that the quality of the Company’s real estate will continue to generate sustainable and growing cash flows while producing superior returns on investment over the long term. E V E N T S S U B S E Q U E N T TO D E C E M B E R 3 1 , 2 0 0 5 Acquisitions Since January 1, 2006, First Capital Realty has invested $56.3 million in the acquisition of interests in two income-producing properties totalling 160,000 square feet, both in Calgary and the purchase of additional space and land parcels at or adjacent to existing properties, adding 101,000 square feet of space at three properties and 2.3 acres of commercial land at two properties. The two income property acquisitions are detailed below. The Company acquired Richmond Square, a 102,000 square foot shopping centre located on the northeast corner of Sarcee Trail and Richmond Road in Calgary, Alberta. The centre is 45 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued anchored by an adjacent tenant-owned Canadian Tire store, as well as a 41,000 square foot Home Outfitters store and a 25,000 square foot Goodlife Fitness centre. The purchase price of approximately $19.6 million, including closing costs, was satisfied in cash. The property is situated across the street from the Company’s London Place shopping centre. The Company acquired a 58,000 square foot neighbourhood shopping centre, with a redevelopment opportunity, located on the southwest corner of Southland Drive SE and Fairmount Drive SE in Calgary, Alberta. Major tenants include a 9,000 square foot Royal Bank and a 3,000 square foot Tim Hortons. The purchase price of approximately $10.4 million, including closing costs, was satisfied by a combination of cash and the assumption of $3.9 million of debt at 6.84% fixed rate due in January 2008. Interest on Convertible Debentures On February 21, 2006 the Company announced that it will pay the interest due on March 31, 2006 to holders of both classes of its 5.50% debentures due September 30, 2017, by the issuance of common shares. The number of common shares to be issued per $1,000 principal amount of debentures will be calculated by dividing the dollar amount of interest payable by an amount equal to 97% of the volume-weighted average trading price of the common shares of First Capital Realty on the TSX calculated for the 20 consecutive trading days ending on March 24, 2006. The interest payment due is approximately $1.54 million. It is the current intention of the Company to continue to satisfy its obligations to pay principal and interest on its 5.50% debentures by the issuance of common shares. Quarterly Dividend The Company announced that it will pay a dividend of $0.30 per common share on April 6, 2006 to shareholders of record on March 29, 2006. The Board of Director’s current intention is to increase the quarterly dividend to $0.31 starting with the 2006 second quarter dividend. S U M M A R Y O F S I G N I F I CA N T AC C O U N T I N G E S T I M AT E S A N D P O L I C I E S Summary of Critical Accounting Estimates First Capital Realty’s significant accounting policies are described in Note 1 to the Consolidated Financial Statements. Management believes the policies which are most subject to estimation and management’s judgment are those outlined below. Property Acquisitions For acquisitions subsequent to September 12, 2003, in accordance with the Canadian Institute of Chartered Accountants (“CICA”) Handbook Sections 1581 and 3062, management is required to allocate the purchase price to land, building, tenant improvements, and intangibles such as the value of above-market and below-market leases, lease origination costs, tenant relationships and mortgages, if any. Management uses estimates and judgments to determine the following: • The fair value of land as of the acquisition date. • The value of the depreciated replacement cost of buildings as of the acquisition date based on prevailing construction costs for buildings of a similar class and age. • The value of the above and below market leases based on the present value of the difference between the rents payable under the terms of the in-place leases and estimated market rents. 46 FIRST CAPITAL REALTY 2005 ANNUAL REPORT • The value of deferred leasing costs, including tenant improvements, at depreciated replacement cost based on estimates of prevailing construction costs, taking into account the condition of tenants’ premises and year of improvement. • The value of lease origination costs based on estimates of the costs that would be required for the existing leases to be put in place under the same terms and conditions. These costs include leasing commissions, foregone rent and operating cost recoveries during an estimated lease-up period. • The value of the tenant relationships, if any, based on the net costs avoided if the tenants were to renew their leases at the end of the existing term, and the probability that the tenants will renew. • The fair value of debt assumed on acquisition by reference to prevailing market interest rates. Estimates of fair values and market rates used could vary and impact reported financial results. Impairment of Assets Under Canadian GAAP, management is required to write down to fair value any long-lived asset that is determined to have been permanently impaired. First Capital Realty’s long-lived assets consist of investments in income-producing properties and mortgages receivable. The fair value of investments in income-producing properties is dependent upon anticipated future cash flows from operations over the anticipated holding period. The review of anticipated cash flow involves subjective assumptions of estimated occupancy, rental rates and a residual value. In addition to reviewing anticipated cash flows, management assesses changes in business climates and other factors which may affect the ultimate value of the property. These assumptions are subjective and may not be ultimately achieved. The fair value of mortgages receivable depends upon the financial covenant of the issuer and the economic value of the underlying security. In the event these factors result in a carrying value that exceeds the sum of the undiscounted cash flows expected to result from the direct use and eventual disposition of the property, an impairment would be recognized. The estimates of future cash flows and the impact of other factors could vary, and result in a different calculation of the impairment. Amortization of Income Properties Amortization is recorded on buildings using a straight-line basis over the expected useful economic life of the building, which is typically 40 years. A significant portion of the acquisition cost of each property is allocated to the building. The allocation of the acquisition cost to the building and the determination of the useful life are based upon management’s estimates. In the event the allocation to the building is inappropriate or the estimated useful life of the building proves incorrect, the computation of amortization will not be appropriately reflected over future periods. Fair Value of Financial Instruments The Company is required to determine annually the fair value of its mortgage debt, unsecured debentures, loans, mortgages and marketable securities and its convertible debentures. In determining the fair value of the Company’s outstanding mortgages, management uses internally developed models, which incorporate estimated market rates. In determining market rates, management adds a credit spread to quoted rates on Canadian government bonds with similar maturity dates to the Company’s mortgages. The fair value of the 47 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Company’s convertible debentures is based on current trading prices. Estimates of market rates and the credit spread applicable to a specific property could vary and result in a different disclosed fair value. Summary of Changes to Significant Accounting Policies New accounting policies adopted by the Company in 2005 are as follows: Variable Interest Entities In June 2003, CICA issued Accounting Guideline 15 (“AcG15”), Consolidation of Variable Interest Entities (“VIE”), which was effective January 1, 2005. AcG15 provides guidance on identifying entities for which control is achieved through means other than voting rights, and how to determine when and which business enterprises should consolidate the VIE. The adoption of this change in accounting policy did not have a material impact on the consolidated financial statements. Convertible Debentures – Retroactive Application Effective January 1, 2005, the Company adopted the revisions to CICA 3860 (“Financial Instruments”) and applied them retroactively. This change affected the treatment of the Company’s convertible debentures which are compound instruments, in that there is a traditional debenture component, and an option of the holder to convert to equity at a pre- determined price. GAAP has required, and continues to require, that these elements be valued and recorded separately. The discussion below describes each element, and how they have been affected by the changes to GAAP. Convertible Debentures – The Debenture Element The debenture element is broken down into two component parts – the present value of the principal repayment at the end of the term, and the present value of the stream of interest payments required to be made throughout the term. The interest rate factor used in determining the present value of each payment stream is a rate which would notionally have been payable had the debenture been issued without a conversion feature. This rate is typically higher than the face rate of the convertible debenture, as investors are normally willing to accept a lower yield when given an option to convert into equity at a pre-determined price. This interest factor is determined at the time of original issue, and is not revisited or revised in later years as circumstances change. Historically, a stream of payments due under a convertible debenture was classified as debt if, and only if, it was required that the Company complete that payment in cash. If the Company had the option of fulfilling its obligation through the issuance of shares, the present value of the obligation was included in shareholders’ equity. As a result, First Capital Realty’s convertible debentures were substantially recorded as an element of shareholders’ equity, as the Company had the option of fulfilling the entire principal balance and a majority of its contractual interest obligations through the issuance of shares. The change to Section 3860 (Financial Instruments) of the CICA handbook requires that the entire present value of the payment obligations be reflected as debt on the Company’s balance sheet. This is due to the fact that the Company’s option to settle the principal amount of the convertible debentures in common shares requires a variable number of shares to be issued. Convertible Debentures – Interest Expense The recording of interest expense has historically followed the treatment and division of the debenture values; specifically, if a liability was recognized, interest would be recorded as an expense within the statement of operations, while interest on a component of shareholders’ 48 FIRST CAPITAL REALTY 2005 ANNUAL REPORT equity would be recorded as a charge directly to retained earnings. It is important to note that the interest recorded, whether as an expense or as a charge to retained earnings, was calculated using the notional interest rate applicable to non-convertible debt. The difference between the notional interest and the contractual interest is accretion and is included in interest expense and in charges to retained earnings or deficit. In First Capital Realty’s historical financial statements, only a fraction of the total interest flowed through the statement of operations. The remaining interest was charged directly to retained earnings, as required by GAAP, and was disclosed in the statement of deficit, net of tax. As a result of the change to GAAP, all interest expense is now reflected in the statement of operations, consistent with the treatment of the entire obligation as debt. Convertible Debentures – Issue Costs The costs incurred in the issue of the convertible debentures are deferred and amortized over the term of the debentures. These costs are pro-rated to each of the elements of the debenture. The recording of the amortization of each portion of the costs follows the treatment of the related interest. For issue costs related to a recorded liability, issue costs are amortized on the statement of operations. For issue costs related to the holders’ option, issue costs are