WRIT Washington Real Estate Investment Trust 2005 Annual Report expertise Funds from Operations (in dollars per share) Net Operating Income Contribution by Sector 1.96 1.97 2.04 2.05 2.07 01 02 03 04 05 Off ice . . . . . . . . . . . . .38.4% Industrial . . . . . . . . . .19.0% Shopping Center . .19.0% Multi-family . . . . . .13.4% Medical Office . . . .10.2% Return on Invested Capital Source: Stifel, Nicolaus & Company, Inc. Cash Dividends Paid (in dollars per share) 9.1% 8.5% 5.9% 6.2% 6.9% s T I E R l a i r t s u d n I s T I E R y l i m a f - i t l u M s T I E R e c i f f O s T I E R r e t n e C g n i p p o h S T I R W 1.39 1.47 1.31 1.55 1.60 01 02 03 04 05 Selected Financial and Operating Data (in millions, except fully diluted per share amounts) FOR THE YEAR Real Estate Revenue Net Income Funds from Operations Cash Dividends Paid Average Shares Outstanding PER FULLY DILUTED COMMON SHARE Net Income Funds from Operations Cash Dividends Paid AT YEAR-END Total Assets Total Debt Shareholders’ Equity 2001 2002 2003 2004 2005 $ 135 52 74 50 38 $ 141 52 77 54 39 $ 154 45 81 59 40 $ 172 46 86 65 42 $ 190 78 87 67 42 $1.38 1.96 1.31 $1.32 1.97 1.39 $1.13 2.04 1.47 $ 1.09 2.05 1.55 $ 1.84 2.07 1.60 $ 708 360 324 $ 756 403 326 $ 928 517 379 $1,012 610 366 $1,141 714 380 experience and knowledge At Washington Real Estate Investment Trust, it is the knowledge and keen insight of our seasoned professionals that have led to our remarkable success. For over 40 years, we have focused our real estate investing on the Greater Washington, D.C. metropolitan region and we have acquired extensive expertise in all the market sectors in which we operate. The fourth largest metropolitan region in the United States, the National Capital area has led all major metro areas in employment growth for over a 20-year period. In this strong and stable environment, our approach has been to acquire and manage a diverse range of income-producing properties throughout the region. This strategy protects our portfolio of assets from single property-type value fluctuations and continues to steadily increase earnings and shareholder value. development In 2005, we continued to make progress on a number of development projects. Currently under construction is Rosslyn Towers, a 224-unit apartment complex in Arlington, Virginia, neighboring our office building at 1600 Wilson Boulevard. This project is scheduled to be completed in early 2007. We also began construction on a 75-unit apartment building and underground parking garage at our 800 South Washington Street retail property in Old Town Alexandria, Virginia—a highly desirable location for retail and residential tenants— where completion is expected in the first quarter of 2007. Also in Alexandria, Virginia, WRIT is renovating the “Shoppes at Foxchase.” When completed in late 2006, this neighborhood retail center will contain a total of 187,000 square feet of both renovated in-line stores and the addition of a newly constructed 55,000 square foot Harris Teeter grocery store. Construction has also started on the newly acquired Dulles Station in Herndon, Virginia. The first phase of the 187,000 square foot office building and adjacent garage is expected to be delivered in the second quarter of 2007. Our Associates in accounting are a dedicated team with great camaraderie. They are committed to our core values of integrity and excellence in financial standards and internal controls. They work diligently to maintain these standards of excellence, while at the same time creating an enjoyable work environment. WRIT has created an invaluable investment opportunity with the development of WRIT Rosslyn Center in Arlington, Virginia, by redeveloping an in-fill location and acquiring adjacent parcels and development rights. Our actions in this development have already created an additional $13 million in land value. acquisitions With four new acquisitions in 2005, WRIT’s current portfolio includes 69 real estate assets. In March, we acquired the 100% leased Frederick Crossing Shopping Center in Frederick, Maryland, which consists of 295,000 square feet, for $45.1 million. We acquired two properties in Chantilly, Virginia: Albermarle Point and The Coleman Building. Albermarle Point consists of a 29-acre business park, featuring five single-story flex buildings totaling 207,000 square feet, and a two-story office building totaling 89,000 square feet at a cost of $65.9 million. With the purchase of The Coleman Building, a one-story office building totaling 60,000 square feet at a cost of $8.8 million, we completed the acquisition of Dulles Business Park. Finally, in late December of 2005, we acquired a 5.27-acre site for our Dulles Station development project for $24.7 million, which is now under construction in Herndon, Virginia. This site, one of the last remaining with frontage along the Dulles Toll Road, is part of a planned 63-acre mixed use development. Our site is approved for 540,000 gross square feet of office and retail space. Our Phase One 185,000 square foot building and adjacent garage is expected to be complete in the second quarter of 2006. At WRIT, we are committed to a highly disciplined acquisition strategy. WRIT’s strategy of geographic focus and property diversification permits management to clearly anticipate regional growth opportunities across the five property sector types in which we invest. Another credit to our success is our thorough due diligence process, in which property management is an important consideration. Our adherence to our due diligence process ensures that the returns on our acquisitions generally meet or exceed our initial projections. These are some of the factors that set us apart from our competitors. leasing In 2005, we experienced solid leasing performance in all of our commercial sectors. 380 commercial leases were executed for over 1.7 million square feet of space, with average rental rates increasing 8.7% on a GAAP basis. Leasing activity and rental rate growth was strong in the retail, industrial and multi-family sectors. Because of its increasing contribution to our net operating income, we have separated our medical office portfolio, which had an occupancy rate in excess of 99% in 2005, into its own sector. The downtown Washington, D.C. office market continues to lead the region, as well as the nation, in overall occupancy. A major milestone in our Suburban Maryland office portfolio was the leasing of Maryland Trade Centers I and II, which were 93% leased at year-end. We expect continued improvement in both occupancy and rental rate growth. Most of our tenant architecture and construction is completed in-house. The benefit to WRIT is the reduction of tenant improvement costs and accelerated occupancy. Members of WRIT’s leasing team are specialists in the leasing of property types to which they are assigned. They are assisted in their efforts by the in-house asset management, space planning and construction teams. shareholder letter Edmund B. Cronin, Jr. Dear Shareholder, 2005 was a busy and productive year for WRIT. During this past year, we acquired four properties at a cost of $145 million and disposed of four others for $73.5 million, which produced a GAAP gain of $37 million. The acquisitions included a 295,000 square foot shopping center, two industrial properties totaling 360,000 square feet, and a site for the development of two multi-story office buildings containing 540,000 square feet, plus a parking deck. Since the entitlements to develop and a fixed construction contract for the first 187,000 square foot building were already in place at the time of purchase, WRIT was able to begin construction in early January. Our strategic plan to acquire, redevelop, and renovate real estate assets, while disposing of those that do not meet our earnings objectives, continues to move forward. A few years ago, we embarked on an effort to reduce WRIT’s exposure to the general office sector and in its place, add medical office buildings, along with other property types, to the portfolio. As a result, the contribution to net operating income from the general office sector has decreased to 38%, while the medical office sector has grown to 10.1%. We expect that over the near term, the medical office building sector’s income contribution to the portfolio will increase. Throughout the year, we experienced steady occupancy and income growth across our portfolios, though the general office sector was slower to respond than we initially expected. At year- end, the general office sector was 91% leased compared to 83% in 2004. The major vacancies were in two properties, Maryland Trades I and II and 7900 Westpark Drive. MTC I and II are now 93% leased, and activity at 7900 Westpark has increased significantly. The multi-family sector was 91% leased compared to 92% in 2004. The medical office building sector held steady at 99%. The retail centers sector was 99% leased compared to 97% in 2004, and the industrial/flex sector was 93% leased compared to 95% in 2004. The minor declines in occupancy were a result of year-end move-outs in the industrial/flex and multi-family sectors. We expect that these high occupancy levels, combined with a continued strong economy and positive job growth, should provide very attractive rental rate growth over the next year. Looking ahead to late 2006 and early 2007, WRIT has several projects under renovation and development, which will be nearing completion. In Rosslyn, Virginia, we are well underway with our 224-unit, 15-story, multi-family apartment building. We expect the first units to be delivered in early 2007. In Alexandria, Virginia, construction has commenced on 75 luxury multi-family units, plus a 2,600 square foot retail addition and underground parking behind our 45,000 square foot Main Street retail on South Washington Street. Completion is expected in early 2007. Also in Alexandria, at “The Shoppes at Foxchase,” WRIT has approximately 61,000 square feet under renovation, and Harris Teeter is constructing a 59,000 square foot grocery store on our property. When completed, this neighborhood retail center will contain 128,000 square feet in total. It is expected to open in late 2006. As the company continues to grow, it is necessary to deepen the senior management ranks. Last year, WRIT created a new corporate position, Executive Vice President/Chief Investment Officer. In October, Christopher P. Mundy was selected for that position. Prior to joining WRIT, Mr. Mundy held the position of Executive Vice President at another well-known real estate investment trust. Overall, 2005 was an interesting year for real estate investment trusts. Again, the industry indices outperformed most others for the fifth year in a row, and as we start 2006, they are continuing this trend. We continue to see a substantial amount of domestic and foreign capital available for real estate investment. In spite of increasing interest rates, which normally have a negative effect on real estate values, there has not been any diminution in value, nor has there been a lack of interest in the properties offered for sale in our region from acquirers. We will continue to selectively invest in this environment, while maintaining a conservative leverage position. In closing, I thank our Board of Trustees for their guidance and oversight, as well as all our officers and associates, whose collaborative efforts enable WRIT to excel. Sincerely, Edmund B. Cronin, Jr. Chairman of the Board, President and Chief Executive Officer foRm 10-k United States Securities and Exchange Commission, Washington, DC 20549 (Mark One) n Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 or Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2005 Commission file number 1–6622 Washington Real Estate Investment Trust (Exact name of registrant as specified in its charter) (State or other jurisdiction of incorporation or organization) Maryland (I.R.S. Employer Identification No.) (Address of principal executive office) (Zip code) 53–0261100 6110 Executive Boulevard, Suite 800 Rockville, Maryland 20852 (Registrant’s telephone number, including area code) (301) 984–9400 Securities registered pursuant to Section 12(b) of the Act: (Title of each class) (Name of exchange on which registered) Shares of Beneficial Interest New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES X NO Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. NO X YES Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or such shorter period that the Registrant was required to file such report) and (2) has been subject to such filing requirements for the past ninety (90) days. YES X NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). Large Accelerated Filer X Non-Accelerated Filer Accelerated Filer Indicate by check mark whether the registrant Act). NO X YES is a shell company (as defined in Rule 12b-2 of the As of February 27, 2006 42,175,428 Shares of Beneficial Interest were outstanding. As of June 30, 2005, the aggregate market value of such shares held by non-affiliates of the registrant was approximately $1,314,238,598 (based on the closing price of the stock on June 30, 2005). Documents Incorporated by Reference Portions of the Trust’s definitive Proxy Statement relating to the 2006 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K as indicated herein. 10 Washington Real Estate Investment Trust and Subsidiaries INDEX PaRt I Item 1. Business Item 1A. Risk Factors Item 1B. Unresolved Staff Comments Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PaRt II Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Item 6. Selected Financial Data Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Qualitative and Quantitative Disclosures about Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information PaRt III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions Item 14. Principal Accountant Fees and Services PaRt IV Item 15. Exhibits and Financial Statement Schedules Signatures Page 12 16 22 23 26 26 27 28 28 62 63 63 63 63 64 64 64 65 65 66 70 Washington Real Estate Investment Trust and Subsidiaries 11 paRT I IteM 1. BUSINeSS the trust Washington Real Estate Investment Trust (“WRIT,” the “Trust,” or the “company”) is a self-administered, self- managed, equity real estate investment trust (“REIT”) successor to a trust organized in 1960. Our business consists of the ownership and development of income-producing real properties in the greater Washington/Baltimore region. We own a diversified portfolio of general purpose office buildings, medical office buildings, industrial/flex properties, multifamily buildings and retail centers. We believe that we qualify as a REIT under Sections 856–860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute 90% of our ordinary taxable income to our shareholders. When selling properties, we have the option of (i) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (ii) paying out capital gains to the shareholders with no tax to the company or (iii) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. $33.5 million of the gains from property disposed in 2005 was reinvested in replacement properties. Approximately $3.5 million of gains from disposed property in 2005 was distributed to shareholders. We distributed all of our 2005, 2004 and 2003 ordinary taxable income to our shareholders. Gains from the property disposed in 2004 were distributed to shareholders. No provision for income taxes was necessary in 2005, 2004 or 2003. Over the last five years, dividends paid per share have been $1.60 for 2005, $1.55 for 2004, $1.47 for 2003, $1.39 for 2002 and $1.31 for 2001. We generally incur short-term floating rate debt in connection with the acquisition of real estate. As market conditions permit, we replace the floating rate debt with fixed-rate secured loans or unsecured senior notes, or repay the debt with the proceeds of sales of equity securities. We may acquire one or more properties in exchange for our equity securities or operating partnership units which are convertible into WRIT shares. Our geographic focus is based on two principles: 1. Real estate is a local business and is more effectively selected and managed by owners located, and with expertise, in the region. 2. Geographic markets deserving of focus must be among the nation’s best markets with a strong primary industry foundation and diversified enough to withstand downturns in their primary industry. We consider markets to be local if they can be reached from the Washington centered market within two hours by car. Our Washington centered market reaches north to Philadelphia, Pennsylvania, and south to Richmond, Virginia. While we have historically focused most of our investments in the greater Washington/Baltimore Region, in order to maximize acquisition opportunities we will and have considered investments within the two-hour radius described above. We will also consider opportunities to duplicate our Washington-focused approach in other geographic markets which meet the criteria described above. All of our Trustees, officers and employees live and work in the greater Washington/Baltimore region, and our officers average over 20 years of experience in this region. This section includes or refers to certain forward-looking statements. You should refer to the explanation of the qualifications and limitations on such forward-looking statements beginning on page 59. 12 Washington Real Estate Investment Trust and Subsidiaries the greater Washington/Baltimore economy 2005 proved to be a year of strong performance for the greater Washington/Baltimore area, with both the professional and business services sectors fueling job growth. Federal procurement spending continues to be strong, particularly in the defense industry, with its issuance of defense, intelligence and security contracts. Continued spending by the General Services Administration and the corresponding government contracting firms and professional services firms is expected to further drive regional growth. Office leasing activity has increased and has had a positive impact on the industrial and multifamily rental markets. Retail leasing space has been positively affected by the Metro area’s overall population growth and high levels of discretionary income. We believe regional job growth in 2006 will continue to be driven by professional services firms, including government contractors. According to Delta Associates/Transwestern Commercial Services (“Delta”), a national full-service real estate firm that provides market research and evaluation services for commercial property types including office, industrial, retail and apartments: • The Metropolitan Washington region led the nation in job growth for the fifth year in a row, adding 86,900 jobs through the 12 months ended November 2005. • The Washington area unemployment rate was 3.3% in November 2005, down from 3.7% one year ago and well below the national rate of 5.0%. • Approximately 75,000 new jobs are projected for the region in 2006. While growth is very important, from an investment perspective, economic stability is equally important. The Federal government, professional/business services and transportation are the core industries in the greater Washington/ Baltimore area economy. Increased spending by the Federal Government is expected to continue driving regional economic growth. Federal Government spending in the region increased 15% in 2005 and accounts for 17% of the Gross Regional Product. greater Washington/Baltimore Real estate Markets The economic stability in the greater Washington/Baltimore region has translated into stronger relative real estate market performance in each of our four sectors, compared to other national metropolitan regions, as reported by Delta: Office and Medical Office Sectors • Rents rose 2.5% in 2005 in the region as a whole; rents are expected to rise 4.0% Metro wide in 2006, as vacancy in suburban Maryland submarkets and Northern Virginia declines. • Vacancy was 7.9% (with sublet space included) at year-end 2005, down from 9.2% (with sublet space) at year- end 2004, among the lowest of any major metro area. • The overall vacancy rate is projected to increase in the District over the next two years due to levels of new construction. • Net absorption totaled 7.6 million square feet, down from 11.6 million square feet in 2004. • Of the 17.7 million square feet of office space under construction at year-end 2005, 49% was estimated as pre-leased. Washington Real Estate Investment Trust and Subsidiaries 13 Multifamily Sector • Overall, apartment rents increased 4.6% in the greater Washington/Baltimore region in 2005. • Rental rates are expected to rise over the next 12 months with nominal concessions. • The pipeline of new supply is at its lowest level in several years. grocery-anchored Retail Centers Sector • Retail employment increased by 8,200 positions in 2005. • Strong regional household income averages as follows—Fairfax County, Virginia—$130,000, Montgomery County, Maryland—$128,300 and Alexandria, Virginia—$115,700—versus a national average of $64,800. • Steady vacancy rates at 2.9% at year-end 2005 compared to 2.8% at year-end 2004. • Rental rates at grocery-anchored centers increased 22.7% in 2005. Industrial/Flex Sector • Average industrial rents increased 1.5% in the greater Washington/Baltimore region in 2005. • Rents are projected to increase 2–3% in 2006, as vacancy rates improve. • Vacancy was 2.4% (with sublet space) at year-end 2005, down from 10.4% (with sublet space) at year- end 2004. • Of the 5.1 million square feet of industrial space under construction at year-end 2005, 34% is pre-leased, as compared to 3.7 million and 19%, respectively, at year-end 2004. WRIt PORtFOLIO As of December 31, 2005, we owned a diversified portfolio of 68 properties consisting of 21 office buildings, 7 medical office buildings, 12 retail centers, 9 multifamily buildings and 19 industrial/flex properties. Our principal objective is to invest in high-quality properties in prime locations, then proactively manage, lease and develop ongoing capital improvement programs to improve their economic performance. The percentage of total real estate rental revenue by property group for 2005, 2004 and 2003 and the percent leased, calculated as the percentage of physical net rentable area leased, as of December 31, 2005, were as follows: Percent Leased* December 31, 2005 91% 99% 99% 91% 93% Office Buildings Medical Office Buildings Retail Centers Multifamily Industrial * Data excludes discontinued operations. 2005 40% 10 17 16 17 Real Estate Rental Revenue* 2004 45% 8 16 17 14 2003 46% 5 17 18 14 100% 100% 100% On a combined basis, our portfolio was 94% leased at December 31, 2005, and 92% leased at December 31, 2004 and 2003. 14 Washington Real Estate Investment Trust and Subsidiaries Total rental revenue from continuing operations was $190.0 million for 2005, $171.6 million for 2004 and $153.6 million for 2003. During the three-year period ended December 31, 2005, we acquired two office buildings, five medical office buildings, two retail centers and five industrial properties. During that same time frame, we sold three office buildings and one industrial property. These acquisitions and dispositions were the primary reason for the shifting of each group’s percentage of total revenue reflected above. No single tenant accounted for more than 3.3% of revenue in 2005, 3.3% of revenue in 2004, and 2.5% of revenue in 2003. All Federal government tenants in the aggregate accounted for approximately 1.8% of our 2005 total revenue. Federal government tenants include the Department of Defense, U.S. Patent and Trademark Office, Federal Bureau of Investigation, Office of Personnel Management, U.S. Department of Consumer Affairs and the National Institutes of Health. WRIT’s larger non-Federal government tenants include the World Bank, Sunrise Senior Living, Inc., Lockheed Corporation, George Washington University, IQ Solutions, Sun Microsystems, INOVA Health Systems, United Communications Group and Westat. We expect to continue investing in additional income-producing properties. We invest only in properties which we believe will increase in income and value. Our properties compete for tenants with other properties throughout the respective areas in which they are located on the basis of location, quality and rental rates. We have recently engaged in ground-up development in order to further strengthen our portfolio with long-term growth prospects. We currently have three ground-up development projects underway. The first is a 224-unit mixed-use residential and retail property in Arlington, Virginia, referred to as Rosslyn Towers, with completion of the mid-rise building expected in late 2006 and of the high-rise building expected in the second quarter of 2007. The second is a 75-unit mixed-use residential and retail property in Alexandria, Virginia, referred to as South Washington Street, with completion expected in early 2007. The third is our December 2005 acquisition of Dulles Station in Herndon, Virginia. These two office buildings will total 540,000 square feet when the two phases are complete. The completion of the first 185,000 square feet of building construction is expected late in 2007, and the second building of 355,000 square feet is expected to be completed sometime in 2008 or 2009 depending on market conditions. We make capital improvements on an ongoing basis to our properties for the purpose of maintaining and increasing their value and income. Major improvements and/or renovations to the properties in 2005, 2004, and 2003 are discussed under the heading “Capital Improvements.” Further description of the property groups is contained in Item 2, Properties, and in Schedule III. Reference is also made to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. On February 28, 2006, we had 260 employees including 179 persons engaged in property management functions and 81 persons engaged in corporate, financial, leasing and asset management functions. aVaILaBILItY OF RePORtS A copy of this Annual Report on Form 10-K, as well as our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports are available, free of charge, on the Internet on our website www.writ. com. All required reports are made available on the website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission. The reference to our website address does not constitute incorporation by reference of the information contained in the website, and such information should not be considered part of this document. Washington Real Estate Investment Trust and Subsidiaries 15 IteM 1a. RISK FaCtORS Set forth below are the risks that we believe are material to our shareholders. We refer to the shares of beneficial interest in Washington Real Estate Investment Trust as our “shares,” and the investors who own shares as our “shareholders.” This section includes or refers to certain forward-looking statements. You should refer to the explanation of the qualifications and limitations on such forward-looking statements beginning on page 59. Our performance and value are subject to risks associated with our real estate assets and with the real estate industry. Our economic performance and the value of our real estate assets are subject to the risk that if our office, medical office, industrial, multifamily and retail properties do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow and ability to pay distributions to our shareholders will be adversely affected. The following factors, among others, may adversely affect the revenues generated by our commercial and multifamily properties: • downturns in the national, regional and local economic climate; • competition from similar asset type properties; • local real estate market conditions, such as oversupply or reduction in demand for office, industrial, multi- family or retail properties; increased operating costs, including insurance premiums, utilities and real estate taxes; inflation; • changes in interest rates and availability of financing; • vacancies, changes in market rental rates and the need to periodically repair, renovate and re-let space; • • • weather conditions; • consumer confidence, unemployment rates, and consumer tastes and preferences; • civil disturbances, earthquakes and other natural disasters, terrorist acts or acts of war may result in uninsured or underinsured losses; • significant expenditures associated with each investment, such as debt service payments, real estate taxes, insurance and maintenance costs, are generally not reduced when circumstances cause a reduction in revenues from a property; and • the economic health of our tenants and the ability to collect rents. We are dependent upon the economic climate of the greater Washington/Baltimore region. All of our properties are located in the greater Washington/Baltimore region. General economic conditions and local real estate conditions in this geographic region have a particularly strong effect. We face risks associated with property acquisitions. We intend to continue to acquire properties which would continue to increase our size and could alter our capital structure. Our acquisition activities and success may be exposed to the following risks: • we may be unable to acquire a desired property because of competition from other real estate investors, including publicly traded real estate investment trusts, institutional investment funds and private investors; • even if we enter into an acquisition agreement for a property, it is subject to customary conditions to closing, including completion of due diligence investigations which may be unacceptable; • competition from other real estate investors may significantly increase the purchase price; 16 Washington Real Estate Investment Trust and Subsidiaries • we may be unable to finance acquisitions on favorable terms; • acquired properties may fail to perform as we expected in analyzing our investments; and • our estimates of the costs of repositioning or redeveloping acquired properties may be inaccurate. We may acquire properties subject to liabilities and without recourse, or with limited recourse, with respect to unknown liabilities. As a result, if liability were asserted against us based upon the acquisition of a property, we may have to pay substantial sums to settle it, which could adversely affect our cash flow. Unknown liabilities with respect to properties acquired might include: liabilities for cleanup of undisclosed environmental contamination; • • claims by tenants, vendors or other persons dealing with the former owners of the properties; • • claims for indemnification by general partners, directors, officers and others indemnified by the former owners liabilities incurred in the ordinary course of business; and of the properties. We face new and different risks associated with property development. The ground-up development of Rosslyn Towers, South Washington Street and Dulles Station, as opposed to renovation and redevelopment of an existing property, is a relatively new activity for WRIT. Developing properties, in addition to the risks historically associated with our business, presents a number of new and additional risks for us, including risks that: • the development opportunity may be abandoned after expending significant resources, if we are unable to obtain all necessary zoning and other required governmental permits and authorizations; • the development and construction costs of the project may exceed original estimates; • construction and/or permanent financing may not be available on favorable terms or may not be available at all; • the project may not be completed on schedule as a result of a variety of factors, many of which are beyond our control, such as weather, labor conditions and material shortages, which would result in increases in construction costs and debt service expenses; and • occupancy rates and rents at the newly completed property may not meet the expected levels and could be insufficient to make the property profitable. Properties developed or acquired for development may generate little or no cash flow from the date of acquisition through the date of completion of development. In addition, new development activities, regardless of whether or not they are ultimately successful, may require a substantial portion of management’s time and attention. We face potential difficulties or delays renewing leases or re-leasing space. From 2006 through 2010, leases on our office, medical office, retail and industrial properties will expire on a total of approximately 69% of our leased square footage as of December 31, 2005, with leases on approximately 14% of our leased square footage expiring in 2006, 11% in 2007, 15% in 2008, 14% in 2009 and 15% in 2010. We derive substantially all of our income from rent received from tenants. Also, when our tenants decide not to renew their leases, we may not be able to re-let the space. If tenants decide to renew their leases, the terms of renewals, including the cost of required improvements or concessions, may be less favorable than current lease terms. As a result, our cash flow could decrease and our ability to make distributions to our shareholders could be adversely affected. Residential properties are leased under operating leases with terms of generally one year or less. For the years ended 2005, 2004 and 2003, the residential tenant retention rate was 57%, 59% and 53%, respectively. Washington Real Estate Investment Trust and Subsidiaries 17 We face potential adverse effects from major tenants’ bankruptcies or insolvencies. The bankruptcy or insolvency of a major tenant may adversely affect the income produced by a property. Although we have not experienced material losses from tenant bankruptcies or insolvencies in the past, a major tenant could file for bankruptcy protection or become insolvent in the future. We cannot evict a tenant solely because of its bankruptcy. On the other hand, a court might authorize the tenant to reject and terminate its lease. In such case, our claim against the bankrupt tenant for unpaid, future rent would be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease, and our claim for unpaid rent would likely not be paid in full. This shortfall could adversely affect our cash flow and results from operations. If a tenant experiences a downturn in its business or other types of financial distress, it may be unable to make timely rental payments. Our properties face significant competition. We face significant competition from developers, owners and operators of office, medical office, industrial, multifamily, retail and other commercial real estate. Substantially all of our properties face competition from similar properties in the same market. Such competition may affect our ability to attract and retain tenants and may reduce the rents we are able to charge. These competing