not amortized. As a result of the change in GAAP, all issue cost amortization is now reflected in the statement of operations, consistent with the treatment of the entire obligation as debt. Convertible Debentures – Holders’ Option As discussed above, the debenture element of the convertible debenture was calculated as a stand-alone element. The remaining value was deemed to be the value of the option to convert to equity at a pre-determined price. This value was recorded in shareholders’ equity, and the amount does not change until the convertible debenture is converted or redeemed. The changes to GAAP do not affect the treatment of the holders’ option, and therefore the value assigned to this option continues to be recorded within shareholders’ equity. Convertible Debentures – Retroactive Impact to Financial Statements The retroactive effect on the Company’s balance sheet at December 31, 2004 and statement of operations for the year ended December 31, 2004 of the change to GAAP regarding convertible debentures is as follows: (thousands of dollars) Assets Liabilities Shareholders’ equity Increase (Decrease) $ 1,547 247,736 (246,189) The impact on the consolidated statement of operations for the year ended December 31, 2004 was as follows: (thousands of dollars) Interest and amortization expense Loss on redemption of convertible debentures Future income tax expense Net income Increase (Decrease) $ 27,353 719 (8,672) (19,400) 49 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued There is no change to earnings per share or diluted earnings per share as a result of the retroactive application of this change to GAAP. Future changes in accounting policies The CICA released section 3855, Financial Instruments – Recognition and Measurement, which standard is applicable to the Company commencing January 1, 2007. This standard provides more comprehensive guidance on how to recognize financial instruments on the balance sheet, how to measure them, and how to account for gains and losses. The Company is currently in the process of assessing the impact of this new standard on its consolidated financial statements. Disclosure Controls and Procedures The Company maintains appropriate information systems, procedures and controls to ensure that new information disclosed externally is complete, reliable and timely. The Chief Executive Officer and the Chief Financial Officer of the Company evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Multilateral Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings) as at December 31, 2005 and have concluded that such disclosure controls and procedures are operating effectively. R I S K S A N D U N C E R TA I N T I E S First Capital Realty, as an owner of income-producing properties and development land, is exposed to numerous business risks in the normal course of its business that can impact both short and long-term performance. Income-producing and development properties are affected by general economic conditions and local market conditions such as oversupply of similar properties or a reduction in tenant demand. It is the responsibility of management, under the supervision of the board of directors, to identify and, to the extent possible, mitigate or minimize the impact of all such business risks. The major categories of risk the Company encounters in conducting its business and the manner in which it takes actions to minimize their impact are outlined below. The Company’s Annual Information Form provides a more detailed discussion of these risks and can be found on SEDAR at www.sedar.com and the Company’s website www.firstcapitalrealty.ca. Operating Risk All real property investments are subject to a degree of risk. They are affected by various factors including changes in general economic conditions (such as the availability of long- term mortgage funds) and in local conditions (such as an oversupply of space or a reduction in demand for real estate in the area), the attractiveness of the properties to tenants, competition from other available space, the ability of the owner to provide adequate maintenance at an economic cost and various other factors. In addition, fluctuations in interest rates may affect the Company. The Company’s portfolio has major concentrations in Ontario, Quebec, Alberta and British Columbia. As a result, economic and real estate conditions in these regions will significantly affect the Company’s revenues and the value of its properties. The value of real property and any improvements thereto may also depend on the credit and financial stability of the tenants. The Company’s income and funds available for distributions to shareholders would be adversely affected if a significant tenant or a number of smaller tenants were to become unable or unwilling to meet their obligations to the Company or if the Company were unable to lease a significant amount of available space in its properties on economically favourable lease terms. 50 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Risk Management The following chart summarizes the top 30 tenants of the Company, which together represent 56.5% of the Company’s annualized minimum rent from its Canadian portfolio. Tenant of Stores Square Feet Leasable Area Minimum Rent Credit Rating Number Canadian Gross Annualized Organization Percent Percent of of Total Total Canadian S&P(1) Top Thirty Tenants 1 Sobeys (including Western Cellars) 2 Loblaws 3 Metro / A&P 4 Canadian Tire (incl. Mark’s Work Wearhouse) 5 Zellers 6 Shoppers Drug Mart (incl. Home Health Care) 7 Canada Safeway 8 Wal-Mart 9 TD Canada Trust 10 CIBC 11 Royal Bank 12 H. Y. Louie Group (London Drugs) 13 Save-On-Foods 14 Rogers 15 Reitmans Group 16 Scotiabank 17 Winners / HomeSense 18 Tim Hortons / Wendy’s 19 LCBO 20 Staples 21 Future Shop 22 Blockbuster 23 SAQ 24 Dollarama 25 Pharma Plus 26 Forzani Group (Sport Mart / Sport Chek) 27 Cara Operations (Swiss 36 25 23 18 15 35 8 4 23 21 16 7 4 25 32 17 4 33 10 7 5 16 14 15 9 1,326,000 1,314,000 819,000 716,000 1,406,000 432,000 326,000 474,000 112,000 98,000 104,000 181,000 181,000 101,000 147,000 84,000 150,000 93,000 90,000 163,000 140,000 80,000 50,000 124,000 65,000 8.4% 8.4% 5.2% 4.6% 8.9% 2.8% 2.1% 3.0% 0.7% 0.6% 0.7% 1.2% 1.2% 0.6% 0.9% 0.5% 1.0% 0.6% 0.6% 1.0% 0.9% 0.5% 0.3% 0.8% 0.4% 7 88,000 0.6% 8.0% 7.7% 4.4% 4.3% 4.3% 4.3% 1.9% 1.8% 1.6% 1.3% 1.1% 1.1% 1.1% 1.1% 1.0% 1.0% 0.9% 1.0% 0.9% 0.9% 0.9% 0.8% 0.7% 0.7% 0.7% 0.7% Chalet / Kelsey’s / Second Cup) 28 Toys ’R’ Us 29 Bank of Montreal 30 Michael’s Arts and Crafts Total: Top 30 Tenants (1) Standard & Poor’s 15 3 13 3 463 57,000 113,000 53,000 68,000 9,155,000 0.4% 0.7% 0.3% 0.4% 58.3% 0.7% 0.6% 0.6% 0.4% 56.5% BBB– A BBB BBB+ BB– BBB BBB– AA A+ A+ AA– BB AA– A BBB+ AA BBB BBB B– A+ B+ B– AA– BBB– 51 M A N AG E M E N T ’ S D I S C U SS I O N A N D A N A LY S I S continued Lease Maturities First Capital Realty’s lease maturities are spread on a property-by-property basis, which helps to generate a more stable cash flow and mitigate risks related to changing market conditions. Lease expirations in each of the next ten years range from 1.5% to 9.0% of the annualized minimum rent in the Company’s portfolio. The Company’s lease maturity profile at December 31, 2005 is as follows: Number Occupied Percent of Total Annualized Minimum Percent Average Annual of Total Minimum Rent Rent at Annualized per Square Foot Date of Stores Square Feet Square Feet Expiration Minimum Rent at Expiration Month-to-month 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Thereafter Total/Average 49 404 322 325 307 254 103 119 124 135 105 25 138 241,000 1,164,000 867,000 1,128,000 1,117,000 919,000 897,000 908,000 991,000 883,000 980,000 752,000 4,075,000 2,410 14,922,000 1.5% $ 3,260,000 15,162,000 7.4% 14,607,000 5.5% 16,309,000 7.2% 19,087,000 7.1% 15,485,000 5.8% 11,572,000 5.7% 15,137,000 5.8% 15,021,000 6.3% 13,122,000 5.6% 14,314,000 6.2% 8,416,000 4.8% 26.1% 51,761,000 95.0% $ 213,253,000 1.5% 7.1% 6.8% 7.6% 9.0% 7.3% 5.4% 7.1% 7.0% 6.2% 6.7% 3.9% 24.4% 100.0% $ 13.55 13.02 16.85 14.46 17.09 16.85 12.91 16.67 15.16 14.87 14.60 11.19 12.70 $ 14.29 Financing and Repayment of Indebtedness The Company has outstanding indebtedness in the form of mortgages, credit facilities, debentures and convertible debentures and, as such, is subject to the risks normally associated with debt financing, including the risk that the Company’s cash flow will be insufficient to meet required payments of principal and interest. There is a possibility that the Company’s internally generated cash may not be sufficient to repay all of its outstanding indebtedness. Upon the expiry of the term of the financing on any particular property owned by the Company, refinancing on a conventional mortgage loan basis may not be available in the amount required or may be available only on terms less favourable to the Company than the existing financing. This will be dependent upon the economic circumstances prevailing at such time. Also, a disruption in the capital markets could have an adverse impact on the Company’s ability to meet its obligations and grow its business. The Company may elect to repay certain indebtedness through refinancings or through the issuance of equity securities. The Company’s strategy of spreading the maturities of its debt is also helpful in mitigating its exposure to interest rate fluctuations. Credit Ratings Changes or anticipated changes in the credit rating assigned by DBRS to the Company’s unsecured debentures, or changes in the stability rating, may affect the Company’s access to financial markets and its cost of borrowing. Risks of Foreign Equity Investments and Borrowings The Company holds a significant equity investment in Equity One and may acquire investments in other U.S. REITs or real estate investment vehicles from time to time. The value of the 52 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Company’s investments of this nature is subject to the risks inherent in investments in equity securities, including the risk that the financial condition of the issuers of the equity securities held by the Company may become impaired or that the general condition of the stock market may deteriorate. The investee companies are also subject to risks associated with real property ownership which are similar to those described for the Company itself. Common stocks are also susceptible to general stock market fluctuations with potentially volatile increases and decreases in value as market confidence in and perceptions of their issuers change. The Company’s U.S. investment is self-sustaining and financed in part by U.S. dollar- denominated credit facilities, which are serviced by the cash flow generated by the dividends from this investment. The Company has not traditionally fully hedged its net U.S. dollar asset position. Acquisition, Expansion and Development Risk The key to the Company’s ongoing success will be its ability to create and enhance value through the skill, creativity and energy of its management team and the opportunities which the market presents. First Capital Realty will continue to seek out acquisition, expansion and selective development opportunities that offer acceptable risk-adjusted rates of return. The Company competes for suitable real property investments with individuals, corporations, real estate investment companies, trusts and other institutions (both Canadian and foreign) which may seek real property investments similar to those desired by the Company. Many of these investors may also have financial resources, which are comparable to, or greater than, those of the Company. An increase in the availability of investment funds, and an increase of interest in real property investments, increases competition for real property investments thereby increasing purchase prices and reducing the yield thereon. Further, the Company’s development commitments are subject to those risks usually attributable to construction projects, which include: (i) construction or other unforeseeable delays; (ii) cost overruns; (iii) the failure of tenants to occupy and pay rent in accordance with existing lease agreements, some of which are conditional; and (iv) increase in interest rates during the life of the development. Government Regulations and Environmental Risk The Company and its real estate investments are subject to various government legislation and regulations. Any change in such legislation or regulations adverse to the Company or its investments could affect the operating and financial performance of the Company. In addition, laws and policies relating to the protection of the environment have become increasingly important in recent years. Environmental laws and regulations can change rapidly and the Company may become subject to more stringent environmental laws and regulations in the future. Compliance with more stringent environmental laws and regulations could have a material adverse effect on the Company’s business, financial condition or results of operations. Economic Conditions The economic conditions in the markets in which the Company operates can have a significant impact on the Company’s financial success. Adverse changes in general or local economic conditions can result in some retailers being unable to sustain viable businesses and meet their lease obligations to the Company, and may also limit the Company’s ability to attract new or replacement tenants. 53 S H O P P I N G C E N T R E P O R T FO L I O Property Location Year Built or Acquired Footage Total Square Percent Occupied Anchors and Major Tenants O N TA R I O ( 5 1 ) Cedarbrae Mall Toronto 1996 479,000 93.3% Fairview Mall St. Catharines 1994 394,000 99.4% College Square (3) Ottawa 2005 388,000 100.0% Meadowvale Town Centre Mississauga 2003 382,000 94.8% Gloucester City Centre Brantford Mall Ottawa Brantford Brampton Corners Brampton Tillsonburg Town Centre (2) Tillsonburg 2003 1995 2001 1994 342,000 325,000 98.3% 86.4% 302,000 100.0% 277,000 89.9% Parkway Centre Peterborough 1996 248,000 100.0% Bridgeport Plaza Harwood Plaza Waterloo Ajax Stanley Park Mall Kitchener Queenston Place Hamilton Fairway Plaza Kitchener Sheridan Plaza Appleby Mall Ambassador Plaza University Plaza Toronto Burlington Windsor Windsor Westney Heights Plaza Ajax Bowmanville Mall Grimsby Square Shopping Centre Festival Marketplace Orleans Gardens (3) Bowmanville Grimsby Stratford Ottawa McLaughlin Corners (3) Brampton Loblaws Plaza Maple Grove Village King Liberty Village Thickson Place York Mills Gardens Ottawa Oakville Toronto Whitby Toronto Strandherd Crossing Ottawa Brooklin Towne Centre (3) Whitby Norfolk Mall Byron Village Tillsonburg London Chartwell Shopping Centre Toronto 1994 1999 1997 1995 2005 1996 2004 1994 2001 2002 2005 2005 1997 1997 2002 2005 2003 2004 1997 2004 2004 2003 2004 2002 2005 208,000 211,000 97.0% 96.7% 189,000 96.9% 171,000 98.8% 169,000 98.5% 168,000 165,000 153,000 150,000 100.0% 95.2% 97.3% 96.8% 147,000 98.5% 99,000 127,000 126,000 111,000 72.1% 100.0% 100.0% 78.9% 110,000 100.0% 106,000 100,000 99,000 93,000 90,000 100.0% 98.7% 96.0% 100.0% 98.5% 90,000 98.2% 90,000 100.0% 88,000 89,000 87.8% 99.1% 85,000 95.9% Credit Valley Town Plaza Mississauga 2003 84,000 100.0% Dufferin Corners (4) Midland Lawrence Plaza Toronto Toronto Eagleson Place Delta Centre Ottawa Cambridge 2003 2002 1997 1998 76,000 76,000 76,000 71,000 84.8% 94.5% 90.2% 97.6% Loblaws, Zellers, Canadian Tire, Toys ’R’ Us, LCBO, Scotiabank, CIBC, Bally Total Fitness, Dollarama Food Basics (A&P), Zehrs (1) (Loblaws), Zellers, Cineplex, Chapters, Office Depot, Future Shop, Mark’s Work Wearhouse, LCBO, CIBC, Scotiabank, Sport Chek Loblaws, Home Depot, Pharma Plus, Rogers, Reitmans, LCBO, Bank of Montreal, Beer Store Dominion (A&P), Canadian Tire, Shoppers Drug Mart, LCBO, TD Canada Trust, CIBC, Bank of Montreal Loblaws, Zellers, Pharma Plus, Scotiabank, CIBC Zehrs (Loblaws), Wal-Mart, Cineplex, LCBO, CIBC, Reitmans Fortino’s (Loblaws), Wal-Mart, Chapters, National Bank, Scotiabank, Kelsey’s Zellers, Canadian Tire, Business Depot (Staples), Shoppers Drug Mart, LCBO, CIBC, TD Canada Trust Price Chopper (Sobeys), Zellers, Winners, Reitmans, Sport Mart Sobeys, Zellers, Rogers Video Food Basics (A&P), Shoppers Drug Mart, Scotiabank, Blockbuster Zehrs (Loblaws), Zellers, Pharma Plus, LCBO, TD Canada Trust Zellers, Mark’s Work Wearhouse, Penningtons (Reitmans), Aaron’s Electronics Food Basics (A&P), Winners/HomeSense, Sport Chek, Pier 1 Imports, Dollarama Food Basics (A&P), Zellers Fortino’s (Loblaws), Pharma Plus, LCBO, Bank of Montreal Zellers, LCBO, CIBC, Scotiabank, Royal Bank A&P, Canadian Tire, Shoppers Drug Mart, Bank of Montreal Sobeys, Shoppers Drug Mart, CIBC, Scotiabank, TD Canada Trust A&P, Shoppers Drug Mart, Dollarama Sobeys, Canadian Tire, Shoppers Drug Mart, Royal Bank, Mark’s Work Wearhouse, Beer Store Sears (1), Canadian Tire (1) Your Independent Grocer (Loblaws), CIBC, Scotiabank, Rogers Video A&P, Shoppers Drug Mart, Royal Bank, Rogers Video, Pizza Hut Loblaws, Fabricland Sobeys, Pharma Plus, CIBC, Rogers Video A&P, TD Canada Trust, Blockbuster, Toronto Economic Development Corp A&P, Toys ’R’ Us (1), CIBC, TD Canada Trust Longo’s Supermarket, Shoppers Drug Mart, TD Canada Trust, Rogers Video Loeb (Metro), Shoppers Drug Mart, Royal Bank, TD Canada Trust, Rogers Video Price Chopper (Sobeys), Shoppers Drug Mart, Scotiabank Zehrs (Loblaws) (1), Wal-Mart A&P, Pharma Plus, LCBO, TD Canada Trust, Rogers Video Price Chopper (Sobeys), Shoppers Drug Mart, CIBC, Bank of Montreal Loblaws, Pharma Plus, CIBC, TD Canada Trust, Rogers Video Shoppers Drug Mart, TD Canada Trust Price Chopper (Sobeys), Part Source (Canadian Tire), Tormedco Loblaws, Rogers Video Price Chopper (Sobeys), Dollarama, Shoppers Home Health Care 54 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Year Built or Acquired Footage Total Square Percent Occupied Anchors and Major Tenants 2001 1999 2000 2004 1999 2003 2005 2003 2003 2005 2004 2003 70,000 68,000 89.0% 97.1% 65,000 95.7% 53,000 52,000 50,000 46,000 46,000 37,000 19,000 15,000 — 7,275,000 63.1% 100.0% 94.0% 100.0% 97.2% 100.0% 100.0% 100.0% 100.0% 95.7% Sobeys, Government of Canada Price Chopper (Sobeys), Shoppers Drug Mart, Montana’s Price Chopper (Sobeys), Shoppers Drug Mart, Blockbuster Dominion (A&P) Sobeys, Pharma Plus, Royal Bank, Rogers Video Sleep Country No Frills (Loblaws), Pharma Plus Food Basics (A&P), Bank of Montreal Business Depot (Staples), Mark’s Work Wearhouse Shoppers Drug Mart, Wendy’s Shoppers Drug Mart Loblaws Property Towerhill Centre Wellington Corners Location Peterborough London Pickering Toronto Waterloo Newmarket Burlington Markham Toronto London Waterloo Ottawa Steeple Hill Shopping Centre Merchandise Building Northfield Centre (9) Yonge-Davis Centre Burlingwood Shopping Centre Bayview Lane Plaza 3434 Lawrence Adelaide Shoppers Shoppers Waterloo Eagleson Cope Drive Sub-Total – Ontario Q U E B E C ( 4 5 ) Les Galeries de Lanaudière (3) Centre Domaine Centre commercial Côte St. Luc Plaza Delson Montréal Montréal Delson Carrefour St. Hubert Longueuil La Porte de Gatineau Gatineau Montréal Lévis Québec City Châteauguay Montréal Place Viau Promenades Lévis Carrefour Soumande La Porte de Châteauguay Centre commercial Wilderton Centre commercial Beaconsfield Centre Maxi Trois Rivières Lachenaie 2002 269,000 100.0% Galeries Normandie Montréal 2002 223,000 99.5% 2002 2002 2002 2002 1994 2002 2004 2004 1995 2002 195,000 182,000 98.6% 94.0% 173,000 100.0% 160,000 55.0% 155,000 98.4% 152,000 141,000 140,000 132,000 127,000 100.0% 80.3% 87.1% 100.0% 94.7% Montréal 2002 128,000 87.0% Trois Rivières 2003 122,000 99.3% Les Galeries de Repentigny Repentigny Place Pointe-aux-Trembles Montréal Montréal Centre commercial Maisonneuve (2) Place Fleury Les Promenades du Parc Montréal Longueuil Plaza Don Quichotte Hooper Building Place Pierre Boucher Île Perrot Sherbrooke Longueuil Centre commercial Van Horne Carrefour du Versant Place des Cormiers Place Vilamont Carrefour Don Quichotte Plaza Laval Élysée Place Nelligan (4) Place Michelet Galeries Brien Place Cité Des Jeunes Galeries des Chesnaye Montréal Gatineau Sept-Îles Laval Île Perrot Laval Gatineau Montréal Repentigny Gatineau Lachenaie 1997 2002 2003 2002 1997 2004 2005 2004 2002 2003 2004 2002 2004 2004 2002 2005 2002 2001 2005 120,000 119,000 114,000 110,000 105,000 99,000 93,000 89,000 98.9% 94.2% 93.0% 100.0% 94.3% 97.2% 86.1% 76.6% 80,000 97.4% 80,000 97.3% 75,000 72,000 72,000 63,000 59,000 59,000 59,000 58,000 57,000 94.6% 98.2% 93.5% 100.0% 94.2% 97.3% 98.0% 97.6% 94.5% Staples, Winners, Future Shop, Sears Home, Home Depot (1), Pier 1 Imports, Dollar Max, Old Navy, Reitmans, Kelsey’s, TD Canada Trust IGA (Sobeys), Provigo (Loblaws), Pharmaprix, Rossy, Royal Bank, Bank of Montreal, SAQ, Baron Sports, Dollarama Metro (3), Zellers, Rossy, CIBC, Dollarama, Uniprix IGA (Sobeys), Jean Coutu, SAQ, Royal Bank, Blockbuster, World Gym, Dollarama Loblaws, Jean Coutu, Cineplex, SAQ, National Bank, Rogers Video Provigo (Loblaws), Jean Coutu, CIBC, SAQ, Dollarama Maxi (Loblaws), Toys ’R’ Us (1), Future Shop, CIBC, TD Canada Trust, SAQ Maxi (Loblaws), Zellers Metro, Bank of Montreal Toys ’R’ Us, Fruiterie 440 Zellers, Blockbuster Metro, Pharmaprix (Shoppers Drug Mart), SAQ, Royal Bank, Laurentian Bank, Femme Fitness, Dollarama Metro, Pharmaprix (Shoppers Drug Mart), SAQ, Royal Bank, Dollarama Maxi (Loblaws), Value Village, Jean Coutu, Bank of Montreal, Blockbuster Super C (Metro), Pharmaprix (Shoppers Drug Mart) Metro, Rossy, Jean Coutu Provigo (Loblaws), Canadian Tire, TD Canada Trust, SAQ, Brunet, Rogers Video Metro, Pharmaprix (Shoppers Drug Mart), SAQ IGA (Sobeys), Pharmaprix (Shoppers Drug Mart), Laurentian Bank, Blockbuster, National Bank IGA (Sobeys), SAQ, Caisse Populaire Desjardins IGA Extra (Sobeys), Familiprix Maxi (Loblaws), Pharmaprix (Shoppers Drug Mart), SAQ IGA (Sobeys), Pharmaprix (Shoppers Drug Mart), Royal Bank, Scotiabank IGA (Sobeys), Dollarama, Familiprix, TD Canada Trust, SAQ Provigo (Loblaws), Bureau en Gros (Staples), SAQ Provigo (Loblaws), Jean Coutu, Laurentian Bank Metro, Pharmacie Essaim, CIBC Provigo (Loblaws), Pharmaprix (Shoppers Drug Mart), Laurentian Bank IGA (Sobeys), Citifinancial IGA Extra (Sobeys), TD Canada Trust IGA (Sobeys), Uniprix Metro, Uniprix IGA (Sobeys), Uniprix, SAQ 55 Year Built or Acquired Footage Total Square Percent Occupied Anchors and Major Tenants S H O P P I N G C E N T R E P O R T FO L I O continued Property Le Campanîle Location Montréal Québec City Chicoutimi Place Seigneuriale Place de la Colline Toys ’R’ Us / Pier 1 Imports Montréal Carrefour des Forges Place Provencher Place Roland Therrien Place du Commerce IGA Tremblant Village des Valeurs Place Bordeaux (5) Verdun Shoppers Sub-Total – Québec Drummondville Montréal Longueuil Montréal Mont-Tremblant Laval Gatineau Montréal A L B E R TA ( 1 8 ) Northgate Centre Edmonton South Park Centre Edmonton 2003 2004 2004 2002 2005 2004 2000 2004 2004 2002 2002 2005 1997 1996 58,000 97.1% 54,000 52,000 52,000 50,000 46,000 42,000 40,000 38,000 27,000 28,000 19,000 4,388,000 97.1% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 85.0% 87.4% 94.2% 511,000 82.1% 377,000 96.4% Royal Oak (6) Calgary 2003 336,000 99.4% Towerlane Mall Airdrie Red Deer Village Red Deer Sherwood Towne Square The Village Market McKenzie Towne Centre Gateway Village Tuscany Market West Lethbridge Towne Centre Old Strathcona (3) Sherwood Centre London Place West Lakeview Plaza Uplands Common Sherwood Park Sherwood Park Calgary St. Albert Calgary Lethbridge Edmonton Sherwood Park Calgary Calgary North Lethbridge Kingsland Shopping Centre Calgary Eastview Shopping Centre Sub-Total – Alberta Red Deer 2005 1999 1997 1997 2003 1994 2003 1998 2003 1997 1998 2005 2005 2005 2004 207,000 93.4% 208,000 96.2% 120,000 100.0% 116,000 97.9% 115,000 107,000 86,000 83,000 79,000 76,000 71,000 64,000 53,000 45,000 34,000 2,688,000 99.3% 96.0% 100.0% 95.9% 98.5% 94.9% 100.0% 94.1% 98.0% 90.3% 100.0% 93.9% BRITISH COLUMBIA (11) West Oaks Mall (3) Abbotsford 2004 271,000 99.3% Scott 72 Centre Langley Mall Delta Langley Langley Langley Crossing Shopping Centre Vancouver Harbour Front Centre Pemberton Plaza Vancouver Terra Nova Shopping Centre Richmond Coronation Mall Duncan 1331 Main St. Vancouver Broadmoor Shopping Centre Richmond Vancouver Time Marketplace Sub-Total – British Columbia 2004 2005 2005 2005 2005 2005 2005 2005 2005 2004 163,000 90.7% 132,000 97.0% 129,000 97.8% 127,000 86,000 73,000 100.0% 94.9% 96.6% 58,000 100.0% 55,000 43,000 37,000 100.0% 77.6% 100.0% 1,174,000 96.6% 56 Pharmaprix (Shoppers Drug Mart), Bank of Montreal Metro, Royal Bank, Nautilus Plus Maxi (Loblaws), Uniprix Toys ’R’ Us, Pier 1 Imports IGA (Sobeys) Bureau en Gros (Staples), Uniprix Super C (Metro) (1), Scotiabank, Blockbuster IGA (Sobeys), Jean Coutu IGA (Sobeys) Value Village Pharmaprix (Shoppers Drug Mart), Marche Frais Pharmaprix (Shoppers Drug Mart) Safeway, Zellers, Future Shop, Royal Bank, Sport Mart Canadian Tire, Zellers, Toys ’R’ Us (1), Office Depot (Safeway), Linens ’n Things, Laura’s Shoppes, Sport Chek Sobeys, Wal-Mart, London Drugs, Royal Bank, Blockbuster, Royal Oak Clinic, Reitmans, Petcetera, Home Outfitters Safeway, Saan Store, Super Drug Mart, TD Canada Trust, Blockbuster Sobeys, Shoppers Drug Mart, Canadian