properties may have vacancy rates higher than our properties, which may result in their owners being willing to make space available at lower prices than the space in our properties. Compliance or failure to comply with the americans with Disabilities act and other laws could result in substantial costs. The Americans with Disabilities Act generally requires that public buildings, including commercial and multifamily properties, be made accessible to disabled persons. Noncompliance could result in imposition of fines by the Federal government or the award of damages to private litigants. If, pursuant to the Americans with Disabilities Act, we are required to make substantial alterations and capital expenditures in one or more of our properties, including the removal of access barriers, it could adversely affect our financial condition and results of operations, as well as the amount of cash available for distribution to our shareholders. We may also incur significant costs complying with other regulations. Our properties are subject to various federal, state and local regulatory requirements, such as state and local fire and life safety requirements. If we fail to comply with these requirements, we may incur fines or private damage awards. We believe that our properties are currently in material compliance with all of these regulatory requirements. However, we do not know whether existing requirements will change or whether compliance with future requirements will require significant unanticipated expenditures that will adversely affect our cash flow and results of operations. Some potential losses are not covered by insurance. We carry insurance coverage on our properties of types and in amounts that we believe are in line with coverage customarily obtained by owners of similar properties. We believe all of our properties are adequately insured. The property insurance that we maintain for our properties has historically been on an “all risk” basis, which is in full force and effect until renewal in September 2007. There are other types of losses, such as from wars or catastrophic acts of nature, for which we cannot obtain insurance at all or at a reasonable cost. In the event of an uninsured loss or a loss in excess of our insurance limits, we could lose both the revenues generated from the affected property and the capital we have invested in the affected property. Depending on the specific circumstances of the affected property, it is possible that we could be liable for any mortgage indebtedness or other obligations related to the property. Any such loss could adversely affect our business and financial condition and results of operations. 18 Washington Real Estate Investment Trust and Subsidiaries Also, we have to renew our policies in most cases on an annual basis and negotiate acceptable terms for coverage, exposing us to the volatility of the insurance markets, including the possibility of rate increases. Any material increase in insurance rates or decrease in available coverage in the future could adversely affect our results of operations and financial condition. Potential liability for environmental contamination could result in substantial costs. Under Federal, state and local environmental laws, ordinances and regulations, we may be required to investigate and clean up the effects of releases of hazardous or toxic substances or petroleum products at our properties, regardless of our knowledge or responsibility, simply because of our current or past ownership or operation of the real estate. In addition, the U.S. Environmental Protection Agency and the U.S. Occupational Safety and Health Administration are increasingly involved in indoor air quality standards, especially with respect to asbestos, mold and medical waste. The cleanup of any environmental contamination, including asbestos and mold, can be costly. If unidentified environmental problems arise, we may have to make substantial payments which could adversely affect our cash flow, because: • as owner or operator we may have to pay for property damage and for investigation and cleanup costs incurred in connection with the contamination; • the law typically imposes cleanup responsibility and liability regardless of whether the owner or operator knew of or caused the contamination; • even if more than one person may be responsible for the contamination, each person who shares legal liability under the environmental laws may be held responsible for all of the cleanup costs; and • governmental entities and third parties may sue the owner or operator of a contaminated site for damages and costs. These costs could be substantial and in extreme cases could exceed the value of the contaminated property. The presence of hazardous or toxic substances or petroleum products or the failure to properly remediate contamination may adversely affect our ability to borrow against, sell or rent an affected property. In addition, applicable environmental laws create liens on contaminated sites in favor of the government for damages and costs it incurs in connection with a contamination. We have a storage tank third-party liability, corrective action and cleanup policy in place to cover potential hazardous releases from underground storage tanks on our properties. This insurance is in place to mitigate any potential remediation costs from the effect of releases of hazardous or toxic substances from these storage tanks. Additional coverage is in place under a pollution legal liability real estate policy. This would, dependent on circumstance and type of pollutants discovered, provide further coverage above and beyond the storage tank policy. Environmental laws also govern the presence, maintenance and removal of asbestos. Such laws require that owners or operators of buildings containing asbestos: • properly manage and maintain the asbestos; • notify and train those who may come into contact with asbestos; and • undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. Such laws may impose fines and penalties on building owners or operators who fail to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers. Washington Real Estate Investment Trust and Subsidiaries 19 It is our policy to retain independent environmental consultants to conduct Phase I environmental site assessments and asbestos surveys with respect to our acquisition of properties. These assessments generally include a visual inspection of the properties and the surrounding areas, an examination of current and historical uses of the properties and the surrounding areas, and a review of relevant state, Federal and historical documents, but do not involve invasive techniques such as soil and ground water sampling. Where appropriate, on a property-by-property basis, our practice is to have these consultants conduct additional testing, including sampling for asbestos, for mold, for lead in drinking water, for soil contamination where underground storage tanks are or were located or where other past site usages create a potential environmental problem, and for contamination in groundwater. Even though these environmental assessments are conducted, there is still the risk that: • the environmental assessments and updates did not identify all potential environmental liabilities; • a prior owner created a material environmental condition that is not known to us or the independent consultants preparing the assessments; • new environmental liabilities have developed since the environmental assessments were conducted; and • future uses or conditions such as changes in applicable environmental laws and regulations could result in environmental liability to us. Recently enacted changes in securities laws are likely to increase our costs. The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission, have required change in some of our corporate governance and accounting practices. In addition, the New York Stock Exchange has promulgated a number of regulations. We expect these laws, rules and regulations to increase our legal and financial compliance costs and to make some activities more difficult, time consuming and costly. We also expect these new rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur significantly higher costs to obtain coverage. These new laws, rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of trustees, particularly to serve on our audit committee, and qualified executive officers. We face risks associated with the use of debt to fund acquisitions and developments, including refinancing risk. We rely on borrowings under our credit facilities to finance acquisitions and development activities and for working capital. If we were unable to borrow under our credit facilities, or to refinance existing indebtedness, our financial condition and results of operations would likely be adversely affected. We are subject to the risks normally associated with debt financing, including the risk that our cash flow may be insufficient to meet required payments of principal and interest. We anticipate that only a small portion of the principal of our debt will be repaid prior to maturity. Therefore, we are likely to need to refinance at least a portion of our outstanding debt as it matures. There is a risk that we may not be able to refinance existing debt or that the terms of any refinancing will not be as favorable as the terms of the existing debt. If principal payments due at maturity cannot be refinanced, extended or repaid with proceeds from other sources, such as new equity capital, our cash flow will not be sufficient to repay all maturing debt in years when significant “balloon” payments come due. Rising interest rates would increase our interest costs. We may incur indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will our interest costs, which could adversely affect our cash flow and our ability to service debt. As a protection against 20 Washington Real Estate Investment Trust and Subsidiaries rising interest rates, we may enter into agreements such as interest rate swaps, caps, floors and other interest rate exchange contracts. These agreements, however, increase our risks, including other parties to the agreements not performing or the agreements proving unenforceable. Covenants in our debt agreements could adversely affect our financial condition. Our credit facilities contain customary restrictions, requirements and other limitations on our ability to incur indebtedness. We must maintain certain ratios, including total debt to assets, secured debt to total assets, debt service coverage and minimum ratios of unencumbered assets to unsecured debt. Our ability to borrow under our credit facilities is subject to compliance with our financial and other covenants. Failure to comply with any of the covenants under our unsecured credit facilities or other debt instruments could result in a default under one or more of our debt instruments. This could cause our lenders to accelerate the timing of payments and would therefore have a material adverse effect on our business, operations, financial condition and liquidity. Further issuances of equity securities may be dilutive to current shareholders. The interests of our existing shareholders could be diluted if additional equity securities are issued to finance future developments and acquisitions instead of incurring additional debt. Our ability to execute our business strategy depends on our access to an appropriate blend of debt financing, including unsecured lines of credit and other forms of secured and unsecured debt, and equity financing. Failure to qualify as a ReIt would cause us to be taxed as a corporation, which would substantially reduce funds available for payment of dividends. If we fail to qualify as a REIT for federal income tax purposes, we would be taxed as a corporation. We believe that we are organized and qualified as a REIT and intend to operate in a manner that will allow us to continue to qualify as a REIT. If we fail to qualify as a REIT, we could face serious tax consequences that could substantially reduce the funds available for payment of dividends for each of the years involved because: • we would not be allowed a deduction for dividends paid to shareholders in computing our taxable income and could be subject to federal income tax at regular corporate rates; • we also could be subject to the Federal alternative minimum tax and possibly increased state and local taxes; • unless we are entitled to relief under statutory provisions, we could not elect to be subject to tax as a REIT for four taxable years following the year during which we are disqualified; and • all dividends would be subject to tax as ordinary income to the extent of our current and accumulated earnings and profits and potentially eligible as “qualified dividends” subject to the 15% income tax rate. In addition, if we fail to qualify as a REIT, we would no longer be required to pay dividends. As a result of these factors, our failure to qualify as a REIT could impair our ability to expand our business and raise capital and could adversely affect the value of our shares. Washington Real Estate Investment Trust and Subsidiaries 21 the market value of our securities can be adversely affected by many factors. As with any public company, a number of factors may adversely influence the public market price of our common shares, many of which are beyond our control. These factors include: level of institutional interest in us; • • perception of REITs generally and REITs with portfolios similar to ours, in particular, by market professionals; • attractiveness of securities of REITs in comparison to other companies taking into account, among other things, that a substantial portion of REITs’ dividends are taxed as ordinary income; • our financial condition and performance; • the market’s perception of our growth potential and potential future cash dividends; • government action or regulation, including changes in tax law; • increases in market interest rates, which may lead investors to expect a higher annual yield from our distributions in relation to the price of our shares; and • relatively low trading volume of shares of REITs in general, which tends to exacerbate a market trend with respect to our stock. IteM 1B. UNReSOLVeD StaFF COMMeNtS None. 22 Washington Real Estate Investment Trust and Subsidiaries IteM 2. PROPeRtIeS The schedule on the following pages lists our real estate investment portfolio as of December 31, 2005, which consisted of 68 properties. As of December 31, 2005, the percent leased is the percentage of net rentable area for which fully executed leases exist and may include signed leases for space not yet occupied by the tenant. Cost information is included in Schedule III to our financial statements included in this Annual Report on Form 10-K. SCHeDULe OF PROPeRtIeS Properties Location Year Acquired Year Constructed Net Rentable Square Feet Percent Leased 12/31/05 Office Buildings 1901 Pennsylvania Avenue 51 Monroe Street 515 King Street The Lexington Building The Saratoga Building Brandywine Center 6110 Executive Boulevard 1220 19th Street Maryland Trade Center I Maryland Trade Center II 1600 Wilson Boulevard 7900 Westpark Drive 600 Jefferson Plaza 1700 Research Boulevard Parklawn Plaza Wayne Plaza Courthouse Square One Central Plaza The Atrium Building 1776 G Street Albemarle Point Subtotal Washington, DC Rockville, MD Alexandria, VA Rockville, MD Rockville, MD Rockville, MD Rockville, MD Washington, DC Greenbelt, MD Greenbelt, MD Arlington, VA McLean, VA Rockville, MD Rockville, MD Rockville, MD Silver Spring, MD Alexandria, VA Rockville, MD Rockville, MD Washington, DC Chantilly, VA 1977 1979 1992 1993 1993 1993 1995 1995 1996 1996 1997 1997 1999 1999 1999 2000 2000 2001 2002 2003 2005 1960 1975 1966 1970 1977 1969 1971 1976 1981 1984 1973 1972/’86/’991 1985 1982 1986 1970 1979 1974 1980 1979 2001 97,000 208,000 78,000 46,000 59,000 35,000 199,000 102,000 190,000 158,000 166,000 521,000 115,000 103,000 40,000 91,000 113,000 267,000 81,000 262,000 90,000 3,021,000 92% 96% 78% 64% 99% 94% 85% 100% 93% 88% 90% 84% 89% 95% 100% 100% 98% 94% 96% 100% 89% 91% Washington Real Estate Investment Trust and Subsidiaries 23 SCHeDULe OF PROPeRtIeS (Continued) Properties Location Year Acquired Year Constructed Net Rentable Square Feet Percent Leased 12/31/05 Medical Office Buildings Woodburn Medical Park I Woodburn Medical Park II Prosperity Medical Center I Prosperity Medical Center II Prosperity Medical Center III Shady Grove Medical Village II 8301 Arlington Boulevard Subtotal Retail Centers Takoma Park Westminster Concord Centre Wheaton Park Bradlee Chevy Chase Metro Plaza Montgomery Village Center Shoppes of Foxchase2 Frederick County Square 800 S. Washington Street3 Centre at Hagerstown Frederick Crossing Subtotal Annandale, VA Annandale, VA Merrifield, VA Merrifield, VA Merrifield, VA Rockville, MD Fairfax, VA Takoma Park, MD Westminster, MD Springfield, VA Wheaton, MD Alexandria, VA Washington, DC Gaithersburg, MD Alexandria, VA Frederick, MD Alexandria, VA Hagerstown, MD Frederick, MD Multifamily Buildings/# units 3801 Connecticut Avenue/306 Roosevelt Towers/190 Country Club Towers/227 Park Adams/200 Washington, DC Falls Church, VA Arlington, VA Arlington, VA Munson Hill Towers/279 Falls Church, VA The Ashby at McLean/254 McLean, VA Walker House Apartments/212 Gaithersburg, MD Bethesda Hill Apartments/194 Bethesda, MD Avondale/237 Subtotal (2,099 units) Laurel, MD 1998 1998 2003 2003 2003 2004 2004 1963 1972 1973 1977 1984 1985 1992 1994 1995 1998/’032 2002 2005 1963 1965 1969 1969 1970 1996 1996 1997 1999 1984 1988 2000 2001 2002 1999 1965 1962 1969 1960 1967 1955 1975 1969 1960 1973 1955/’59 2000 1999/’03 1951 1964 1965 1959 1963 1982 1971/’034 1986 1987 71,000 96,000 92,000 88,000 75,000 66,000 50,000 538,000 51,000 146,000 76,000 72,000 168,000 50,000 198,000 128,000 227,000 45,000 334,000 295,000 1,790,000 177,000 168,000 159,000 172,000 259,000 244,000 154,000 226,000 170,000 1,729,000 97% 100% 100% 100% 100% 100% 88% 99% 100% 90% 100% 100% 100% 100% 99% 97% 100% 100% 100% 100% 99% 91% 89% 96% 92% 90% 81% 95% 92% 94% 91% 24 Washington Real Estate Investment Trust and Subsidiaries SCHeDULe OF PROPeRtIeS (Continued) Properties Location Industrial Distribution/Flex Properties Fullerton Business Center Charleston Business Center Tech 100 Industrial Park Crossroads Distribution Center The Alban Business Center The Earhart Building Ammendale Technology Park I Ammendale Technology Park II Pickett Industrial Park Northern Virginia Industrial Park 8900 Telegraph Road Dulles South IV Sully Square Amvax Sullyfield Center Springfield, VA Rockville, MD Elkridge, MD Elkridge, MD Springfield, VA Chantilly, VA Beltsville, MD Beltsville, MD Alexandria, VA Lorton, VA Lorton, VA Chantilly, VA Chantilly, VA Beltsville, MD Chantilly, VA Fullerton Industrial Center Springfield, VA 8880 Gorman Road Dulles Business Park Portfolio Albemarle Point Subtotal TOTAL Laurel, MD Chantilly, VA Chantilly, VA Year Acquired Year Constructed Net Rentable Square Feet Percent Leased 12/31/05 1985 1993 1995 1995 1996 1996 1997 1997 1997 1998 1998 1999 1999 1999 2001 2003 2004 2004 2005 1980 1973 1990 1987 1981/’82 1987 1985 1986 1973 1968/’91 1985 1988 1986 1986 1985 1980 2000 1999–2004 2001/’03/’05 104,000 85,000 167,000 85,000 87,000 93,000 167,000 108,000 246,000 788,000 32,000 83,000 95,000 31,000 245,000 137,000 141,000 325,000 206,000 3,225,000 10,303,000 100% 93% 88% 70% 100% 100% 91% 76% 100% 94% 100% 100% 49% 100% 100% 83% 100% 99% 100% 93% 1 A 49,000 square foot addition to 7900 Westpark Drive was completed in September 1999. 