Tire, Mark’s Work Wearhouse, Sportmart, TD Canada Trust, Rogers Video, Reitmans Home Depot (1), Mark’s Work Wearhouse, Staples, HomeSense, Royal Bank, Michael’s Safeway, London Drugs, Scotiabank Sobeys, Super Drug Mart, Blockbuster Safeway, CIBC, Royal Bank, Scotiabank Sobeys, Super Drug Mart, Scotiabank Safeway, Home Hardware, Blockbuster Canada Post, Edward D. Jones Save-On-Foods (1), CIBC, Rogers Video London Drugs, Bank of Montreal, Rogers Video IGA (Sobeys), Super Drug Mart, Scotiabank Sobeys Shoppers Drug Mart, Starbucks IGA (Sobeys), Bank of Montreal, 7-Eleven Save-On-Foods, Linens ’n Things, London Drugs, Future Shop, Michael’s, Reitmans, CIBC, Pier 1 Imports, Sport Mart London Drugs, Staples, TD Canada Trust, Van City Savings, Starbucks IGA Marketplace (H. Y. Louie Group), Army & Navy, TD Canada Trust Rona, BDO Financial Services, Citifinancial Canadian Tire, Michael’s, Van City Savings, Kelsey’s Save-On-Foods, Van City Savings, Starbucks Save-On-Foods, Royal Bank, Coast Capital Savings, Pizza Hut, Starbucks Save-On-Foods, TD Canada Trust, Blockbuster, BC Liquor Store Innovation Giftware Royal Bank, Coast Capital Savings IGA Marketplace (H. Y. Louie Group), Shoppers Drug Mart FIRST CAPITAL REALTY 2005 ANNUAL REPORT Property Location Year Built or Acquired Footage Total Square Percent Occupied Anchors and Major Tenants OT H E R S ( 4 ) Regent Park Shopping Centre Cole Harbour Shopping Centre Ropewalk Lane Registan Shopping Centre Sub-Total – Others TOTAL (1) Tenant (or other) owned. (2) Interest is leasehold. Regina, SK 1999 67,000 86.5% Safeway, Scotiabank Dartmouth, NS 1997 54,000 93.3% Sobeys (1), Canadian Tire (1), Shoppers Drug Mart, TD Canada Trust St. John’s, NF Regina, SK 1997 1999 40,000 26,000 187,000 15,712,000 73.8% 100.0% 90.2% 95.0% Safeway, Scotiabank (3) 50% interest owned, directly or indirectly, by the Company. (4) 75% interest owned, directly or indirectly, by the Company. (5) 80% interest owned, directly or indirectly, by the Company. (6) 60% interest owned, directly or indirectly, by the Company. 57 M A N AG E M E N T ’ S R E S P O N S I B I L I T Y The accompanying consolidated financial statements are the responsibility of management and have been prepared in accordance with Canadian generally accepted accounting principles. The preparation of financial statements necessarily involves the use of estimates based on management’s judgment, particularly when transactions affecting the current accounting period cannot be finalized with certainty until future periods. The consolidated financial statements have been properly prepared within reasonable limits of materiality and in light of information available up to March 8, 2006. Management is also responsible for the maintenance of financial and operating systems, which include effective controls to provide reasonable assurance that the Company’s assets are safeguarded and that reliable financial information is produced. The Board of Directors is responsible for ensuring that management fulfills its responsibilities through its Audit Committee whose members are not involved in day-to-day operations of the Company. Each quarter the Audit Committee meets with management and, as necessary, with the independent auditors, Deloitte & Touche LLP, to satisfy itself that management’s responsibilities are properly discharged and to review and report to the Board on the consolidated financial statements. In accordance with generally accepted auditing standards, the independent auditors conduct an examination each year in order to express a professional opinion on the consolidated financial statements. Dori J. Segal President and Chief Executive Officer A U D I TO R S ’ R E P O R T Karen H. Weaver, CPA Chief Financial Officer To the Shareholders of First Capital Realty Inc. We have audited the consolidated balance sheets of First Capital Realty Inc. as at December 31, 2005 and 2004 and the consolidated statements of operations, deficit and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2005 and 2004 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Toronto, Ontario March 8, 2006 Chartered Accountants 58 FIRST CAPITAL REALTY 2005 ANNUAL REPORT C O N S O L I DAT E D B A L A N C E S H E E T S December 31 (thousands of dollars) A S S E T S Real Estate Investments Shopping centres (note 3) Land and shopping centres under development (note 4) Deferred costs (note 5) Intangible assets (note 6) Investment in Equity One, Inc. (note 7) Loans, mortgages and other real estate assets (note 8) Other assets (note 9) Amounts receivable (note 10) Cash and cash equivalents Future income tax assets (note 18) L I A B I L I T I E S Mortgages and credit facilities (note 11) Accounts payable and other liabilities (note 12) Unsecured debentures (note 13) Convertible debentures payable (note 14) Future income tax liabilities (note 18) S H A R E H O L D E R S ’ E Q U I T Y (note 15) See accompanying notes to the consolidated financial statements Approved by the Board of Directors: 2005 2004 (Restated – note 2) $ 1,939,775 136,475 52,938 24,340 2,153,528 211,830 26,912 2,392,270 37,592 17,026 5,335 17,065 $ 2,469,288 $ 1,297,040 102,116 100,000 96,990 30,598 1,626,744 842,544 $ 2,469,288 $ 1,489,250 74,957 31,884 13,508 1,609,599 203,988 18,130 1,831,717 26,033 14,276 4,883 16,688 $ 1,893,597 $ 1,002,965 72,048 — 247,736 22,355 1,345,104 548,493 $ 1,893,597 Chaim Katzman Director Dori J. Segal Director 59 C O N S O L I DAT E D S TAT E M E N T S O F O P E R AT I O N S Years ended December 31 (thousands of dollars, except per share amounts) 2005 2004 R E V E N U E Property rental revenue Interest and other income E X P E N S E S Property operating costs Interest expense (note 16) Amortization (note 17) Corporate expenses Equity income from Equity One, Inc. (note 7) Gain on disposition of real estate Dilution gain on investment in Equity One, Inc Gain (loss) on redemption of convertible debentures (note 14) Income before income and other taxes Income and other taxes (note 18): Current Future Net income Net earnings per common share (note 19) Basic Diluted See accompanying notes to the consolidated financial statements (Restated – note 2) $ 264,840 3,802 268,642 $ 215,022 6,480 221,502 99,791 80,332 50,321 14,372 244,816 17,475 — — 1,018 42,319 4,067 9,056 13,123 29,196 0.72 0.50 $ $ $ 82,204 80,258 38,056 11,639 212,157 18,228 1,163 3,201 (934) 31,003 4,806 8,310 13,116 17,887 0.46 0.45 $ $ $ 60 C O N S O L I DAT E D S TAT E M E N T S O F D E F I C I T FIRST CAPITAL REALTY 2005 ANNUAL REPORT Years ended December 31 (thousands of dollars) Deficit, beginning of year Net income for the year Dividends Deficit, end of year See accompanying notes to the consolidated financial statements 2005 2004 $ (133,163) 29,196 (87,617) $ (191,584) $ (Restated – note 2) (96,279) 17,887 (54,771) $ (133,163) 61 C O N S O L I DAT E D S TAT E M E N T S O F CA S H F LOW S Years ended December 31 (thousands of dollars) CA S H F LOW P R OV I D E D B Y ( U S E D I N ) : O P E R AT I N G ACT I V I T I E S Net income Items not affecting cash Amortization Amortization of deferred financing fees Amortization of above- and below-market leases Amortization of deferred rent receivable Gain on disposition of real estate and investments (Gain) loss on redemption of convertible debentures Non-cash compensation expense Convertible debenture interest in excess of coupon Convertible debenture interest paid in common shares Equity income from Equity One, Inc. Dilution gain on investment in Equity One, Inc. Future income taxes Deferred leasing costs Dividends received from Equity One, Inc. Net change in non-cash operating items Cash provided by operating activities I N V E S T I N G ACT I V I T I E S Acquisition of shopping centres (note 3) Acquisition of land for development (note 4) Proceeds on disposition of real estate Expenditures on shopping centres Expenditures on land and shopping centres under development Investment in common shares of Equity One, Inc. Repayment of loans and mortgage receivable Investment in marketable securities Proceeds on disposition of marketable securities Cash used in investing activities F I N A N C I N G ACT I V I T I E S Proceeds of mortgage financings and credit facilities Repayments of mortgages payable and credit facilities Payment of financing fees Issuance of common shares, net of issue costs Repayment or redemption of debentures Issuance of unsecured debentures, net of issue costs Issuance of convertible debentures, net of issue costs Payment of dividends Cash provided by financing activities Effect of currency rate movement on cash balances Increase in cash and cash equivalents Cash and cash equivalents, beginning of the year Cash and cash equivalents, end of the year S U P P L E M E N TA R Y I N FO R M AT I O N Cash income taxes paid Cash interest paid (note 16) See accompanying notes to the consolidated financial statements 2005 2004 (Restated – note 2) $ 29,196 $ 17,887 48,225 2,096 (1,130) (3,677) — (1,018) 1,581 1,438 10,465 (17,475) — 9,056 (7,621) 18,221 5,293 94,650 (309,308) (52,161) — (27,050) (62,843) (15,882) 3,065 (30,509) 19,056 (475,632) 441,443 (260,364) (3,493) 61,842 — 95,365 98,912 (52,363) 381,342 92 452 4,883 5,335 4,495 75,935 $ $ $ 35,332 2,724 (289) (3,559) (1,163) 934 960 3,953 19,137 (18,228) (3,201) 8,310 (3,491) 18,671 (3,168) 74,809 (171,451) (24,399) 8,523 (34,718) (52,502) (5,381) 1,286 (8,580) 8,758 (278,464) 169,086 (35,059) (2,250) 159,938 (35,134) — — (48,749) 207,832 627 4,804 79 4,883 4,110 63,924 $ $ $ 62 FIRST CAPITAL REALTY 2005 ANNUAL REPORT N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S December 31, 2005 and 2004 (thousands of dollars, except per share amounts and as otherwise noted) 1 . S I G N I F I CA N T AC C O U N T I N G P O L I C I E S First Capital Realty Inc. (the “Company”) was incorporated under the laws of Ontario to engage in the business of acquiring, developing, redeveloping, owning and operating neighbourhood and community shopping centres. The Company’s accounting policies and its standards of financial disclosure are in accordance with Canadian generally accepted accounting principles. The Company’s significant accounting policies are as follows: (a) Principles of Consolidation The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, trusts, and the Company’s proportionate share of assets, liabilities, revenues and expenses of partnership, co-ownership and limited liability corporate ventures, which are accounted for using the proportionate consolidation method. The Company’s investment in Equity One, Inc. is accounted for on the equity basis. (b) Shopping Centres Shopping centres are stated at cost less accumulated amortization. The purchase price of shopping centre properties is allocated to land, building, deferred leasing costs, and intangibles including lease origination costs associated with in-place leases, the value of above- and below-market leases, and the value of tenant relationships, if any. Allocations of the purchase price are generally based on the following criteria: Land is recorded at its estimated fair value. Buildings are recorded at depreciated replacement cost based on estimates of prevailing construction costs for buildings of a similar class and age. Deferred leasing costs, including tenant improvements, are recorded at depreciated replacement cost based on estimates of prevailing construction costs, taking into account the condition of tenants’ premises and year of improvement. Lease origination costs are determined based on estimates of the costs that would be required for the existing leases to be put in place under the same terms and conditions. These costs include leasing commissions, foregone rent and operating cost recoveries during an estimated lease-up period. Values ascribed to above- and below-market in-place leases are determined based on the present value of the difference between the rents payable under the terms of the in-place leases and estimated market rents. Tenant relationship values are determined based on the net costs avoided if the tenants were to renew their leases at the end of the existing term, adjusted for the estimated probability that the tenants will renew. Any differences between the estimated fair values of the acquired assets and assumed liabilities and the cost of the acquired property is allocated on a pro rata basis to all of the acquired assets and assumed liabilities. (c) Land and Shopping Centres Under Development Land and shopping centres under development are stated at cost. If it is determined that the carrying amount of a property exceeds the undiscounted estimated future net cash flows 63 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued expected to be received from the ongoing use and residual worth of the completed property, after taking into account estimated costs to complete the development, it is reduced to its estimated fair value. Cost includes all expenditures incurred in connection with the acquisition, development, redevelopment and initial leasing of the properties. These expenditures include acquisition costs, construction costs, initial leasing costs, other direct costs, building improvement costs and carrying costs. Carrying costs (including property taxes and interest on both specific and general debt, net of operating results) are capitalized to the cost of the properties until the accounting completion date (which is based on achieving a satisfactory occupancy level within a pre-determined time limit). Upon completion, the properties are classified as shopping centres. (d) Deferred Costs Deferred costs include tenant inducements and leasing costs incurred through leasing activities and deferred costs related to shopping centre acquisitions. (e) Intangible Assets and Liabilities Intangible assets and liabilities include lease origination costs associated with in-place leases, the value of the above- and below-market leases, and the value of customer relationships, allocated to existing tenants in acquired shopping centres. (f) Impairment of Long-Lived Assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined that the net recoverable amount of a long-lived asset is less than its carrying value, the long-lived asset is written down to its fair value. Net recoverable amount represents the undiscounted estimated future cash flow expected to be received from the long-lived asset. Assets reviewed for impairment under this policy include shopping centres, land and shopping centres under development, intangible assets, and furniture, fixtures and equipment. (g) Furniture, Fixtures and Equipment Furniture, fixtures and equipment are recorded at cost. (h) Marketable Securities Marketable securities are stated at the lower of cost and quoted market value. (i) Property Rental Revenue Property rental revenue includes rents earned from tenants under lease agreements, including percentage participation rents, property tax and operating cost recoveries, and incidental income, including lease cancellation payments. Property rental revenue also includes the amortization of above- and below-market leases allocated on asset acquisitions. The Company uses the straight-line method of recognizing rental revenue whereby the total amount of rental revenue to be received from leases is accounted for on a straight-line basis over the term of the lease. Accordingly, a deferred rent receivable is recorded from the tenants for the current difference between the straight-line rent recorded as rental revenue and the rent that is contractually due from the tenants. 64 FIRST CAPITAL REALTY 2005 ANNUAL REPORT (j) Amortization Buildings and improvements are amortized on a straight-line basis, so as to fully amortize the properties over their estimated useful lives, which vary but do not exceed 40 years. Deferred costs, including leasing fees and tenant inducements incurred on securing leases, other than initial leases on shopping centres under development, are amortized over the term of such leases on a straight-line basis. Lease origination costs and above and below-market leases associated with in-place leases are amortized over the remaining life of the associated leases. The value of tenant relationships is amortized over the expected term of the relationship. In the event a tenant vacates its leased space prior to the contractual termination of the lease, and no rental payments are being made on the lease, any unamortized balance relating to that lease will be expensed immediately. Commitment fees and other costs incurred in connection with debt financing are amortized over the term of such financing on a straight-line basis. Furniture, fixtures and equipment are amortized on a straight-line basis over estimated useful lives ranging from three to ten years. (k) Cash and Cash Equivalents Cash and cash equivalents are comprised of cash and short-term deposits with original maturities of three months or less. (l) Foreign Currency The Company carries on business in the United States through operationally and financially self-sustaining entities. Assets and liabilities denominated in United States dollars are translated into Canadian dollars at year-end exchange rates. The resulting net gains or losses are accumulated as a separate component of shareholders’ equity. Revenues and expenses denominated in United States dollars are translated at the weighted average daily exchange rate for the periods being reported on. (m) Derivative Financial Instruments Derivative financial instruments are utilized by the Company in the management of its foreign currency and interest rate exposures. Realized and unrealized gains and losses on derivative financial instruments designated as hedges of financial risks are included in income in the same period as when the underlying asset, liability or anticipated transaction affects income. The Company documents its eligibility for hedge accounting and assesses the effectiveness of these relationships based on the degree of expected future offsetting cash flows. Gains or losses on forward exchange contracts, which represent designated hedges of a portion of the net investment in the United States self-sustaining operations, are recorded in the cumulative translation account in shareholders’ equity. Derivative financial instruments that are not designated as hedges are carried at estimated fair values, and gains and losses arising from changes in fair values are recognized in income in the period the changes occur. The Company does not utilize derivative financial instruments for trading or speculative purposes. 65 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued (n) Convertible Debentures The Company presents its convertible debentures in their liability and equity component parts where applicable, as follows: (i) The liability component represents the present value of interest and principal obligations to be satisfied by cash or common shares of the Company, where a variable number of common shares is required to settle the obligation, discounted at the rate of interest that would have been applicable to a debt-only instrument of comparable term and risk at the date of issue. As a result, the interest payments are treated as a reduction of the liability component and interest expense, calculated on the discount rate is recorded as an increase in the liability component. On January 1, 2005, the Company changed its accounting policy for convertible debentures in accordance with recommendations of the Canadian Institute of Chartered Accountants (“CICA”). Previously, only the present value of interest and principal obligations that were required to be settled in cash were presented as liabilities. This change was applied retroactively with restatement of prior periods, and is described in note 2. (ii) The equity component of the convertible debentures is included in Shareholders’ Equity in the consolidated balance sheets. The equity component consists of the value ascribed to the conversion right granted to the holder, which remains a fixed amount over the term of the debentures. Prior to the change in accounting policy, the equity component also included the present value of obligations that could be settled in common shares at the Company’s option. (o) Income Taxes Income taxes are accounted for using the liability method. Under this method, future income taxes are recognized for the expected future tax consequences of differences between the carrying amount of balance sheet items and their corresponding tax values. Future income taxes are computed using substantively enacted corporate income tax rates for the years in which the differences are expected to reverse. (p) Stock-Based Compensation Plans The Company has stock-based compensation plans as described in note 15(d) and (e). The Company recognizes compensation expense for stock-based compensation awards at the fair value as at the granting date over the vesting period. (q) Use of Estimates The preparation of the Company’s financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the balance sheet date and the reported amounts of revenue and expenses during the reporting year. Actual results could differ from such estimates. Significant estimates are required in the allocation of the purchase prices of shopping centre acquisitions, determining future cash flows when assessing assets for impairment, determining the useful lives of assets for amortization purposes, and determining fair values of financial instruments. 66 FIRST CAPITAL REALTY 2005 ANNUAL REPORT 2 . C H A N G E S I N AC C O U N T I N G P O L I C I E S (i) Convertible Debentures Effective January 1, 2005, the Company adopted the Canadian Institute of Chartered Accountants’ (“CICA”) new accounting requirements on the classification of financial instruments as liabilities or equity. The CICA amended its requirements surrounding the presentation of financial instruments that may be settled, at the issuer’s discretion, in cash or with a variable number of the issuer’s own equity instruments, as liabilities. As a result of these new standards, a portion of convertible debentures previously presented as equity on the Company’s balance sheet has been reclassified as a liability. Correspondingly, interest expense and related amortization of issue costs recognized on the convertible debentures are presented on the consolidated statements of operations as opposed to the previous presentation on the consolidated statements of deficit. The value ascribed to the conversion rights of the holders remain in shareholders’ equity. These presentation changes had no impact on the Company’s earnings per share. The changes have been applied retroactively with restatement of prior periods and had the following impact on the Company’s consolidated balance sheet at December 31, 2004: (thousands of dollars) Assets Liabilities Shareholders’ equity Increase (Decrease) $ 1,547 247,736 (246,189) The impact on the consolidated statement of operations for the year ended December 31, 2004 was as follows: (thousands of dollars) Interest and amortization expense Gain/loss on redemption of convertible debentures Future income tax expense Net income Increase (Decrease) $ 27,353 719 (8,672) (19,400) (ii) Variable Interest Entities In June 2003, the CICA issued Accounting Guideline 15 (AcG15), Consolidation of Variable Interest Entities (“VIE”), which was effective January 1, 2005. AcG15 provides guidance on identifying entities for which control is achieved through means other than voting rights, and how to determine when and which business enterprises should consolidate the VIE. The adoption of this change in accounting policy did not have a material impact on the consolidated financial statements. 3 . S H O P P I N G C E N T R E S (thousands of dollars) Land Buildings and improvements Accumulated amortization 2005 2004 $ 443,440 1,598,619 2,042,059 (102,284) $ 1,939,775 $ 312,921 1,241,895 1,554,816 (65,566) $ 1,489,250 67 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued The Company acquired properties as follows: (thousands of dollars) 2005 2004 Allocation of purchase prices: Shopping centres Shopping centres under development Deferred costs Intangible assets and liabilities Total purchase price, including acquisition costs Less mortgages assumed on acquisition Difference between principal amount and fair value of assumed mortgages Net cash outlay for acquisitions The acquisitions were funded as follows: Proceeds from new mortgages Cash and credit facilities Net cash outlay for acquisitions $ 400,474 6,410 12,794 3,587 423,265 (109,324) (4,633) $ 309,308 $ 56,144 253,164 $ 309,308 $ $ $ $ 248,975 — 9,031 8,066 266,072 (90,321) (4,300) 171,451 35,111 136,340 171,451 4 . L A N D A N D S H O P P I N G C E N T R E S U N D E R D E V E LO P M E N T During the years ended December 31, 2005 and 2004, the Company acquired land and shopping centres under development as follows: (thousands of dollars) 2005 2004 Purchase price of land and shopping centres acquired for development or redevelopment Less mortgages assumed Net cash outlay for acquisitions $ $ 61,114 (8,953) 52,161 $ $ 26,759 (2,360) 24,399 In addition, during the year ended December 31, 2005, completed developments with a book value of $68.9 million (2004 – $67.1 million) were transferred to shopping centres. Interest expense and incremental direct internal costs capitalized to development properties during the year ended December 31, 2005 totalled $5.8 million (2004 – $4.5 million) and $2.1 million (2004 – $0.9 million), respectively. The costs to complete projects currently under development are estimated at $72.0 million. 