2 Approximately 60,000 square feet of the center is under development. 3 South Washington Street includes 718 E. Jefferson Street, acquired in May 2003 to complete the ownership of the entire block of 800 S. Washington Street. 4 A 16-unit addition referred to as The Gardens at Walker House was completed in October 2003. * Multifamily buildings are presented in gross square feet. Washington Real Estate Investment Trust and Subsidiaries 25 IteM 3. LegaL PROCeeDINgS None. IteM 4. SUBMISSION OF MatteRS tO a VOte OF SeCURItY HOLDeRS No matters were submitted to a vote of security holders during the fourth quarter of 2005. 26 Washington Real Estate Investment Trust and Subsidiaries paRT II IteM 5. MaRKet FOR tHe RegIStRaNt’S COMMON eQUItY, ReLateD StOCKHOLDeR MatteRS aND ISSUeR PURCHaSeS OF eQUItY SeCURItIeS Our shares trade on the New York Stock Exchange. Currently, there are approximately 47,300 shareholders. The high and low sales price for our shares for 2005 and 2004, by quarter, and the amount of dividends we paid per share are as follows: Dividends Per Share Quarterly Share Price Range High Low $.4025 $.4025 $.4025 $.3925 $.3925 $.3925 $.3925 $.3725 $32.00 $33.69 $32.54 $33.95 $34.48 $31.47 $32.95 $32.50 $28.36 $29.42 $28.70 $27.65 $30.17 $27.31 $25.21 $28.10 Quarter 2005 Fourth Third Second First 2004 Fourth Third Second First We have historically paid dividends on a quarterly basis. Dividends are normally paid based on our cash flow from operating activities. During the period covered by this report, we did not sell any equity securities without registration under the Securities Act. Neither we nor any affiliated purchaser (as that term is defined in Securities Exchange Act Rule 10b-18(a)(3)) made any repurchases of our shares during the fourth quarter of the fiscal years covered by this report. Washington Real Estate Investment Trust and Subsidiaries 27 IteM 6. SeLeCteD FINaNCIaL Data (in thousands, except per share data) Real estate rental revenue Income from continuing operations 2005 $ 190,046 $ 40,443 2004 $ 171,646 $ 40,641 2003 $153,576 $ 40,558 2002 $141,136 $ 41,725 2001 $134,775 $ 40,496 Discontinued Operations: Income from operations of properties sold or held for sale Gain on property disposed Income before gain on sale of $ $ 184 37,011 $ $ 3,894 1,029 $ 4,329 — $ 6,273 $ 3,838 $ 7,561 — real estate $ 77,638 $ 45,564 $ 44,887 $ 51,836 Gain on sale of real estate — — — — Net income $ 77,638 $ 45,564 $ 44,887 $ 51,836 Income per share from continuing operations—diluted Earnings per share—diluted Total assets Lines of credit payable Mortgage notes payable Notes payable Shareholders’ equity Cash dividends paid Cash dividends paid per share $ $ 0.96 1.84 $1,141,285 $ 24,000 $ 169,617 $ 520,000 $ 380,305 $ $ 67,322 1.60 $ $ 0.97 1.09 $1,012,393 $ 117,000 $ 173,429 $ 320,000 $ 366,009 $ $ 64,836 1.55 $ $ 1.02 1.13 $928,089 — $142,182 $375,000 $378,748 $ 58,605 $ 1.47 $ $ 1.06 1.32 $756,299 $ 50,750 $ 86,951 $265,000 $326,177 $ 54,352 $ 1.39 $ 48,057 $ 4,296 $ 52,353 $ $ 1.08 1.38 $707,935 — $ 94,726 $265,000 $323,607 $ 49,686 $ 1.31 IteM 7. MaNageMeNt’S DISCUSSION aND aNaLYSIS OF FINaNCIaL CONDItION aND ReSULtS OF OPeRatIONS The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate these estimates, including those related to estimated useful lives of real estate assets, estimated fair value of acquired leases, cost reimbursement income, bad debts, contingencies and litigation. We base the estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from those estimates. Overview Our revenues are derived primarily from the ownership and operation of income-producing real properties in the greater Washington/Baltimore region. As of December 31, 2005, we owned a diversified portfolio of 68 properties, consisting of 21 office buildings, 7 medical office buildings, 12 retail centers, 9 multifamily buildings and 19 industrial complexes totaling 10.3 million net rentable square feet. We also hold land for development. We have a fundamental strategy of regional focus, diversification by property type and conservative capital management. 28 Washington Real Estate Investment Trust and Subsidiaries When evaluating our financial condition and operating performance, management focuses on the following financial and non-financial indicators, discussed in further detail herein: • Net Operating Income (“NOI”) by segment. NOI is calculated as real estate rental revenue less real estate operating expenses. It is a supplemental measure to Net Income. • Economic occupancy (or “occupancy”—defined as actual rental revenues recognized for the period indicated as a percentage of gross potential rental revenues for that period), leased percentage (the percentage of available physical net rentable area leased for our commercial segments and percentage of apartment units leased for our residential segment) and rental rates. • Leasing activity—new leases, renewals and expirations. • Funds From Operations (“FFO”), a supplemental measure to Net Income. During 2005 we continued our long-standing strategy of focusing in the greater Washington/Baltimore region, one of the most stable real estate markets in the country. The region posted positive job growth of approximately 3.0% in the twelve months ended November 2005 and an unemployment rate of 3.3%, compared to the national average of 5.0%. The job growth occurred principally in the professional/business services, retail and construction sectors. This is a positive sign for continued economic growth in the region. Overall conditions in the region improved during the year, with continued strength in the retail sector and stabilizing rents in the office and industrial sectors, as the multifamily sector began to benefit from the overall market conditions. Overall occupancies as well as our results in 2005 were primarily impacted by the $229.1 million in acquisitions we completed in 2004 and 2005, the dispositions of $83.5 million and the performance of our core portfolio (consisting of properties owned for the entirety of 2005 and the same time period in 2004), which improved slightly compared to 2004. The performance of our five operating segments generally reflected market conditions in our region: • The regional office market, particularly Northern Virginia, improved during the year. While leasing activity increased, rental rates generally remained flat to slightly up due to remaining vacant space. Our Northern Virginia office portfolio was 87% leased, compared to 98% in our Washington, D.C. portfolio and 93% in the Maryland portfolio. The Washington, D.C. office market led the region in overall occupancy and development activity and experienced moderate rental rate growth due to strong market conditions. Overall leasing activity in the suburban Maryland market improved; however, rental rates were generally flat to down depending on the submarket, as the pace of economic recovery was slower than anticipated and National Institutes of Health and its subcontractors showed little demand. • The medical office market is excellent, with little to no new construction activity and strong demand. This is reflected in our medical office portfolio, which is 99% leased at year-end. • The neighborhood and community shopping center market remained strong in the region due to continued job growth spurring high occupancies and strong sales, as was reflected in our retail portfolio, which was 99% leased at year-end. • The multifamily market is in strong condition due to the healthy job market and low unemployment rate combined with decreasing supply due to condo conversions. The multifamily portfolio was 91% occupied as of December 31, 2005. • The industrial market benefited from the region’s strengthening economy during the year, particularly in the Baltimore/Washington and Dulles corridors, with positive absorption and increased rents. Our industrial portfolio was 93% leased at year-end. Washington Real Estate Investment Trust and Subsidiaries 29 During 2005 development continued on Phase I of Rosslyn Towers, our mixed-use residential and retail community in Virginia. We began development at South Washington Street and redevelopment at Foxchase Shopping center, both in Alexandria, Virginia, and started the planning, late in the year, for the development of Dulles Station, acquired in December 2005. Significant transactions during the two years ended December 31, 2005, are summarized below: 2005 • The acquisition of one retail property, for a purchase price of $44.8 million, adding approximately 295,000 square feet of rentable retail space which was 100% leased as of the end of 2005, one industrial property for a purchase price of $8.8 million, adding approximately 60,000 square feet of rentable industrial space which was 100.0% leased as of the end of 2005 and one office and industrial property for a purchase price of $66.8 million, adding approximately 90,000 square feet of rentable office space and approximately 206,000 square feet of rentable industrial space which was 97% leased as of the end of 2005. The acquisition of land for $24.7 million for the development of a 540,000 square foot office complex with an estimated completion date for the first building, 185,000 square feet, in the second quarter 2007. • The disposition of one industrial and three office properties, totaling approximately 480,000 square feet, for a gain of approximately $35.1 million and the recognition of a previously deferred gain of $1.9 million from the sale of an office property in November 2004. • The extension and increase of our line of Credit Facility No. 2 until 2008 for $70 million. • The issuance of $50.0 million of 5.05% senior unsecured notes due May 1, 2012, and $50.0 million of 5.35% senior unsecured notes due May 1, 2015, at effective yields of 5.064% and 5.359%, respectively. On October 3, 2005, we reopened the series of 5.35% senior unsecured notes and issued an additional $100 million of notes. • The investment of $17.3 million in the major development and redevelopment of several properties. • The execution of new leases for 1,720,000 square feet of office, medical office, retail and industrial space, combined. 2004 • The acquisitions of two industrial properties for an aggregate purchase price of $57.5 million, adding approximately 406,000 square feet of industrial rental space, and two medical office properties for an aggregate price of $26.5 million, adding approximately 116,000 square feet of medical office rental space. • The disposition of 8230 Boone Boulevard, a 58,000 square foot office property, for a sale price of $10.0 million and a gain of $1.0 million. • The execution of new leases for 1,799,000 square feet of office, medical office, retail and industrial space combined. • The execution of a new $85.0 million line of credit with Bank One, NA and Wells Fargo Bank, National Association that replaced the previous $25.0 million facility with Bank One, NA. • The repayment of $55.0 million of 7.78% unsecured notes in November 2004. Critical accounting Policies and estimates We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Our significant accounting policies are described in Note 2 in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. 30 Washington Real Estate Investment Trust and Subsidiaries Revenue Recognition Residential properties are leased under operating leases with terms of generally one year or less, and commercial properties are leased under operating leases with average terms of three to seven years. We recognize rental income and rental abatements from our residential and commercial leases when earned on a straight-line basis in accordance with SFAS No. 13, “Accounting for Leases.” Recognition of rental income commences when control of the facility has been given to the tenant. We record a provision for losses on accounts receivable equal to the estimated uncollectible amounts. This estimate is based on our historical experience and a review of the current status of the company’s receivables. Percentage rents, which represent additional rents based on gross tenant sales, are recognized when tenants’ sales exceed specified thresholds. In accordance with SFAS No. 66, “Accounting for Sales of Real Estate,” sales are recognized at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to the buyer and we have no significant continuing involvement. We recognize cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements. Capital Expenditures We capitalize those expenditures related to acquiring new assets, significantly increasing the value of an existing asset, or substantially extending the useful life of an existing asset. In addition, we capitalize tenant leasehold improvements when certain conditions are met, including when we supervise construction and will own the improvements. Expenditures necessary to maintain an existing property in ordinary operating condition are expensed as incurred. Real Estate Assets Real estate assets are depreciated on a straight-line basis over estimated useful lives ranging from 28 to 50 years. All capital improvement expenditures associated with replacements, improvements, or major repairs to real property are depreciated using the straight-line method over their estimated useful lives ranging from 3 to 30 years. All tenant improvements are amortized over the shorter of the useful life or the term of the lease. We allocate the purchase price of acquired properties to the related physical assets and in-place leases based on their relative fair values, in accordance with SFAS No. 141, “Business Combinations.” The fair values of acquired buildings are determined on an “as-if-vacant” basis considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. The “as-if-vacant” fair value is allocated to land, building and tenant improvements based on property tax assessments and other relevant information obtained in connection with the acquisition of the property. The fair value of in-place leases consists of the following components—(1) the estimated cost to us to replace the leases, including foregone rents during the period of finding a new tenant, foregone recovery of tenant pass- throughs, tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as “Tenant Origination Cost”); (2) estimated leasing commissions associated with obtaining a new tenant (referred to Washington Real Estate Investment Trust and Subsidiaries 31 as “Leasing Commissions”); (3) the above/at/below market cash flow of the leases, determined by comparing the projected cash flows of the leases in place to projected cash flows of comparable market-rate leases (referred to as “Net Lease Intangible”); and (4) the value, if any, of customer relationships, determined based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the tenant (referred to as “Customer Relationship Value”). The amounts used to calculate Tenant Origination Cost, Leasing Commissions and Net Lease Intangible are discounted using an interest rate which reflects the risks associated with the leases acquired. Tenant Origination Costs are included in Real Estate Assets on our balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. Leasing Commissions are classified as Other Assets and are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. The aggregate value of the cash flow for above market leases results in Net Lease Intangible Assets which are classified as Other Assets and are amortized on a straight-line basis as a decrease to Real Estate Rental Revenue over the remaining term of the underlying leases. The aggregate value of the cash flow for below market leases results in Net Lease Intangible Liabilities which are classified as Other Liabilities and are amortized on a straight-line basis as an increase to Real Estate Rental Revenue over the remaining term of the underlying leases. The aggregate value of the cash flow of leases at market results in no additional assets or liabilities. Discontinued Operations We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and where market conditions for sale are favorable. The proceeds from the sales are reinvested into other properties, used to fund development operations or to support other corporate needs, or are distributed to our shareholders. We classify properties as held for sale when they meet the necessary criteria specified by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. These include: senior management commits to and actively embarks upon a plan to sell the assets, the sale is expected to be completed within one year under terms usual and customary for such sales and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Depreciation on these properties is discontinued, but operating revenues, operating expenses and interest expense continue to be recognized until the date of sale. Under SFAS No. 144, revenues and expenses of properties that are either sold or classified as held for sale are treated as discontinued operations for all periods presented in the Statements of Income. Impairment Losses on Long-Lived Assets We recognize impairment losses on long-lived assets used in operations when indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. If such carrying amount is in excess of the estimated cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to the estimated fair market value. There were no property impairments recognized during the three-year period ended December 31, 2005. 