5 . D E F E R R E D C O S T S (thousands of dollars) 2005 2004 Deferred leasing costs and tenant improvements incurred through leasing activities $ 43,141 $ 28,834 Deferred leasing costs recorded on acquisition of shopping centres Accumulated amortization 24,364 67,505 (14,567) 52,938 $ $ 11,471 40,305 (8,421) 31,884 Incremental direct internal costs related to leasing activities totalling $2.8 million were capitalized in the year ended December 31, 2005 (2004 — not applicable). 68 FIRST CAPITAL REALTY 2005 ANNUAL REPORT 6 . I N TA N G I B L E A S S E T S (thousands of dollars) 2005 2004 Lease origination costs Above-market in-place leases Tenant relationships Accumulated amortization 7 . I N V E S T M E N T I N E Q U I T Y O N E , I N C . (thousands of dollars) Investment in Equity One, beginning of year Equity income Less dividends received Purchase of Equity One common shares (a) Dilution gain Cumulative currency effect Investment in Equity One, end of year (b) Weighted average ownership interest in Equity One $ $ 22,815 2,285 3,679 28,779 (4,439) 24,340 2005 $ 203,988 17,475 (18,221) 15,882 — (7,294) $ 211,830 18% $ $ $ $ 11,863 1,423 1,913 15,199 (1,691) 13,508 2004 211,412 18,228 (18,671) 5,381 3,201 (15,563) 203,988 18% Equity One, Inc. (“Equity One”) (NYSE:EQY), is a self-administered and self-managed real estate investment trust in the United States. The Company and Equity One are each indirectly controlled subsidiaries of Gazit-Globe Ltd. (“Gazit”), an Israeli corporation trading on the Tel Aviv Stock Exchange. (a) In 2005, the Company’s U.S. subsidiaries acquired an additional 595,992 (2004 – 218,423) common shares of Equity One at an average price of US$22.27 (2004 – US$18.45) per share through Equity One’s dividend reinvestment program. (b) The closing price on the NYSE of Equity One’s common shares at December 31, 2005 was US$23.12 (December 31, 2004 – US$23.73) per share. The book value per share of the Company’s investment in Equity One at December 31, 2005 is US$13.65 (December 31, 2004 – US$13.32). At December 31, 2005, 74.9 million (December 31, 2004 – 72.9 million) shares of Equity One were outstanding, of which 13.3 million (December 31, 2004 – 12.7 million) shares were held by the Company. 8 . LOA N S , M O R TGAG E S A N D OT H E R R E A L E S TAT E A S S E T S (thousands of dollars) Loans and mortgages receivable from development partners (a) $ Real estate marketable securities (b) $ 2005 2004 14,617 12,295 26,912 $ $ 17,758 372 18,130 (a) The Company has funded its partners’ share of certain development activities. The loans bear interest at an average rate of 10% and are repayable from the partners’ share of proceeds generated from refinancings or sales. The Company has taken assignments of 69 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued the development partners’ equity interests in the development partnerships as security for the loans receivable. (b) The Company invests from time to time in the marketable securities of publicly traded real estate entities. 9 . OT H E R A S S E T S (thousands of dollars) 2005 2004 Deferred financing, issue and interest rate hedge costs $ 13,721 (net of accumulated amortization of $6,851 (2004 – $7,323)) Prepaid expenses and deposits related to property operations Deposits and costs on properties under option Furniture, fixtures and equipment (net of accumulated amortization of $1,082 (2004 — $698)) 1 0 . A M O U N T S R E C E I VA B L E (thousands of dollars) Accounts receivable Deferred rent receivables 1 1 . M O R TGAG E S A N D C R E D I T FAC I L I T I E S 16,311 5,292 2,268 37,592 2005 8,138 8,888 17,026 $ $ $ (Restated – note 2) 9,481 $ 11,127 4,859 566 26,033 2004 9,084 5,192 14,276 $ $ $ (thousands of dollars) Fixed rate Floating rate (thousands of dollars) Fixed rate Floating rate 2005 Canada U.S. Total $ 1,080,239 62,191 $ 1,142,430 $ 63,965 90,645 $ 154,610 $ 1,144,204 152,836 $ 1,297,040 Canada 838,207 61,732 899,939 $ $ 2004 U.S. Total $ $ 42,070 60,956 103,026 $ 880,277 122,688 $ 1,002,965 Mortgages and credit facilities are secured by shopping centres and the investment in Equity One. 70 FIRST CAPITAL REALTY 2005 ANNUAL REPORT Canada Fixed rate financing bears interest at an average fixed rate of 6.5% (2004 – 6.8%) and matures in years ranging from 2006 to 2019. Floating rate financing bears interest at floating rates determined by reference to Canadian prime lenders or bankers’ acceptance rates and matures in 2006 and 2007. United States Fixed rate financing is comprised of LIBOR swap agreements on a notional US$55 million (2004 – US$35 million) at an average fixed rate of 4.4% (2004 – 4.3%) plus applicable spreads and matures by 2015. Floating rate financing of $73.9 million (US$63.5 million) bears interest at the LIBOR plus 145 basis points and matures in 2010. Floating rate financing of $16.8 million (US$14.4 million) bears interest at U.S. prime. In 2004, floating rate financing bore interest at LIBOR plus 150 – 220 basis points. Principal repayments of mortgages and credit facilities outstanding as at December 31, 2005 are as follows: (thousands of dollars) Canada U.S. Total 2006 2007 2008 2009 2010 Thereafter Total $ 53,352 201,498 80,557 68,437 83,734 654,852 $ 1,142,430 $ $ 23,773 6,978 6,978 6,978 109,903 — 154,610 $ 77,125 208,476 87,535 75,415 193,637 654,852 $ 1,297,040 At December 31, 2005, the Company has $157.7 million of undrawn credit facilities, which are secured by certain shopping centres, available for acquisitions, development, and general corporate purposes. 1 2 . AC C O U N T S PAYA B L E A N D OT H E R L I A B I L I T I E S (thousands of dollars) Trade payables and accruals Accrued interest Dividends payable Tenant deposits Deferred income and other liabilities Below-market in-place leases on acquisitions 2005 2004 $ 48,371 7,800 21,194 4,556 8,038 12,157 $ 102,116 $ $ 36,495 7,766 15,398 3,644 5,480 3,265 72,048 1 3 . U N S E C U R E D D E B E N T U R E S On June 21, 2005, the Company issued $100 million of 5.08% senior unsecured debentures, maturing on June 21, 2012. Interest is payable semi-annually. 71 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued 1 4 . C O N V E R T I B L E D E B E N T U R E S PAYA B L E (thousands of dollars) Interest Rate 2005 2004 (Restated – note 2) Coupon Implicit Principal Liability Equity Principal Liability Equity 5.50% 7.00% 7.25% 5.97% 8.25% 9.60% $ 100,000 $ 96,990 $ — — — — $ 100,000 $ 96,990 $ Significant terms of the convertible debentures: — $ — $ 3,015 $ — 99,999 — 161,702 — 8,238 8,279 3,015 $ 261,701 $ 247,736 $ 16,517 96,595 151,141 Interest Rate Conversion Price(1) Maturity Earliest Redemption Date 5.50% 7.875% 7.00% 7.25% $27.00; $28.00 after January 1, 2012 $16.43 $22.71 $24.40 (1) per common share September 30, 2017 January 31, 2007 February 28, 2008 June 30, 2008 January 1, 2012 Redeemed August 2004 Redeemed September 30, 2005 Redeemed March 30, 2005 On December 19, 2005, the Company issued $100 million of 5.50% convertible unsecured subordinated debentures due September 30, 2017. The debentures require interest payable semi-annually on March 31 and September 30. Holders of the debentures have the right to convert them into common shares at a share price of $27.00 through to December 31, 2011 and $28.00 thereafter to maturity. The Company has the option of repaying the debentures on maturity through the issuance of common shares at 97% of a weighted average trading price of the Company’s common shares. The Company also has the option of paying the semi- annual interest through the issue of common shares valued in the same fashion. The debentures outstanding at December 31, 2004 were unsecured subordinated debentures requiring interest payments semi-annually and were convertible into common shares of the Company at the holders’ option until the day prior to the redemption date. In addition, the Company had the option of repaying the debentures by issuing common shares. If the Company chose to issue common shares, it was to be valued at 95% of a weighted average trading price of the Company’s common shares. The Company also had the option of paying the interest through the issue of common shares valued in the same fashion as with respect to the repayment of principal on those debentures. On September 30, 2005, the Company redeemed the outstanding $100 million principal amount of the 7.0% convertible debentures with the issuance of 4,995,205 shares. Prior to the redemption date, holders of $0.045 million principal amount of the 7.0% convertible debentures converted their debentures in accordance with the terms and conditions of the trust indenture. The early redemption of the 7.0% convertible debentures resulted in a non- cash gain of $0.2 million and an increase in contributed surplus of $8.2 million. On March 31, 2005, the Company redeemed the outstanding $161.7 million principal amount of the 7.25% convertible debentures with the issuance of 8,411,386 shares. Prior to the 72 FIRST CAPITAL REALTY 2005 ANNUAL REPORT redemption date, holders of $0.035 million principal amount of 7.25% convertible debentures converted their debentures in accordance with the terms and conditions of the trust indenture. The early redemption of the 7.25% convertible debentures resulted in a non-cash gain of $0.8 million and an increase in contributed surplus of $8.4 million. On August 30, 2004, the Company redeemed in cash the outstanding $35.1 million principal amount of the 7.875% convertible debentures. Prior to the redemption date, holders of $62.4 million principal amount of 7.875% convertible debentures converted their debentures into 3,797,212 common shares at a conversion price of $16.43 in accordance with the terms and conditions of the trust indenture. Accounting for the early redemption of the 7.875% convertible debentures resulted in a non-cash debt settlement expense of $0.9 million and contributed surplus of $2.8 million. The fair value of the common shares issued to redeem the convertible debentures was based upon the quoted market value of the shares adjusted for price fluctuations, quantities traded, and issue costs. In 2005, 543,547 (2004 – 1,177,143) common shares were issued to pay interest to holders of convertible debentures. 1 5 . S H A R E H O L D E R S ’ E Q U I T Y (thousands of dollars) 2005 2004 Share capital (a) Equity component of convertible debentures (note 14) Warrants (c) Options and deferred share units (d) (e) Cumulative currency translation adjustment (g) Contributed surplus (note 14) Deficit $ 1,022,701 3,015 472 3,004 (14,577) 19,513 (191,584) $ 842,544 $ (Restated – note 2) 673,660 16,517 711 1,273 (13,347) 2,842 (133,163) 548,493 $ (a) Share Capital The Company has an unlimited number of authorized preference shares and common shares. The preference shares may be issued from time to time in one or more series, each series comprising the number of shares, designations, rights, privileges, restrictions and conditions which the Board of Directors determines by resolution; preference shares are non-voting and rank in priority to the common shares with respect to dividends and distributions upon dissolution. No preference shares have been issued. The common shares carry one vote each and participate equally in the earnings of the Company and the net assets of the Company upon dissolution. Dividends are payable on the common shares as and when declared by the Board of Directors. 