32 Washington Real Estate Investment Trust and Subsidiaries Federal Income Taxes We believe that we qualify as a REIT under Sections 856–860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute 90% of our ordinary taxable income to our shareholders. We have the option of (i) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (ii) paying out capital gains to the shareholders with no tax to the company or (iii) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. We distributed 100% of our 2005 and 2004 ordinary taxable income, and the gains from the property disposed in 2004, to shareholders. $33.5 million of the gains from property disposed in 2005 was reinvested in replacement properties. Approximately $3.5 million of gains from disposed property in 2005 was distributed to shareholders. We distributed 100% of our 2003 ordinary taxable income to our shareholders. No provision for income taxes was necessary during the three-year period ended December 31, 2005. ReSULtS OF OPeRatIONS The discussion that follows is based on our consolidated results of operations for the years ended December 31, 2005, 2004 and 2003. The ability to compare one period to another may be significantly affected by acquisitions completed and dispositions made during those years. For purposes of evaluating comparative operating performance, we categorize our properties as “core,” “non-core” or Discontinued Operations. A “core” property is one that was owned for the entirety of the periods being evaluated and is included in continuing operations. A “non-core” property is one that was acquired during either of the periods being evaluated and is included in continuing operations. Results for properties sold or held for sale during any of the periods evaluated are classified as Discontinued Operations. To provide more insight into our operating results, our discussion is divided into two main sections: (1) Consolidated Results of Operations, where we provide an overview analysis of results on a consolidated basis, and (2) Net Operating Income (“NOI”), where we provide a detailed analysis of core versus non-core property-level NOI results by segment. NOI is calculated as real estate rental revenue less real estate operating expenses. Consolidated Results of Operations Real estate Rental Revenue Real estate rental revenue is summarized as follows (all data in thousands except percentage amounts): Minimum base rent Recoveries from tenants Parking and other tenant charges 2005 $170,038 2004 $154,956 2003 $139,035 2005 vs 2004 $15,082 % Change 9.7% 2004 vs 2003 $15,921 % Change 11.4% 15,482 4,526 11,989 4,701 9,885 4,656 3,493 29.1% 2,104 21.2% (175) (3.7%) 45 1.0% $190,046 $171,646 $153,576 $18,400 10.7% $18,070 11.8% Real estate rental revenue is comprised of (1) minimum base rent, which includes rental revenues recognized on a straight-line basis, (2) revenue from the recovery of operating expenses from our tenants and (3) other revenue such as parking and termination fees and percentage rents. Washington Real Estate Investment Trust and Subsidiaries 33 Minimum base rent increased $15.1 million (9.7%) in 2005 as compared to 2004 and $15.9 million (11.4%) in 2004 as compared to 2003. The increase in minimum base rent in 2005 was due primarily to the increase in rent from properties acquired in 2004 and 2005 ($12.5 million), combined with a $2.6 million increase in minimum base rent from core properties due to lower vacancies and rental rate increases in the retail, industrial and multifamily sectors. The increase in minimum base rent in 2004 was due primarily to the increase in rent from properties acquired in 2004 ($1.8 million) and 2003 ($13.1 million), combined with a $1.0 million increase in minimum base rent from core properties due to rental rate increases and lower vacancies in the office and retail sectors. A summary of economic occupancy for properties classified as continuing operations by sector follows: Consolidated economic Occupancy Sector Office Medical Office Retail Multifamily Industrial Total 2005 88.1% 98.4% 97.6% 93.2% 94.5% 92.4% 2004 89.2% 98.2% 94.8% 90.5% 92.7% 91.4% 2003 88.9% 97.4% 96.0% 90.8% 87.9% 90.6% 2005 vs 2004 (1.1%) 0.2% 2.8% 2.7% 1.8% 1.0% 2004 vs 2003 0.3% 0.8% (1.2%) (0.3%) 4.8% 0.8% Our overall economic occupancy increased 100 basis points in 2005 as compared to 2004 and increased 80 basis points in 2004 as compared to 2003. Property acquisitions in the industrial and retail sectors and decreased vacancy in the multifamily sector, partially offset by higher vacancies in the office sector, accounted for the increase in overall economic occupancy in 2005. Acquisitions of highly occupied properties and increased industrial leasing activity, partially offset by higher vacancies in the multifamily and retail sectors, accounted for the increase in 2004. A detailed discussion of occupancy by sector can be found in the Net Operating Income section. Recoveries from tenants increased $3.5 million (29.1%) in 2005 as compared to 2004 and $2.1 million (21.2%) in 2004 as compared to 2003. The increase in recoveries from tenants in 2005 was due primarily to increased recovery income from core properties ($1.7 million) due to higher operating expense, utilities, common area maintenance, real estate taxes and from properties acquired in 2005 and 2004 ($1.8 million). The increase in recoveries from tenants in 2004 was due primarily to recoveries from properties acquired in 2003 and 2004 ($0.8 million) and a $1.3 million increase in recoveries from core properties due to higher common area maintenance, real estate tax and operating expenses. Parking and other tenant charges decreased $0.2 million in 2005 as compared to 2004 and were flat in 2004 as compared to 2003. The decrease in parking and other charges in 2005 was driven by core properties due primarily to lower percentage rent. 34 Washington Real Estate Investment Trust and Subsidiaries Real estate Operating expenses Real estate operating expenses are summarized as follows (all data in thousands except percentage amounts): Property operating expenses Real estate taxes 2005 $42,158 15,958 2004 $37,266 14,062 2003 $32,743 11,884 $58,116 $51,328 $44,627 2005 vs 2004 $4,892 1,896 $6,788 % Change 13.1% 13.5% 13.2% 2004 vs 2003 $4,523 2,178 $6,701 % Change 13.8% 18.3% 15.0% Property operating expenses include utilities, repairs and maintenance, property administration and management, operating services, common area maintenance and other operating expenses. Real estate operating expenses as a percentage of revenue were 30.6% for 2005, 29.9% for 2004 and 29.1% for 2003. Properties acquired in 2004 and 2005 accounted for $2.1 million (43.5%) of the $4.9 million increase in 2005 property operating expenses. Core property operating expenses increased $2.9 million as a result of higher utility costs due largely to rate increases and energy taxes, increased administrative expenditures and higher repairs and maintenance costs. Real estate taxes increased $1.9 million due primarily to the properties acquired in 2004 and 2005, which accounted for $1.1 million (59.1%) of the increase. The remainder of the increase in real estate taxes was due primarily to higher value assessments among our core properties. Property acquisitions in 2004 and 2003 accounted for $2.7 million (60%) of the $4.5 million increase in property operating expenses in 2004. Core property operating expenses increased $1.8 million as a result of higher utility costs due largely to rate increases and an increase in the Montgomery County, Maryland energy tax, increased security related expenditures and higher repairs and maintenance costs. Real estate taxes increased $2.2 million due primarily to property acquisitions, which accounted for $1.7 million (77%) of the increase. The remainder of the increase in real estate taxes was due primarily to higher value assessments among our core properties. Other Operating expenses Other operating expenses are summarized as follows (all data in thousands except percentage amounts): Depreciation and amortization Interest expense General and administrative 2005 $47,161 37,743 8,005 2004 $39,309 34,500 6,194 2003 $33,490 30,040 5,275 2005 vs 2004 $ 7,852 3,243 1,811 $92,909 $80,003 $68,805 $12,906 % Change 20.0% 9.4% 29.2% 16.1% 2004 vs 2003 $ 5,819 4,460 919 $11,198 % Change 17.4% 14.8% 17.4% 16.3% Depreciation and amortization The $7.9 million increase in depreciation and amortization expense in 2005 relative to 2004 was due substantially to acquisitions of $145.1 million and $84.0 million in 2005 and 2004, respectively. The increase in depreciation and amortization expense attributable to 2005 and 2004 acquisitions combined was $5.1 million or 64.7% of the total $7.9 million increase. Washington Real Estate Investment Trust and Subsidiaries 35 The $5.8 million increase in depreciation and amortization expense in 2004 as compared to 2003 was due primarily to acquisition activity in both years. The increase in depreciation and amortization expense attributable to 2004 and 2003 acquisitions combined was $4.9 million (84%) of the total $5.8 million increase, due to the $84.0 million and $174.4 million acquisitions in 2004 and 2003, respectively. Interest expense The $3.2 million increase in interest expense in 2005 as compared to 2004 was primarily due to (1) the issuance in April 2005 of $50.0 million of 5.05% senior unsecured notes due May 1, 2012, and $50.0 million of 5.35% senior unsecured notes due May 1, 2015, and in October 2005, the issuance of an additional $100.0 million of notes of the series of 5.35% senior unsecured notes due May 1, 2015, (2) the increase in short-term borrowing on our lines of credit to fund acquisitions and (3) the mortgage assumption of $24.3 million (fair value of $25.0 million) in March 2005 for the acquisition of Frederick Crossing Shopping Center. The increase to interest expense as a result of this activity ($7.5 million) was partially offset by lower interest expense of $3.9 million due to repayment of $55.0 million of 7.78% unsecured notes in November 2004 and higher capitalized interest on development projects of $0.4 million. The $4.5 million increase in interest expense in 2004 as compared to 2003 was primarily due to (1) the issuance of $100.0 million in 5.25% unsecured notes in December 2003 to refinance short-term borrowings used to fund a portion of the 1776 G Street and Prosperity Medical Center acquisitions, (2) the issuance of $60.0 million in 5.125% unsecured notes in March 2003, (3) the assumption of $49.8 million in mortgages in October 2003 for the acquisition of Prosperity Medical Center and (4) the assumption of $29.6 million in mortgages in 2004 for the acquisitions of Shady Grove Medical Village II and Dulles Business Park. The increase to interest expense as a result of this activity ($7.7 million) was partially offset by lower interest expense of $2.2 million due to the payoff of $50.0 million of 7.125% unsecured notes in August 2003 and $0.5 million due to the repayment of $55.0 million of 7.78% unsecured notes in November 2004, and higher capitalized interest on development projects of $0.4 million. A summary of interest expense for the years ended December 31, 2005, 2004 and 2003, appears below (in millions): Debt Type Notes payable Mortgages Lines of credit/short-term note payable Capitalized interest Total General and administrative expense 2005 $25.5 11.2 2.1 (1.1) $37.7 2004 $24.5 9.7 1.0 (0.7) $34.5 2003 $21.4 7.4 1.5 (0.3) $30.0 2005 vs 2004 $ 1.0 1.5 1.1 (0.4) $ 3.2 2004 vs 2003 $ 3.1 2.3 (0.5) (0.4) $ 4.5 The $1.8 million increase in general and administrative expense in 2005 was due to increased salary costs for the addition of the Chief Investment Officer and other staff related to the growth of our portfolio. Benefits expense also increased as a result of both this staffing and benefit rate increases. This was somewhat offset by decreases in reduced depreciation, software maintenance and internal audit costs. 36 Washington Real Estate Investment Trust and Subsidiaries The $0.9 million increase in general and administrative expense in 2004 from 2003 was due primarily to increased internal and external audit costs related to Sarbanes-Oxley Section 404, which requires management to report on the company’s internal control over financial reporting, an increase in long-term equity incentive compensation based on share grants issued in 2003 and 2004 under our long-term incentive plan and increased salary expense due to staffing increases, partially offset by lower short-term (cash) incentive compensation. Discontinued Operations We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and where market conditions for sale are favorable. The proceeds from the sales are reinvested into other properties, used to fund development operations or to support other corporate needs, or distributed to our shareholders. On February 1, 2005, we sold three office buildings, 7700 Leesburg, Tycon Plaza II, Tycon Plaza III, and certain development rights and approvals related to Tycon Plaza II for a sale price of $67.5 million with a gain on the sale of $32.1 million. $31.3 million of the proceeds from the disposition was escrowed in a tax-free property exchange account and subsequently used to fund a portion of the purchase price of Frederick Crossing Shopping Center on March 23, 2005, and the Coleman Building on April 8, 2005. $31.0 million of the proceeds was used to pay down $31.0 million outstanding under Credit Facility No. 2. On September 8, 2005, the Pepsi Distribution Center, an industrial property, was sold for $6.0 million for a gain of $3.0 million. Proceeds of $5.8 million were escrowed in a tax-free exchange account. Discontinued operations for 2005 consist of the properties sold in February and September 2005. For 2004, discontinued operations include those same properties and 8230 Boone Boulevard, which was sold on November 15, 2004. There was a gain of $1.9 million recognized in 2005 that had been previously deferred from the sale of Boone Boulevard. On November 15, 2004, we sold 8230 Boone Boulevard for a sale price of $10.0 million. A portion of the proceeds was in the form of a subordinated $1.8 million 10% note receivable from the seller, which matured in November 2005. We recognized a gain on disposal of $1.0 million and offset the $1.8 million note from the buyer with a deferred gain liability in the same amount, in accordance with Statement of Financial Accounting Standards (SFAS) No. 66, “Accounting for Sales of Real Estate.” SFAS No. 66 limits gain recognition when the seller’s note is subject to future subordination to the amount by which the buyer’s cash payments at settlement exceed the seller’s cost of the property sold. The deferred gain was recognized in April 2005. Also in November 2004 we concluded that 7700 Leesburg, Tycon Plaza II, Tycon Plaza III and certain development rights and approvals related to Tycon Plaza III met the criteria specified by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” necessary to classify these properties as held for sale. Senior management had committed to, and actively embarked upon, a plan to sell the assets, and the sale was expected to be completed within one year under terms usual and customary for such sales, with no indication that the plan would be significantly altered or abandoned. Depreciation on these properties was discontinued at that time, but operating revenues and other operating expenses continued to be recognized until the date of sale. Under SFAS No. 144, revenues and expenses of properties that are classified as held for sale or sold are treated as discontinued operations for all periods presented in the Statements of Income. Washington Real Estate Investment Trust and Subsidiaries 37 Operating results of the properties classified as discontinued operations are summarized as follows (in thousands): Revenues 2005 $ 656 2004 $ 8,895 2003 $ 9,829 Property expenses (401) (3,217) Depreciation and amortization (71) (1,784) (3,235) (2,265) $ 184 $ 3,894 $ 4,329 Net operations of properties sold or held for sale decreased $3.7 million for 2005 compared to 2004 and $0.4 million for 2004 compared to 2003. Both decreases were due primarily to the timing of the property sales within each year. Net Operating Income Real estate Net Operating Income (“NOI”), defined as real estate rental revenue less real estate operating expenses, is the primary performance measure we use to assess the results of our operations at the property level. We provide NOI as a supplement to net income calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP”). NOI does not represent net income calculated in accordance with GAAP. As such, it should not be considered an alternative to net income as an indication of our operating performance. NOI is calculated as net income, less non-real estate (“other”) revenue and the results of discontinued operations (including the gain on sale, if any), plus interest expense, depreciation and amortization and general and administrative expenses. A reconciliation of NOI to net income is provided on the following page. 38 Washington Real Estate Investment Trust and Subsidiaries 2005 Compared to 2004 The following tables of selected operating data provide the basis for our discussion of NOI in 2005 compared to 2004. All amounts are in thousands except percentage amounts. Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Reconciliation to Net Income NOI Other revenue Other income from property settlement Interest expense Depreciation and amortization General and administrative expenses Discontinued operations(2) Gain on disposal 2005 $173,963 16,083 $190,046 $ 54,429 3,687 $ 58,116 $119,534 12,396 $131,930 Years Ended December 31, 2004 $ Change % Change $169,595 2,051 $171,646 $ 50,890 438 $ 51,328 $118,705 1,613 $120,318 $ 4,368 14,032 $18,400 $ 3,539 3,249 $ 6,788 $ 829 10,783 $11,612 2.6% 684.2% 10.7% 7.0% 741.8% 13.2% 0.7% 668.5% 9.7% $131,930 $120,318 918 504 (37,743) (47,161) (8,005) 184 37,011 326 — (34,500) (39,309) (6,194) 3,894 1,029 Net Income $ 77,638 $ 45,564 Economic Occupancy Core Non-core(1) Total (1) Non-core properties include: 2005 91.9% 97.4% 92.4% 2004 91.4% 97.8% 91.4% 2005 acquisitions—Frederick Crossing, Coleman Building and Albemarle Point 2004 acquisitions—Shady Grove Medical Village II, 8301 Arlington Boulevard, 8880 Gorman Road and Dulles Business Park (2) Discontinued operations include gain on disposals and income from operations for: 2005 disposals—Tycon Plaza II, Tycon Plaza III, 7700 Leesburg Pike and the Pepsi Distribution Center 2004 disposal—8230 Boone Boulevard We recognized NOI of $131.9 million in 2005, which was $11.6 million (9.7%) greater than in 2004 due largely to our acquisitions of one office building, two medical office buildings, one retail property and four industrial properties in 2004 and 2005, which added approximately 1,173,000 square feet of net rentable space. Acquired properties contributed $12.4 million in NOI in 2005 (9.4% of total NOI), a $10.8 million increase over 2004. Rental operations at 718 E. Jefferson Street ceased in the third quarter of 2004 as the property was incorporated into the South Washington Street development project. Washington Real Estate Investment Trust and Subsidiaries 39 Core properties experienced a $0.8 million (0.7%) increase in NOI due to a $4.4 million increase in revenues offset by a $3.5 million increase in real estate expenses. The increase in core expenses was driven by the industrial, office and multifamily sectors, which contributed $0.5, $1.2 and $1.2 million, respectively, in additional expense as a result of higher utilities, repairs and maintenance, operating services, and real estate taxes. Revenue was positively impacted by improvements in all lines of business except the office sector due to lower occupancy and reduced rental rates. Higher occupancy and rental rate increases in the industrial, medical office, retail and multifamily sectors and higher expense recoveries in the retail and industrial sectors positively impacted those respective lines of business. Overall economic occupancy increased from 91.4% in 2004 to 92.4% in 2005 due to higher core occupancy, higher occupancy in our acquired office property and 100% occupancy in our acquired retail property. Core economic occupancy increased 50 basis points due to increases in every sector except the office sector. During 2005, 70.2% of the square footage expiring was renewed as compared to 65.9% in 2004 and 1,720,000 square feet were leased at an average rental rate increase of 8.7% An analysis of NOI by sector follows. Office Sector Real estate Rental Revenue Core Non-core (1) Total Real Estate Rental Revenue Real estate expenses Core Non-core (1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core (1) Total 2005 $76,055 921 $76,976 $26,015 262 $26,277 $50,040 659 $50,699 2005 88.1% 90.1% 88.1% Years Ended December 31, 2004 $ Change % Change $(1,015) 921 $ (94) $ 1,180 262 $ 1,442 $(2,195) 659 $(1,536) (1.3%) 100.0% (0.1%) 4.8% 100.0% 5.8% (4.2%) 100.0% (2.9%) $77,070 — $77,070 $24,835 — $24,835 $52,235 — $52,235 2004 89.2% — 89.2% (1) Non-core properties include: 2005 acquisitions—Albemarle Point Office Building (2) Discontinued operations include gain on disposals and income from operations for: 2005 disposals—Tycon Plaza II, Tycon Plaza III, 7700 Leesburg Pike 2004 disposal—8230 Boone Boulevard The office sector recognized NOI of $50.7 million (2.9%) lower than in 2004 due primarily to the $2.2 million reduction in Core NOI. The property acquired in 2005 contributed $0.7 million (1.3% of total) to NOI. 40 Washington Real Estate Investment Trust and Subsidiaries Core office properties experienced a $2.2 million (4.2%) decrease in NOI due to a $1.0 million decline in revenues combined with a $1.2 million increase in core real estate expenses. Revenue was impacted by lower minimum base rent of $0.6 million due primarily to higher vacancies and a decrease in rental rates, higher bad debt expense of $0.3 million and lower lease termination fee income of $0.1 million. The increase in real estate expenses was due to higher utility costs driven by escalating fuel rates and energy taxes, additional real estate tax expense due to higher value assessments for properties across several tax jurisdictions and increased repairs and maintenance costs. Core economic occupancy declined 110 basis points due to vacancies at Maryland Trade Center I, 6110 Executive Boulevard, Saratoga, Lexington, and 515 King Street. Overall economic occupancy decreased from 89.2% to 88.1%. During 2005, 65.1% of the square footage that expired was renewed compared to 50.5% in 2004, excluding properties sold or classified as held for sale. During 2005, we executed new leases for 711,700 square feet of office space at an average rent increase of 3.8%. Medical Office Sector Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core(1) Total 2005 $14,787 3,237 $18,024 $ 3,686 964 $ 4,650 $11,101 2,273 $13,374 2005 99.3% 94.5% 98.4% Years Ended December 31, 2004 $ Change % Change $ 771 2,203 $2,974 $ 286 678 $ 964 $ 485 1,525 $2,010 5.5% 213.1% 19.8% 8.4% 237.1% 26.2% 4.6% 203.9% 17.7% $14,016 1,034 $15,050 $ 3,400 286 $ 3,686 $10,616 748 $11,364 2004 98.4% 96.3% 98.2% (1) Non-core properties include: 2004 acquisitions—Shady Grove Medical Village II and 8301 Arlington Boulevard The medical office sector NOI increased from $11.4 million in 2004 to $13.4 million in 2005, an increase of $2.0 million or 17.7%. This was substantially due to the acquisitions made in 2004, which contributed $2.3 million to the NOI and added approximately 116,000 net rentable square feet to the portfolio. Core medical office property NOI increased $0.5 million with a $0.8 million revenue increase offset somewhat by a $0.3 million increase in real estate expenses. Revenues for core properties were positively impacted by increased occupancy and rental rates as well as increased expense reimbursements from tenants. Expenses increased due to higher utility costs and real estate taxes. Core occupancy increased 90 basis points as vacancies decreased at Woodburn II. Washington Real Estate Investment Trust and Subsidiaries 41 During 2005, 74.7% of the square footage that expired was renewed compared to 100% in 2004. During 2005, we executed new leases for 40,000 square feet of medical office space at an average rent increase of 11.2%. Retail Sector Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core(1) Total (1) Non-core properties include: 2005 acquisition—Frederick Crossing 2005 $28,425 3,482 $31,907 $ 6,296 582 $ 6,878 $22,129 2,900 $25,029 2005 97.3% 100.0% 97.6% Years Ended December 31, 2004 $ Change % Change $1,182 3,482 $4,664 $ 397 582 $ 979 $ 785 2,900 $3,685 4.3% 100.0% 17.1% 6.7% 100.0% 16.6% 3.7% 100.0% 17.3% $27,243 — $27,243 $ 5,899 — $ 5,899 $21,344 — $21,344 2004 94.8% — 94.8% Retail sector NOI increased $3.7 million (17.3%) in 2005 due to the 2005 acquisition, which contributed $2.9 million to NOI, and a $0.8 million increase in NOI from core properties. The acquisition NOI was $2.9 million (11.6%) of the total. The core revenue increase was due to rental rate growth of 1.5% driven by escalating market rates, higher common area maintenance and real estate tax recoveries and higher occupancy. Rental operations at 718 E. Jefferson Street ceased in the third quarter of 2004 as the property was incorporated into the South Washington Street development project. Overall economic occupancy for the retail sector increased approximately 250 basis points primarily as a result of the completion of the renovation at Westminster for a national grocery store chain, which took possession in November 2004. During 2005, our retention rate was 95.3% compared to 77.4% in 2004 and we executed new leases for 180,700 square feet of retail space at an average rent increase of 28.6%. 42 Washington Real Estate Investment Trust and Subsidiaries Multifamily Sector Real estate Rental Revenue Core/Total Real estate expenses Core/Total Net Operating Income Core/Total Economic Occupancy Core/Total 2005 Years Ended December 31, 2004 $ Change % Change $30,529 $28,858 $1,671 5.8% 12,816 11,637 1,179 10.1% $17,713 $17,221 $ 492 2.9% 2005 93.2% 2004 90.5% Multifamily NOI increased $0.5 million (2.9%) as compared to 2004 as a result of a $1.7 million increase in revenue offset somewhat by a $1.2 million increase in expenses. The revenue increase was driven by an increase in minimum base rent and increases in occupancy throughout most of the portfolio. Occupancy for the overall portfolio increased 270 basis points compared to 2004. Revenue was additionally impacted by increased rent abatements, the result of efforts to improve leasing activity across the portfolio. Real estate expenses increased $1.2 million due primarily to higher administrative costs related to property-level leasing and maintenance positions and increased marketing costs, higher repairs and maintenance expense and increased utility expense related to higher fuel costs. Washington Real Estate Investment Trust and Subsidiaries 43 Industrial Sector Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core(1) Total 2005 $24,167 8,443 $32,610 $ 5,616 1,879 $ 7,495 $18,551 6,564 $25,115 2005 93.0% 98.6% 94.5% Years Ended December 31, 2004 $ Change % Change $1,759 7,426 $9,185 $ 497 1,727 $2,224 $1,262 5,699 $6,961 7.8% 730.2% 39.2% 42.4% 1,136.2% 42.4% 7.3% 658.8% 38.3% $22,408 1,017 $23,425 $ 5,119 152 $ 5,271 $17,289 865 $18,154 2004 92.4% 99.5% 92.7% (1) Non-core properties include: 2005 acquisitions—Coleman Building and Albemarle Point Industrial Buildings 2004 acquisitions—8880 Gorman Road and Dulles Business Park Industrial sector NOI increased $7.0 million (38.3%) over 2004 due to the acquisitions of 8880 Gorman Road and Dulles Business Park in 2004 and the acquisition of the Coleman Building and the Albemarle Point Industrial Buildings in 2005. These acquisitions contributed $6.6 million in NOI, 26.1% of the total NOI. Core properties experienced a $1.3 million (7.3%) increase in NOI due to a $1.8 million increase in real estate revenues, while real estate expenses increased only $0.5 million. The revenue increase was driven by a 60 basis point growth in occupancy due to increased leasing activity, particularly at Ammendale Technology Park II, Earhart and Northern Virginia Industrial Park. Revenue was also positively impacted by higher lease termination fees and reimbursements for common area maintenance and real estate taxes ($0.5 million combined) and a 4.4% increase in rental rates. We executed new leases for 787,500 square feet of industrial space at an average rent increase of 12.2%. 44 Washington Real Estate Investment Trust and Subsidiaries 2004 Compared to 2003 The following tables of selected operating data provide the basis for our discussion of NOI in 2004 compared to 2003. All amounts are in thousands except percentage amounts. Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Reconciliation to Net Income NOI Other revenue Interest expense Depreciation and amortization General and administrative expenses Discontinued operations(2) Net income Economic Occupancy Core Non-core(1) Total (1) Non-core properties include: 2004 $148,250 23,396 $171,646 $ 45,053 6,275 $ 51,328 $103,197 17,121 $120,318 Years Ended December 31, 2003 $ Change % Change $146,250 7,326 $153,576 $ 42,713 1,914 $ 44,627 $103,537 5,412 $108,949 $ 2,000 16,070 $18,070 $ 2,340 4,361 $ 6,701 $ (340) 11,709 $11,369 1.4% 219.4% 11.8% 5.5% 227.8% 15.0% (1.3%) 216.4% 10.4% $120,318 $108,949 326 (34,500) (39,309) (6,194) 4,923 414 (30,040) (33,490) (5,275) 4,329 $ 45,564 $ 44,887 2004 90.1% 98.9% 91.4% 2003 90.4% 93.8% 90.6% 2004 acquisitions—8880 Gorman Road, Shady Grove Medical Village II, 8301 Arlington Boulevard and Dulles Business Park 2003 acquisitions—1776 G Street, Prosperity Medical Center I, Prosperity Medical Center II, Prosperity Medical Center III, 718 E. Jefferson Street and Fullerton Industrial. (2) Discontinued operations include the gain on disposals and income from operations for: 2005 disposals—7700 Leesburg Pike, Tycon II, Tycon III and the Pepsi Distribution Center 2004 disposal—8230 Boone Boulevard NOI was $11.4 million (10.4%) greater than in 2003 due largely to our acquisitions of one office building, five medical office buildings, one retail property and three industrial properties in 2003 and 2004, which added 1,181,000 square feet of net rentable space. These acquired properties contributed $17.1 million in NOI in 2004 (14.2% of total NOI) and $5.4 million in NOI in 2003 (5.0% of total NOI). 718 E. Jefferson Street was acquired in connection with our development projects at South Washington Street. Core property NOI was flat due to a $2.0 million increase in revenues offset by a $2.3 million increase in real estate expenses. The revenue increase was driven by higher revenue in the retail, multifamily and industrial sectors due to higher minimum base rent and increased rental rates. The increase in core expenses was driven by the office and Washington Real Estate Investment Trust and Subsidiaries 45 multifamily sectors, which contributed $1.5 million and $0.8 million, respectively, to the increase as a result of higher utilities, property administrative costs, common area maintenance and operating services and supplies. Overall economic occupancy increased from 90.6% in 2003 to 91.4% in 2004. The decrease in core economic occupancy was due to higher vacancies in every sector except Industrial, which increased due to greater leasing activity. During 2004, the retention rate on our commercial properties (office, medical office, retail and industrial sectors) was 63.1% compared to 72.3% in 2003. An analysis of NOI by sector follows. Office Sector Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core(1) Total (1) Non-core properties include: 2003 acquisitions—1776 G Street 2004 $65,980 11,090 $77,070 $21,432 3,403 $24,835 $44,548 7,687 $52,235 2004 87.6% 100.0% 89.2% Years Ended December 31, 2003 $ Change % Change $ (204) 6,967 $ 6,763 $ 1,451 2,193 $ 3,644 $(1,655) 4,774 $ 3,119 (0.3%) 169.0% 9.6% 7.3% 181.2% 17.2% (3.6%) 163.9% 6.4% $66,184 4,123 $70,307 $19,981 1,210 $21,191 $46,203 2,913 $49,116 2003 88.8% 90.1% 88.9% Office NOI was $3.1 million (6.4%) higher than in 2003 due primarily to WRIT’s acquisition of 1776 G Street in August 2003, which contributed $7.7 million in NOI. Core office properties experienced a $1.7 million (3.6%) decrease in NOI due to a $0.2 million decrease in revenues, while core real estate expenses increased $1.5 million. The revenue decline was due to a 120 basis point drop in occupancy and expenses increased due to higher utility costs, additional real estate tax expense due to higher value assessments for properties across several tax jurisdictions, increased repairs and maintenance costs and additional security-related expenditures. Overall occupancy for the office sector increased to 89.2% from 88.9%. Core occupancy decreased to 87.6% from 88.8%. This was driven primarily by increased vacancy at Maryland Trade Centers I and II, 7900 Westpark and the Tyson’s Corner properties sold in early 2005, offset somewhat by the decreased vacancy at 1700 Research Boulevard. The increase in non-core occupancy from 90.1% to 100.0% reflects the 100.0% occupancy at 1776 G Street acquired in 2003. 