73 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued The following table sets forth the particulars of the issued and outstanding shares of the Company: Issued and outstanding at December 31, 2003 Issuance of common shares (b) Conversion of 7.875% convertible debentures (note 14) Payment of interest on convertible debentures (note 14) Exercise of warrants (c) Exercise of options (d) Issue costs, net of income taxes Issued and outstanding at December 31, 2004 Issuance of common shares (b) Redemption of 7.25% convertible debentures (note 14) Conversion of 7.25% convertible debentures (note 14) Redemption of 7.0% convertible debentures (note 14) Conversion of 7.0% convertible debentures (note 14) Payment of interest on convertible debentures (note 14) Exercise of warrants (c) Exercise of options (d) Dividends reinvested in common shares (f) Issue costs, net of income taxes Issued and outstanding at December 31, 2005 Number of Stated Capital Common Shares (thousands of dollars) 35,109,754 5,366,000 3,797,212 1,177,143 5,849,024 360,450 — 51,659,583 2,700,000 8,411,386 1,434 4,995,205 1,981 543,547 299,311 601,645 1,431,742 — 70,645,834 $ 422,916 86,866 65,778 19,137 76,627 4,615 (2,279) 673,660 51,975 149,891 35 96,425 45 10,465 3,771 8,592 29,174 (1,332) $ 1,022,701 (b) Issuance of Common Shares On January 26, 2005, 2,700,000 common shares were issued at a price of $19.25 per share, for total gross proceeds of $52.0 million, before commission and issue costs. On March 11, 2004, 3,366,000 common shares were issued at a price of $16.30 per share, for total gross proceeds of approximately $54.9 million, before commission and issue costs. On August 30, 2004, 2,000,000 common shares were issued at a price of $16.00 per share for total gross proceeds of $32.0 million, with no commission costs. (c) Warrants During 2005, a total of 299,311 (2004 – 4,849,024) share purchase warrants were exercised at $11.80 per share resulting in proceeds to the Company of $3.5 million (2004 – $57.2 million). In addition, in 2004 1,000,000 advisory warrants were exercised at $13.53 per share resulting in proceeds of $13.5 million. The equity component of the warrants exercised, $0.2 million (2004 – $5.9 million), was transferred to share capital. At December 31, 2005, there were 628,094 outstanding share purchase warrants (2004 – 927,405) exercisable at $11.80 per share during a three-month exercise period commencing on June 1 and ending on August 31 in each year to 2008, on and subject to certain terms and conditions, and may be exercisable in certain other limited circumstances. 74 FIRST CAPITAL REALTY 2005 ANNUAL REPORT (d) Stock Options The Company is authorized to grant up to 3,625,000 (2004 – 2,125,000) common share options to the employees, officers and directors of the Company and third-party service providers. As of December 31, 2005, 1,405,800 (2004 – 395,000) common share options are available to be granted. Options granted by the Company generally expire ten years from the date of grant and vest over three to five years. The outstanding options have exercise prices ranging from $12.42 to $20.80. In 2005, $0.3 million (2004 – $0.2 million) has been recorded as an expense due to the vesting of options granted after January 1, 2003. 2005 2004 Weighted Average Weighted Average Units Exercise Price Units Exercise Price Outstanding, beginning of year Granted Exercised Cancelled Outstanding, end of year Options vested at end of year Weighted average remaining life (years) 1,257,550 501,700 (601,645) (12,500) 1,145,105 468,505 8.4 $ $ $ $ $ $ 14.49 20.75 14.03 15.65 17.46 14.28 1,318,000 320,000 (360,450) (20,000) 1,257,550 657,133 7.2 $ $ $ $ $ $ 13.44 16.90 12.78 14.74 14.49 13.87 During the year ended December 31, 2005, the Company granted 501,700 options (2004 – 320,000 options) which had an approximate fair value of $0.6 million (2004 – $0.3 million) at the time of issue. The fair value associated with the options issued was calculated using the Black-Scholes Model for option valuation, assuming an average volatility of 15% (2004 – 17%) on the underlying shares, a ten-year term to expiry, and the ten-year weighted average risk-free interest rate (typically, the ten-year Canada bond rate at the date of grant). (e) Share Unit Plans The Company’s share unit plans include a Directors Deferred Share Unit Plan, an Employee Restricted Share Unit Plan (“Employee RSU Plan”) and a Chief Executive Officer Restricted Share Unit Plan (“CEO RSU Plan”). A total of 500,000 common shares has been reserved for issuance under these plans. As at December 31, 2005, 49,854 units (2004 – 32,570 units) have been granted under the Directors Deferred Share Unit Plan, and $0.3 million (2004 – $0.3 million) has been recorded as an expense. During 2005, 60,000 units (2004 – 120,000 units) were granted under the RSU plans and the number of units issued as a result of dividends declared on the common shares of the Company was 11,223 (2004 – 6,235). At December 31, 2005 – 197,458 units (2004 – 126,235 units) were outstanding under RSU plans. The Company recorded an expense of $1.0 million in 2005 (2004 – $0.5 million) for the grants under the CEO RSU Plan and Employee RSU Plan. (f) Dividend Reinvestment Plan The Company adopted a Dividend Reinvestment Plan (“DRIP”) in May 2005. Shareholders who hold at least 500 common shares can elect to reinvest cash dividends into additional common shares at a 2% discount to the weighted average trading price of the common shares on the Toronto Stock Exchange for the five consecutive trading days proceeding the dividend payment date. 75 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued (g) Cumulative Currency Translation Adjustment The cumulative currency translation adjustment represents the cumulative unrecognized exchange adjustment on the net assets of the Company’s subsidiaries that operate in the United States. The change for the year reflects the impact of U.S. currency movements during the year on these net assets. The rate of exchange in effect on December 31, 2005 was US$1.00 = Cdn$1.16 (December 31, 2004 – US$1.00 = Cdn$1.20). The average rate of exchange for 2005 was US$1.00 = Cdn$1.21 (2004 – US$1.00 = Cdn$1.30). 1 6 . I N T E R E S T (thousands of dollars) Mortgage and credit facility interest expense Unsecured debenture interest expense Convertible debenture interest expense Interest expense Convertible debenture interest paid in common shares Change in accrued interest Implicit interest rates in excess of coupon rate on convertible debentures Interest paid in excess of implicit interest on assumed mortgages Interest capitalized to land and shopping centres under development Cash interest paid 1 7 . A M O R T I Z AT I O N (thousands of dollars) Shopping centres Deferred costs Deferred financing fees Intangible assets Other 2005 2004 (Restated – note 2) 67,856 2,710 9,766 80,332 (10,465) (34) $ 52,462 — 27,796 80,258 (19,137) 1,930 (1,438) (3,953) 1,710 327 5,830 75,935 4,499 63,924 $ 2005 2004 (Restated – note 2) 36,854 8,467 2,096 2,495 409 50,321 $ $ 29,194 4,447 2,724 1,495 196 38,056 $ $ $ $ 1 8 . I N C O M E A N D OT H E R TA X E S The Company’s business activities are carried out directly and through operating subsidiaries, partnership ventures and trusts in Canada and the United States. The income tax effect on operations depends on the tax legislation in each country and the operating results of each subsidiary and partnership venture and the parent company. 76 FIRST CAPITAL REALTY 2005 ANNUAL REPORT The following table summarizes the provision for income and other taxes: (thousands of dollars) 2005 2004 (Restated – note 2) Provision for income taxes on income at the combined Canadian federal and provincial income tax rate of 35.3% (2004 – 35.5%) $ 14,921 $ 10,997 Increase (decrease) in the provision for income taxes due to the following items: Large Corporations Tax U.S. Operations Non-deductible interest expense Recognition of future tax assets related to convertible debenture redemptions Other Income and other taxes 1,631 (1,782) 507 (2,657) 503 13,123 $ 2,150 (1,283) 1,402 — (150) 13,116 $ The Company’s future income tax assets are summarized as follows: (thousands of dollars) Losses available for carry-forward Other assets Canadian and U.S. minimum tax credits The Company’s future income tax liabilities are summarized as follows: (thousands of dollars) Investments Shopping centres Other 2005 13,880 15,085 1,633 30,598 $ $ 2005 2004 (Restated – note 2) $ $ 16,119 153 793 17,065 $ $ $ $ 15,092 828 768 16,688 2004 13,880 8,475 — 22,355 At December 31, 2005, the Company has tax-loss carry-forwards for Canadian income tax purposes of approximately $42.0 million (2004 – $38 million), which have been recognized as future income tax assets and are available to reduce future Canadian taxable income. These tax-loss carry-forwards expire at various dates between December 31, 2006 and December 31, 2015. 77 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued 1 9 . P E R S H A R E CA LC U L AT I O N S The following tables set forth the computation of per share amounts: (thousands of dollars, except per share amounts) Net income Contributed surplus on settlement of convertible debentures Basic net income available to common shareholders Contributed surplus on settlement of convertible debentures Interest expense and issue cost amortization, net of tax Gain on redemption of convertible debentures Diluted net income Denominator Weighted average shares outstanding for basic per share amounts Convertible debentures Outstanding warrants Outstanding options Denominator for diluted net income available to common shareholders Basic earnings per share Diluted earnings per share 2005 2004 (Restated – note 2) $ $ 29,196 16,671 45,867 (16,671) 6,175 (1,018) 34,353 $ $ 17,887 2,842 20,729 — — — 20,729 63,424,822 4,897,294 336,307 234,866 44,632,159 — 795,231 225,478 68,893,289 0.72 $ 0.50 $ 45,652,868 0.46 0.45 $ $ The following securities were not included in the diluted per share calculation as the effect would have been anti-dilutive: Exercise Price 2005 2004 Number of shares if converted or exercised $ $ $ $ $ $ $ 20.80 16.85 16.91 27.00 16.43 22.71 24.40 486,700 — — 3,703,703 — — — — 45,000 275,000 — 3,767,790 4,403,307 6,627,127 Common share options Common share options Common share options Convertible debentures – 5.5% Convertible debentures – 7.875% Convertible debentures – 7.0% Convertible debentures – 7.25% 2 0 . R I S K M A N AG E M E N T In the normal course of its business, the Company is exposed to a number of risks that can affect its operating performance. These risks, and the actions taken to manage them, are as follows: (a) Interest Rate Risk The Company attempts to structure its financings so as to stagger the maturities of its debt, thereby mitigating its exposure to interest rate fluctuations. A portion of the Company’s 78 FIRST CAPITAL REALTY 2005 ANNUAL REPORT mortgages and credit facilities are floating rate instruments. From time to time, the Company may enter into interest rate swap contracts or other financial instruments to modify the interest rate profile of its outstanding debt without an exchange of the underlying principal amount. The fair value of the Company’s interest rate swaps and other contracts is a positive value of approximately $1.5 million due to changes in interest rates since the contracts were entered into. (b) Credit Risk Credit risk arises from the possibility that tenants and/or debtors may experience financial difficulty and be unable to fulfill their lease commitments or loans. The Company mitigates the risk of credit loss by ensuring that its tenant mix is diversified, by limiting its exposure to any one tenant and by the hypothecated properties. Thorough credit assessments are conducted in respect of all new leasing. (c) Currency Risk The Company maintains its accounts in Canadian dollars. However, a portion of its operations are located in the United States and therefore, the Company is subject to foreign currency fluctuations which may, from time to time, impact its financial position and results. The Company’s U.S. operations are financed in part by U.S. dollar-denominated credit facilities, which are serviced by the cash flow generated by the Company’s dividends from Equity One. The Company also finances a portion of its U.S. net investment through its Canadian company with U.S. dollar-denominated credit facilities. In the normal course of business, the Company enters into forward foreign exchange contracts, which represent designated hedges of a portion of the net investment in the United States self-sustaining operations. While the U.S. dollar financings and forward contracts reduce the Company’s exposure to fluctuations in foreign currency exchange rates, not all of its net U.S. dollar currency risk has been hedged. As a result, a strengthening of the Canadian dollar would result in a reduction in the carrying value of the Company’s net assets in the United States. At December 31, 2005, there are no outstanding forward exchange contracts. (d) Fair Values of Financial Instruments The fair values of the majority of the Company’s financial assets and liabilities, representing net working capital, approximate their recorded values at December 31, 2005 and 2004 due to their short-term nature. The fair value of the Company’s loans, mortgages receivable and marketable securities approximates carrying value. The fair value of the Company’s mortgages and credit facilities exceeds the recorded value by approximately $60 million due to changes in interest rates since the dates on which the individual mortgages were assumed (2004 – $60 million). The fair value of the 5.08% unsecured debentures is approximately $99 million at December 31, 2005. Based on publicly traded listing prices, as at December 31, 2005, the market value of the principal amount of the convertible debentures was $98 million (2004 – $268 million). 