46 Washington Real Estate Investment Trust and Subsidiaries During 2004 we executed new leases for 668,900 square feet of office space at an average rent increase of 1.3%. Medical Office Sector Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core(1) Total (1) Non-core properties include: 2004 $ 5,097 9,953 $15,050 $ 1,259 2,427 $ 3,686 $ 3,838 7,526 $11,364 2004 96.4% 99.3% 98.2% Years Ended December 31, 2003 $ Change % Change $ 13 8,006 $8,019 $ 42 2,016 $2,058 $ (29) 5,990 $5,961 0.3% 411.2% 114.1% 3.5% 490.5% 126.4% (0.7%) 390.0% 100.3% $5,084 1,947 $7,031 $1,217 411 $1,628 $3,867 1,536 $5,403 2003 97.3% 97.7% 97.4% 2004 acquisitions—Shady Grove Medical Village II and 8301 Arlington Boulevard 2003 acquisition—Prosperity Medical Center I, Prosperity Medical Center II, Prosperity Medical Center III Medical office NOI increased $6.0 million (100.3%) due to the three acquisitions in October 2003 and the two acquisitions in the second half of 2004. The five acquisitions combined added 371,000 of net rentable square feet to the medical office portfolio. The core property NOI was flat due to slight increases in both rental revenue and real estate expenses. Overall occupancy increased 80 basis points to 98.2% in 2004 from 97.4% in 2003 due to the 99.3% occupancy of the properties acquired in 2003 and 2004. Core occupancy decreased by 90 basis points from 97.3% in 2003 to 96.4% in 2004 due to increased vacancy at Woodburn I. Washington Real Estate Investment Trust and Subsidiaries 47 Retail Sector Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core(1) Total (1) Non-core properties include: 2003 acquisitions—718 E. Jefferson Street 2004 $27,222 21 $27,243 $ 5,888 11 $ 5,899 $21,334 10 $21,344 2004 94.6% 95.9% 94.8% Years Ended December 31, 2003 $ Change % Change $772 (3) $769 $ (22) — $ (22) $794 (3) $791 2.9% (12.5%) 2.9% (0.4%) — (0.4%) 3.9% (23.1%) 3.8% $26,450 24 $26,474 $ 5,910 11 $ 5,921 $20,540 13 $20,553 2003 95.8% 96.4% 96.0% Retail sector NOI increased $0.8 million (3.8%) in 2004 due to a $0.8 million increase in revenue from core properties. The core revenue increase was due to rental rate growth of 2.4% ($0.6 million) driven by escalating market rates, higher common area maintenance and real estate tax recoveries of $0.4 million and lower bad debt expense, offset slightly by higher vacancy. Rental operations at 718 E. Jefferson Street ceased in the third quarter of 2004 as the property was incorporated into the South Washington Street development project. Both core and overall economic occupancy for the retail sector declined approximately 120 basis points primarily as a result of the renovation at Westminster for a regional grocery store chain, which took possession in November 2004. The 2004 retention rate of 77.4% was lower than the past year’s because of the intentional termination of a large tenant at Foxchase in preparation for the center’s planned renovation. The City Council of Alexandria, Virginia, approved our renovation plans in February 2005; the project is underway and we expect the project to be completed in late 2006. During 2004, we executed new leases for 278,800 square feet of retail space at an average rent increase of 31.3%. 48 Washington Real Estate Investment Trust and Subsidiaries Multifamily Sector Real estate Rental Revenue Core/Total Real estate expenses Core/Total Net Operating Income Core/Total Economic Occupancy Core/Total 2004 Years Ended December 31, 2003 $ Change $28,858 $28,266 $ 592 11,637 10,860 777 % Change 2.1% 7.2% $17,221 $17,406 $(185) (1.1%) 2004 90.5% 2003 90.8% Multifamily NOI declined $0.2 million (1.1%) as compared to 2003 as a result of a $0.6 million increase in revenue offset by a $0.8 million increase in expenses. The revenue increase was driven by an increase in minimum base rent that was generally portfolio-wide but driven by the addition of 16 garden-style apartment units at Walker House in October 2003 and higher rates on the 51 renovated units at The Ashby at McLean, 47 of which were leased as of December 31, 2004. The exception was Bethesda Hill, which experienced significantly lower occupancy as compared to 2003, and no increase in rental rates. Occupancy for the overall portfolio was relatively flat compared to 2003. Revenue was additionally impacted by increased rent abatements, in an effort to improve leasing activity across the portfolio. Real estate expenses increased $0.8 million due primarily to higher administrative costs related to property- level leasing and maintenance positions and increased marketing costs, higher repairs and maintenance expense and increased utility expense related to higher fuel costs. Washington Real Estate Investment Trust and Subsidiaries 49 Industrial Sector Real estate Rental Revenue Core Non-core(1) Total Real Estate Rental Revenue Real estate expenses Core Non-core(1) Total Real Estate Expenses Net Operating Income Core Non-core(1) Total Net Operating Income Economic Occupancy Core Non-core(1) Total 2004 $21,093 2,332 $23,425 $4,837 434 $5,271 $16,256 1,898 $18,154 2004 92.3% 97.8% 92.7% Years Ended December 31, 2003 $ Change % Change $827 1,100 $1,927 $92 152 $244 $735 948 $1,683 4.1% 89.3% 9.0% 1.9% 53.9% 4.9% 4.7% 99.8% 10.2% $20,266 1,232 $21,498 $4,745 282 $5,027 $15,521 950 $16,471 2003 87.9% 89.1% 87.9% (1) Non-core properties include: 2004 acquisitions—8880 Gorman Road and Dulles Business Park 2003 acquisition—Fullerton Industrial Industrial sector NOI increased $1.7 million (10.2%) over 2003 due to the acquisitions of Fullerton Industrial Center in 2003 and 8880 Gorman Road and Dulles Business Park in 2004. These acquisitions contributed $1.9 million in NOI, a 99.8% increase over 2003 NOI from non-core properties. The 870 basis point increase in non-core occupancy was driven by properties acquired in 2004, which had a combined occupancy of 99.5% during the year. Core properties experienced a $0.7 million (4.7%) increase in NOI due to a $0.8 million increase in real estate revenues, while real estate expenses remained relatively flat at $4.8 million. The revenue increase was driven by a 440 basis point increase in occupancy due to leasing activity beginning in the second half of 2003 through the third quarter of 2004, particularly at Ammendale Technology Park II, Earhart and Northern Virginia Industrial Park. Revenue was also positively impacted by higher recoveries of common area expense and real estate taxes ($0.3 million combined), partially offset by a 1.1% decline in rental rates. During 2004, retention in the industrial portfolio was 82% compared to 71% in 2003. We executed new leases for 759,000 square feet of industrial space at an average rent increase of 9.4%. 50 Washington Real Estate Investment Trust and Subsidiaries LIQUIDItY aND CaPItaL ReSOURCeS general Our primary sources of liquidity are our real estate operations and our unsecured credit facilities, in addition to the capital markets. As of December 31, 2005, we had approximately $4.9 million in cash and cash equivalents and $129.0 million available for borrowing under our unsecured credit facilities excluding letters of credit. We derive substantially all of our revenue from tenants under leases at our properties. Our operating cash flow therefore depends materially on our ability to lease our properties to tenants, the rents that we are able to charge to our tenants, and the ability of these tenants to make their rental payments. Our primary uses of cash are to fund distributions to shareholders, to fund capital investments in our existing portfolio of operating assets, to fund new acquisitions, redevelopment and ground-up development activities and to fund operating and administrative expenses. As a REIT, we are required to distribute at least 90% of our taxable income to our shareholders on an annual basis. We also regularly require capital to invest in our existing portfolio of operating assets in connection with large-scale renovations, routine capital improvements, deferred maintenance on properties we have recently acquired, and our leasing activities, including funding tenant improvement allowances and leasing commissions. The amounts of the leasing-related expenditures can vary significantly, depending on negotiations with tenants and the current competitive leasing environment. During 2006, we expect that we will have significant capital requirements, including the following items. There can be no assurance that our capital requirements will not be materially higher or lower than these expectations. • Funding dividends on our common shares and minority interest distributions to third-party unit holders; • Approximately $39.4 million to invest in our existing portfolio of operating assets, including approximately $10.4 million to fund tenant-related capital requirements and leasing commissions; • Approximately $82.0 million to invest in our development projects; • Approximately $118.0 million to fund our expected property acquisitions; We expect to meet our capital requirements using cash generated by our real estate operations, borrowings on our unsecured credit facilities, additional debt or equity capital raised in the public markets, asset dispositions or funding acquisitions of properties through property-specific mortgage debt. We believe that we will generate sufficient cash flow from operations and have access to the capital resources necessary to fund our requirements. However, as a result of general, greater Washington/Baltimore regional, or tenant economic downturns, unfavorable fluctuations in interest rates or our stock price, unfavorable changes in the supply of competing properties, or our properties not performing as expected, we may not generate sufficient cash flow from operations or otherwise have access to capital on favorable terms, or at all. If we are unable to obtain capital from other sources, we may not be able to pay the dividend required to maintain our status as a REIT, make required principal and interest payments, make strategic acquisitions or make necessary routine capital improvements or undertake redevelopment opportunities with respect to our existing portfolio of operating assets. In addition, if a property is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, the holder of the mortgage could foreclose on the property, resulting in loss of income and asset value. If principal amounts due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, such as new equity capital, our cash flow may be insufficient to repay all maturing debt. Prevailing interest rates or other factors at the time of a refinancing (such as possible reluctance of lenders to make commercial real estate loans) may result in higher interest rates and increased interest expense. Washington Real Estate Investment Trust and Subsidiaries 51 Capital Structure We manage our capital structure to reflect a long-term investment approach, generally seeking to match the cash flow of our assets with a mix of equity and various debt instruments. We expect that our capital structure will allow us to obtain additional capital from diverse sources that could include additional equity offerings of common shares, public and private debt financings and possible asset dispositions. Our ability to raise funds through the sale of debt and equity securities is dependent on, among other things, general economic conditions, general market conditions for REITs, our operating performance, our debt rating and the current trading price of our shares. We will always analyze which source of capital is most advantageous to us at any particular point in time; however, the capital markets may not consistently be available on terms that are attractive. In May 2005, we issued $50 million of seven-year and $50 million of ten-year unsecured notes. Also in October 2005, we reopened the 2015 issuance and raised an additional $100 million in unsecured notes, at an effective interest rate of 5.5%. In March and December 2003, respectively, we issued $60 million of 5.125% and $100 million of 5.25%, unsecured notes. Also in December 2003, we issued 2.2 million common shares for net proceeds of approximately $63.0 million. During 2004, we issued no notes or equity securities. In April 2004, we filed a shelf registration with the Securities and Exchange Commission (“SEC”), which allows us to offer from time to time common shares, warrants to purchase common shares and unsecured senior or subordinated debt securities up to an aggregate amount of approximately $503.0 million. Debt Financing We generally use unsecured, corporate-level debt, including unsecured notes and our unsecured credit facilities, to meet our borrowing needs. Long term, we generally use fixed-rate debt instruments in order to match the returns from our real estate assets. We also utilize variable rate debt for short-term financing purposes. At times, our mix of variable and fixed rate debt may not suit our needs. At those times, we may use derivative financial instruments including interest rate swaps and caps, forward interest rate options or interest rate options in order to assist us in managing our debt mix. We would either hedge our variable rate debt to give it a fixed interest rate or hedge fixed rate debt to give it a variable interest rate. At December 31, 2005, there were no derivative securities outstanding. Typically we have obtained the ratings of two credit rating agencies in the underwriting of our unsecured debt. As of December 31, 2005, Standard & Poors had assigned its A- rating, and Moody’s Investor Service has assigned its Baa1 rating, to our unsecured debt offerings. A downgrade in rating by either of these rating agencies could result from, among other things, a change in our financial position or a downturn in general economic condition. Any such downgrade could adversely affect our ability to obtain future financing or could increase the interest rates on our existing variable rate debt. However, we have no debt instruments under which the principal maturity would be accelerated upon a downward change in our debt rating. Each rating is subject to revision or withdrawal at any time by the assigning rating organization. 52 Washington Real Estate Investment Trust and Subsidiaries Our total debt at December 31, 2005, is summarized as follows (in thousands): Fixed rate mortgages Unsecured credit facilities Senior unsecured notes Total Debt $169,617 24,000 520,000 $713,617 The $169.6 million in fixed rate mortgages, which includes $3.9 million in unamortized premiums due to fair value adjustments, bore an effective weighted-average interest rate of 5.9% at December 31, 2005, and had a weighted- average maturity of 5.6 years. Our primary external source of liquidity is our two revolving credit facilities. We can borrow up to $155.0 million under these lines, which bear interest at an adjustable spread over LIBOR based on our public debt rating. Credit Facility No. 1 is a three-year, $85.0 million unsecured credit facility expiring in July 2007. Credit Facility No. 2 is a three-year $70.0 million unsecured credit facility expiring in July 2008. We had $0.0 outstanding as of December 31, 2005 related to Credit Facility No. 1, with $0.9 million in letters of credit issued and $84.1 million unused and available for subsequent acquisitions or capital improvements. At December 31, 2004, $67.0 million was outstanding under this facility, all of which was paid in full using a portion of the proceeds from the April 2005 issuance of $50.0 million of seven-year 5.05% unsecured notes and $50.0 million of ten-year 5.35% unsecured notes (see Note 6—Notes Payable). Borrowings were used to repay mortgage debt in August and September 2005 of $7.5 million and $18.0 million, respectively, and an additional $5.0 million in September to fund capital improvements was repaid in October 2005 using a portion of the proceeds from the October 2005 issuance of an additional $100.0 million of our 5.35% senior unsecured notes maturing in May 2015. We had $24.0 million outstanding as of December 31, 2005, related to Credit Facility No. 2, with an additional $1.1 million in letters of credit issued and $44.9 million unused and available for subsequent acquisitions or capital improvements. Of the $24.0 million outstanding at December 31, 2005, $21.0 million was borrowed in December 2005 to fund the acquisition of Dulles Station and $3.0 million was borrowed to fund certain capital improvements to real estate. At December 31, 2004, $50.0 million was outstanding under this facility. In February 2005, we repaid $31.0 million of the $50.0 million outstanding at December 31, 2004, using a portion of the $67.5 million proceeds from the disposition of 7700 Leesburg, Tycon Plaza II and Tycon Plaza III. In April 2005, we repaid the remaining outstanding balance at December 31, 2004, under Credit Facility No. 2 using a portion of the proceeds from the April 2005 issuance of $50.0 