2 1 . S E G M E N T E D I N FO R M AT I O N The Company and its subsidiaries operate in the shopping centre segment of the real estate industry in both Canada and the United States. 79 N OT E S TO T H E C O N S O L I DAT E D F I N A N C I A L S TAT E M E N T S continued Operating income by geographic segment for the year ended December 31, 2005, is summarized as follows: (thousands of dollars) Canada U.S. Total Property rental revenue Property operating costs Net operating income Equity income from Equity One, Inc. Interest and other income Interest expense Corporate expenses Operating income before amortization Amortization Operating income $ 264,840 99,791 165,049 — 3,794 72,775 13,604 82,464 50,178 32,286 $ $ $ — $ 264,840 99,791 — 165,049 — 17,475 17,475 3,802 8 80,332 7,557 14,372 768 91,622 9,158 50,321 143 41,301 9,015 $ Operating income by geographic segment for the year ended December 31, 2004, is summarized as follows: (thousands of dollars) Canada U.S. Total Property rental revenue Property operating costs Net operating income Equity income from Equity One, Inc. Interest and other income Interest expense Corporate expenses Operating income before amortization Amortization Operating income 2 2 . J O I N T V E N T U R E S $ $ 215,022 82,204 132,818 — 6,480 75,278 10,785 53,235 37,919 15,316 $ $ — — — 18,228 — 4,980 854 12,394 137 12,257 $ $ 215,022 82,204 132,818 18,228 6,480 80,258 11,639 65,629 38,056 27,573 The Company is a participant in 17 (2004 – 15) joint ventures that own land, shopping centres, and shopping centres under development. The Company’s participation in these joint ventures ranges from 50% to 80%. The following amounts are included in the consolidated financial statements and represent the Company’s proportionate interest in the financial accounts of the joint ventures: (thousands of dollars) Assets Liabilities Revenues Expenses Cash flow provided by (used in): Operating activities Investing activities Financing activities 2005 2004 $ 176,791 $ 116,482 22,865 $ 18,821 $ $ $ $ 7,442 (54,013) 28,567 $ $ $ $ $ $ $ 129,858 87,107 13,763 8,006 8,334 (41,565) 36,577 80 FIRST CAPITAL REALTY 2005 ANNUAL REPORT The Company is contingently liable for certain of the obligations of the joint ventures and all of the net assets of the joint ventures are available for the purpose of satisfying such obligations and guarantees (see note 23 (a)). 2 3 . C O N T I N G E N C I E S (a) The Company is contingently liable, jointly and severally, for approximately $49.3 million (2004 – $30.3 million) to various lenders in connection with loans advanced to its joint- venture partners secured by the partners’ interest in the joint ventures. (b) The Company is also contingently liable for letters of credit in the amount of $7.3 million (2004 – $10.9 million) issued in the ordinary course of business. 2 4 . S U B S E Q U E N T E V E N T S (a) The Company invested $56.3 million in the acquisition of interests in two income- producing properties totalling 160,000 square feet, both in Calgary and the purchase of additional space and land parcels at or adjacent to existing properties, adding 101,000 square feet of space at three properties and 2.3 acres of commercial land at two properties. (b) The Company announced that the interest owing on March 31, 2006 on the 5.5% convertible unsecured subordinated debentures will be paid by the issuance of common shares. The number of common shares to be issued will be calculated by dividing the dollar amount of interest payable by an amount equal to 97% of the volume-weighted average trading price of the common shares of the Company on the Toronto Stock Exchange calculated for the 20 consecutive trading days ending on the five days prior to the payment date. (c) The Company announced that it will pay a dividend of $0.30 per common share on April 6, 2006 to shareholders of record on March 29, 2006. 2 5 . C O M PA R AT I V E A M O U N T S Certain comparative amounts have been reclassified to reflect the current year’s presentation. 81 C O R P O R AT E G OV E R N A N C E Sound corporate governance practices are an important part of First Capital Realty’s corporate culture. First Capital Realty has adopted certain practices and procedures to ensure that effective corporate governance practices are followed and that the Board functions independently of management. The following are highlights of the Company’s approach to governance: • The Board of Directors and management believe that sound and effective corporate governance is essential to the Company’s performance. In 2005, the Board undertook a comprehensive review of its corporate governance policies and procedures in light of recent regulatory developments to ensure that its commitment to high standards of corporate governance is maintained. • The Board of Directors supervises the conduct of the affairs of the Company. In carrying out its responsibilities, the Board appoints the senior executives of the Company and meets with them on a regular basis to receive and consider reports on the Company’s business. Along with those matters which must by law be approved by the Board, key strategic decisions are also submitted by management to the Board for approval. In addition to approving specific corporate actions, the Board reviews and approves the reports issued to shareholders, including annual and interim financial statements, as well as materials prepared for shareholders’ meetings. The Board also approves the Company’s overall business strategies and annual business plans for achieving its objectives. • The Board is currently comprised of eight directors, six of whom are independent. • The Board has established two committees comprised entirely of independent directors to assist it in fulfilling its responsibilities. Each of these committees operates under a written charter. The Audit Committee is responsible for assisting the Board in fulfilling its oversight responsibilities in relation to: the integrity of the Company’s financial statements; the Company’s compliance with legal and regulatory requirements related to financial reporting; the qualifications, independence and performance of the Company’s auditor; the design and implementation of internal controls and disclosure controls; and any additional matters delegated to the Audit Committee by the Board. All members of the Audit Committee are financially literate. The Compensation and Corporate Governance Committee is responsible for assisting the Board in fulfilling its oversight responsibilities in relation to: the appointment, development, compensation and retention of senior management; the management of employee benefit plans; the Company’s overall approach to corporate governance including the size, composition and structure of the Board and its committees; orientation and continuing education for directors; related party transactions and other matters involving possible conflicts of interest; and any additional matters delegated to the Compensation and Corporate Governance Committee by the Board. 82 B OA R D O F D I R E CTO R S FIRST CAPITAL REALTY 2005 ANNUAL REPORT CHAIM KATZMAN Chairman First Capital Realty Inc. North Miami Beach, Florida DORI J. SEGAL President and Chief Executive Officer First Capital Realty Inc. Toronto, Ontario Chairman of the Board. Also serves as Chairman and Chief Executive Officer of Equity One, Inc. and Chairman of Gazit- Globe, the Company’s largest shareholder. President and Chief Executive Officer. Also President and Director of Gazit-Globe, Director of Equity One, Inc. and Citycon Oyj. JON HAGAN, C.A. Consultant – JN Hagan Consulting Toronto, Ontario JOHN HARRIS Private Real Estate Investor Toronto, Ontario Principal, JN Hagan Consulting, Director of Bentall Capital Corporation and Sunrise Senior Living REIT. Mr. Hagan has over 30 years experience with leading Canadian real estate corporations including Cadillac Fairview Corporation, Empire Company Limited and Cambridge Shopping Centres Limited. A private real estate investor with over 25 years experience in real estate investment and capital markets. Mr. Harris served in senior positions at real estate investment banking firms including Merrill Lynch Canada Inc., Midland Walwyn Inc. and Deutsche Bank. NATHAN HETZ, C.P.A. Chief Executive Officer and Director Alony Hetz Properties and Investment Ltd. Ramat Gan, Israel STEVEN K. RANSON, C.A. President and Chief Executive Officer Home Equity Income Trust Toronto, Ontario Chief Executive Officer and Director of Alony Hetz Properties, a real estate investment company. Also serves as a Director of Equity One, Inc. Previously a Director of United Mizrahi Bank Ltd. President and Chief Executive Officer, Home Equity Income Trust. Mr. Ranson has over 20 years experience in financial services and capital markets. MOSHE RONEN Barrister and Solicitor Thornhill, Ontario Legal practice focussed on business and real estate law and public policy. Mr. Ronen is a member of the Board of Directors of several insti- tutions, including North York General Hospital and the Jewish National Fund. GARY M. SAMUEL Partner, Crown Realty Partners Toronto, Ontario Partner in Crown Realty, a private real estate investment and management company. Previously, Chief Executive Officer of Royop Properties Corporation and Chief Executive Officer of Canadian Real Estate Investment Trust. 83 S H A R E H O L D E R I N FO R M AT I O N H E A D O F F I C E H E A D O F F I C E BCE Place, TD Canada Trust Tower BCE Place, TD Canada Trust Tower 161 Bay Street, Suite 2820 161 Bay Street, Suite 2820 P.O. Box 219 P.O. Box 219 Toronto, Ontario M5J 2S1 Toronto, Ontario M5J 2S1 TO R O N TO S TO C K E XC H A N G E TO R O N TO S TO C K E XC H A N G E Tel: 416.504.4114 Tel: 416.504.4114 Fax: 416.941.1655 Fax: 416.941.1655 M O N T R E A L O F F I C E M O N T R E A L O F F I C E 2620 de Salaberry, Suite 201 2620 de Salaberry, Suite 201 Montreal, Quebec H3M 1L3 Montreal, Quebec H3M 1L3 Tel: 514.332.0031 Tel: 514.332.0031 Fax: 514.332.5135 Fax: 514.332.5135 CA LGA R Y O F F I C E CA LGA R Y O F F I C E McKenzie Towne Centre McKenzie Towne Centre 60 High Street S.E. 60 High Street S.E. Calgary, Alberta T2Z 3T8 Calgary, Alberta T2Z 3T8 Tel: 403.257.6888 Tel: 403.257.6888 Fax: 403.257.6899 Fax: 403.257.6899 VA N C O U V E R O F F I C E VA N C O U V E R O F F I C E Terra Nova Village Terra Nova Village 3671 Westminster Hwy., Suite 240 3671 Westminister Hwy., Suite 240 L I S T I N G S L I S T I N G S Common Shares: Common Shares: FCR FCR Warrants: Warrants: FCR.WT FCR.WT 5.50% Debentures – CDN FCR. DB. A 5.50% Debentures – CDN FCR. DB. A 5.50% Debentures – U.S. FCR. DB. B 5.50% Debentures – U.S. FCR. DB. B T R A N S F E R AG E N T COMPUTERSHARE TRUST T R A N S F E R AG E N T COMPANY OF CANADA COMPUTERSHARE TRUST 100 University Avenue, 11th Floor COMPANY OF CANADA Toronto, Ontario M5J 2Y1 100 University Avenue, 11th Floor Tel: 416.981.9633 Toronto, Ontario M5J 2Y1 (Toll Free) 1.800.663.9097 Tel: 416.981.9633 (Toll Free) 1.800.663.9097 L E GA L C O U N S E L TORYS LLP L E GA L C O U N S E L Toronto, Ontario TORYS LLP Toronto, Ontario DAVIES WARD PHILLIPS & Richmond, British Columbia V7C 5V2 Richmond, British Columbia V7C 5V2 VINEBERG LLP DAVIES WARD PHILLIPS & Tel: 604.278.0056 Tel: 604.278.0056 Fax: 604.278.3364 Fax: 604.278.3364 A N N U A L S H A R E H O L D E R S ’ U . S . O F F I C E M E E T I N G 1660 N.E. Miami Gardens Drive May 24, 2006 Suite One, North Miami Beach Design Exchange FL 33179 234 Bay Street Tel: 305.944.7988 Toronto, Ontario Fax: 305.944.7986 at 12:30 p.m. A N N U A L S H A R E H O L D E R S ’ M E E T I N G May 24, 2006 Design Exchange 234 Bay Street Toronto, Ontario at 12:30 p.m. Montreal, Quebec VINEBERG LLP Montreal, Quebec A U D I TO R S DELOITTE & TOUCHE LLP A U D I TO R S Toronto, Ontario DELOITTE & TOUCHE LLP Toronto, Ontario O F F I C E R S DORI J. SEGAL O F F I C E R S President and Chief Executive Officer DORI J. SEGAL President and CEO SYLVIE LACHANCE Executive Vice President SYLVIE LACHANCE Executive Vice President KAREN H. WEAVER Chief Financial Officer and Secretary KAREN H. WEAVER Chief Financial Officer & Secretary BRIAN KOZAK Vice President, Western Canada BRIAN KOZAK Vice President, Western Canada 84 a d a n a C n i d e t n i r P 

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