million of seven-year, 5.05% unsecured notes and $50.0 million of ten-year, 5.35% unsecured notes (see Note 6—Notes Payable). In July 2005, we borrowed $63.0 million under this facility to fund our purchase of Albemarle Point, all of which we repaid in October 2005 using a portion of the proceeds from the October 2005 issuance of an additional $100.0 million of our 5.35% senior unsecured notes maturing in May 2015. In March 2004, we borrowed $11.0 million under Credit Facility No. 1 to fund the acquisition of 8880 Gorman Road, an additional $8.6 million in August 2004 to fund the acquisition of Shady Grove Medical Village II, $7.8 million in October to fund the acquisition of 8301 Arlington Boulevard, $7.0 million in November to pay down a portion of the $55.0 million of 7.78% unsecured notes due, plus accrued interest, $28.0 million in November and December to fund the acquisition of Dulles Business Park and $13.2 million to fund certain capital improvements to real estate. The $8.6 million borrowed to fund the Shady Grove Medical Village II acquisition was subsequently repaid in November. We borrowed $50.0 million in November 2004 under Credit Facility No. 2 to pay down the Washington Real Estate Investment Trust and Subsidiaries 53 remaining portion of the $55.0 million 7.78% notes due. In February 2005 we repaid $31.0 million under Credit Facility No. 2 using a portion of the $67.5 million proceeds from the disposition of 7700 Leesburg, Tycon Plaza II and Tycon Plaza III. Our unsecured credit facilities contain financial and other covenants with which we must comply. Some of these covenants include: • A minimum ratio of annual EBITDA (earnings before interest, taxes, depreciation and amortization) to interest expense; • A minimum ratio of tangible fair market value of our unencumbered assets to aggregate unsecured debt; and • A maximum ratio of total debt to tangible fair market value of our assets. Failure to comply with any of the covenants under our unsecured credit facilities or other debt instruments could result in a default under one or more of our debt instruments. This could cause our lenders to accelerate the timing of payments and would therefore have a material adverse effect on our business, operations, financial condition and liquidity. As of December 31, 2005, we were in compliance with our loan covenants; however, our ability to draw on our unsecured credit facility or incur other unsecured debt in the future could be restricted by the loan covenants. We anticipate that over the near term, interest rate fluctuations will not have a material adverse effect on earnings. Our unsecured fixed-rate notes payable have maturities ranging from August 2006 through February 2028 (see Note 6), as follows (in thousands): 7.25% notes due 2006 6.74% notes due 2008 5.103% notes due 2012 5.125% notes due 2013 5.25% notes due 2014 5.41% notes due 2015 7.25% notes due 2028 December 31, 2005 Note Principal 50,000 60,000 50,000 60,000 100,000 150,000 50,000 $520,000 On April 26, 2005, we sold $50.0 million of 5.05% senior unsecured notes due May 1, 2012, and $50.0 million of 5.35% senior unsecured notes due May 1, 2015, at effective yields of 5.064% and 5.359%, respectively. The net proceeds from the sale of the notes of $99.1 million were used to repay borrowings under our lines of credit totaling $90.5 million, and the remainder was used for general corporate purposes. In March 2003, we issued $60.0 million of 5.125% unsecured notes. In August 2003, we repaid $50.0 million of 7.125% unsecured notes. No notes were issued in 2004. As noted above, we repaid $55.0 million of unsecured notes in November 2004 utilizing credit facility borrowings. 54 Washington Real Estate Investment Trust and Subsidiaries Our unsecured notes contain covenants with which we must comply. These include: • Limits on our total indebtedness; • Limits on our secured indebtedness; • Limits on our required debt service payments; and • Maintenance of a minimum level of unencumbered assets. We are in compliance with our unsecured notes covenants as of December 31, 2005. Dividends We pay dividends quarterly. The maintenance of these dividends is subject to various factors, including the discretion of the Board of Trustees, the ability to pay dividends under Maryland law, the availability of cash to make the necessary dividend payments and the effect of REIT distribution requirements, which require at least 90% of our taxable income to be distributed to shareholders. The table below details our dividend and distribution payments for 2005, 2004 and 2003 (in thousands). Common dividends 2005 2004 $67,322 $64,836 $58,605 2003 Minority interest distributions 172 155 89 $67,494 $64,991 $58,694 Dividends paid for 2005 as compared to 2004 increased as a direct result of a dividend rate increase from $1.55 per share in 2004 to $1.60 per share in 2005. Dividends paid in 2004 increased as compared to 2003 due to the dividend rate increase to $1.55 per share from $1.47 per share and the issuance of 2.2 million shares in December 2003. Cash flows from operations are an important factor in our ability to sustain our dividend at its current rate. Cash flows from operations increased from $79.9 million in 2004 to $87.5 million in 2005 due in part to acquisitions completed in 2004 and 2005. If our cash flows from operations were to decline significantly, we may be unable to sustain our dividend payment at its current rate. Capital Commitments We will require capital for development and redevelopment projects currently underway and in the future. As of December 31, 2005, we had under development a residential and retail project with 224 apartment units and 5,900 square feet of retail space in Arlington, Virginia (Rosslyn Towers), a mixed-use project with 75 residential units and 2,600 square feet of retail space in Alexandria, Virginia (South Washington Street), and a 5.27-acre development site located along the Dulles Toll Road which is to be developed in two phases to include approximately 540,000 square feet of office and retail space (Dulles Station). Our total investment in Rosslyn Towers is expected to be $63.6 million. As of December 31, 2005, we had invested $20.2 million in Rosslyn Towers including land costs, and we expect to fund approximately $29.0 million of the total project costs during 2006. Our total investment in South Washington Street is expected to be $32.2 million. As of December 31, 2005, we had invested $7.2 million in this project, completing the first of three phases, and we expect to fund approximately $19.0 million of the total project costs during 2006. There is a $6.2 million letter agreement in place for the second phase of construction. Our investment in phase one of Dulles Station is expected to be $55.8 million including land costs. As of December 31, 2005, we had invested $26.6 million to acquire the land for both phases of this project, and we expect to fund approximately $26.0 million of the total project costs during 2006. Washington Real Estate Investment Trust and Subsidiaries 55 In addition, we anticipate funding a redevelopment project in our retail portfolio during 2006, Foxchase Shopping Center, and several major renovations in our office and residential portfolios at Maryland Trade Centers I and II, Country Club Towers, Bethesda Hill, Roosevelt Towers and Wayne Plaza. Our total investment in Foxchase is expected to be $10.0 million. As of December 31, 2005, we had invested $2.7 million in this project, and we expect to fund approximately $7.3 million of the total project costs during 2006. Our total investment in Maryland Trade Centers I and II is expected to be $3.1 million. As of December 31, 2005, we had invested $1.7 million in this project, and we expect to fund approximately $1.4 million of the total project costs during 2006. Our total investment in Country Club Towers is expected to be $3.2 million. As of December 31, 2005, we had invested $0.1 million in this project, and we expect to fund approximately $3.1 million of the total project costs during 2006. Our total investment in Bethesda Hill is expected to be $2.9 million. As of December 31, 2005, we had invested $0.1 million in this project, and we expect to fund approximately $2.8 million of the total project costs during 2006. Our total investment in Roosevelt Towers is expected to be $1.8 million. As of December 31, 2005, we had invested $0.1 million in this project, and we expect to fund approximately $1.7 million of the total project costs during 2006. Our total investment in Wayne Plaza is expected to be $1.5 million. As of December 31, 2005, we had invested $0.5 million in this project, and we expect to fund approximately $1.0 million of the total project costs during 2006. In addition, we anticipate funding $7.6 million for smaller renovation projects within our existing portfolio during 2006, though not all of the anticipated spending had been committed via executed construction contracts at December 31, 2005. We expect to meet our requirements using cash generated by our real estate operations, through borrowings on our unsecured credit facilities, or raising additional debt or equity capital in the public market. Contractual Obligations Below is a summary of certain contractual obligations that will require significant capital (in thousands): Long-term debt(1) Purchase obligations(2) Estimated development commitments(3) Tenant-related capital(4) Building capital(5) Operating leases Payments due by Period Total $1,020,595 12,133 85,705 5,495 10,391 21 Less than 1 year $99,025 3,031 65,915 4,529 10,391 21 1–3 years $248,262 6,177 19,790 966 — — 4–5 years $69,101 821 — — — — After 5 years $604,207 2,104 — — — — (1) See Notes 4, 5 and 6 of Notes to Consolidated Financial Statements. Amounts include principal, interest, unused commitment fees and facility fees. (2) Represents elevator maintenance contracts with terms through 2016, electricity sales agreements with terms through 2008 and natural gas purchase agreements with terms through 2006. (3) Committed development obligations based on contracts in place as of December 31, 2005. (4) Committed tenant-related capital based on executed leases as of December 31, 2005. (5) Committed building capital additions based on contracts in place as of December 31, 2005. We have various standing or renewable contracts with vendors. The majority of these contracts are cancelable with immaterial or no cancellation penalties, with the exception of our elevator maintenance and natural gas purchase agreements, which are included above on the purchase obligations line. Contract terms on cancelable leases are generally one year or less. We are currently committed to fund tenant-related capital improvements as described in the table above for executed leases. However, expected leasing levels could require additional tenant-related capital 56 Washington Real Estate Investment Trust and Subsidiaries improvements which are not currently committed. We expect that total tenant-related capital improvements, including those already committed, will be approximately $11.3 million in 2006. Due to the competitive office leasing market and higher vacancy rates, we expect that tenant-related capital costs will continue at this level into 2007. Historical Cash Flows Consolidated cash flow information is summarized as follows (in millions): For the year ended December 31, Variance Cash provided by operating activities Cash used in investing activities Cash provided by financing activities 2005 $ 87.5 $(98.5) $ 10.9 2004 $ 79.9 $(80.4) $ 0.8 2003 $ 76.0 $(147.5) $ 63.6 2005 vs 2004 $ 7.6 $(18.1) $ 10.1 2004 vs 2003 $ 3.9 $ 67.1 $(62.8) Operations generated $87.5 million of net cash in 2005 compared to $79.9 million in 2004 and $76.0 million in 2003. The increase in cash flow in both 2004 and 2005 was due primarily to the additional income from assets acquired in 2004 and 2005. The level of net cash provided by operating activities is also affected by the timing of receipt of revenues and payment of expenses. Our investing activities used net cash of $98.5 million in 2005, $80.4 million in 2004 and $147.5 million in 2003. The change in cash flows from investing activities in 2005 was due to the $123.4 million in acquisitions throughout the year, which was $68.3 million higher than the prior year, offset somewhat by property disposals in the first and third quarters that were $65.8 million higher than the prior year. In addition, capital improvements to existing properties increased $15.4 million in 2005 due largely to the redevelopment of Foxchase and improvements across the Residential portfolio, especially at The Ashby. The change in cash flows used in investing activities in 2004 was due primarily to real estate acquisitions net of assumed debt of $55.1 million, $64.9 million lower than acquisitions completed in 2003, and $8.1 million in proceeds from the disposition of 8230 Boone Boulevard, partially offset by an increase in capital improvement expenditures of $5.9 million due largely to the common area renovation project at Munson Hill Towers and increased spending on the redevelopment project at Westminster Shopping Center. Our financing activities provided net cash of $10.9 million in 2005, $0.8 million in 2004 and $63.6 million in 2003. The increase in net cash provided by financing activities in 2005 is the result of the debt offerings in April and October, which provided $197.2 million offset somewhat by repayment of borrowing on the lines of credit of $93.0 million, payment of dividends of $67.3 million and mortgage principal payments of $28.8 million. The decrease in net cash provided by financing activities in 2004 was due primarily to the fact that we drew on our credit facilities to fund acquisitions and development spending, to pay down $55.0 million in unsecured debt that matured in November and we increased our dividend rate. We issued no unsecured debt or equity in 2004. CaPItaL IMPROVeMeNtS Capital improvements of $48.6 million were completed in 2005, including tenant improvements. Capital improvements to our properties in 2004 and 2003 were $33.2 million and $27.4 million, respectively. Washington Real Estate Investment Trust and Subsidiaries 57 Our capital improvement costs for the three years ending December 31, 2005, were as follows (in thousands): Accretive capital improvements: Acquisition related Expansions and major renovations/development Tenant improvements Total accretive capital improvements Other: Total accretive Capital Improvements 2005 $ 918 29,628 8,932 39,478 9,125 $48,603 Year Ended December 31, 2004 $ 212 14,525 9,432 24,169 9,068 $33,237 2003 $ 612 10,725 9,506 20,843 6,548 $27,391 Acquisition Related—These are capital improvements to properties acquired during the current and preceding two years which were anticipated at the time we acquired the properties. These types of improvements were made in 2005 to Frederick Crossing and 1776 G Street. Expansions and Major Renovations—Expansion projects increase the rentable area of a property. Major renovation projects are improvements sufficient to increase the income otherwise achievable at a property. 2005 expansions and major renovations included Foxchase Shopping Center, which includes construction of a pad site for a large regional grocer; common area renovations for The Ashby at McLean, Munson Hill, Roosevelt Towers and Park Adams; and lobby renovations at Maryland Trade Centers I and II. In February 2001, we acquired an apartment building at 1611 North Clarendon Boulevard adjacent to our 1600 Wilson Boulevard office property with the intent of developing a high-rise apartment building on that site utilizing the available density rights from both properties. We subsequently acquired the retail property 1620 Wilson Boulevard in 2002, also adjacent, as part of this planned development. This effort to develop a mixed-use space with 224 multifamily units and 5,900 square feet of retail space is referred to as Rosslyn Towers, with expected completion in late 2006 for the mid-rise building and mid-2007 for the high-rise building. In May 2003, we acquired 718 E. Jefferson Street to complete our ownership of the entire block of 800 S. Washington Street, with the intent of developing a mixed-use property with 75 apartment units and 2,600 square feet of retail space. Completion of South Washington Street is expected in early 2007. Development costs in each of the years presented include costs associated with the development of Rosslyn Towers and South Washington Street. In December 2005, we acquired a 5.27-acre site located along the Dulles Toll Road—the site, referred to as Dulles Station, is part of a planned 63-acre mixed use development and is approved for 540,000 square feet of office and ancillary retail space. Construction will occur in two phases. The first phase is a 185,000 square foot six-story building, with planned delivery in the fourth quarter of 2007. The second phase is a twelve-story, 355,000 square foot office tower with anticipated delivery in 2008 or 2009 depending on market conditions. Tenant Improvements—Tenant improvements are costs, such as space build-out, associated with commercial lease transactions. 58 Washington Real Estate Investment Trust and Subsidiaries Our average tenant improvement costs per square foot of space leased were as follows during the three years ended December 31, 2005: Office Buildings* Medical Office Buildings Retail Centers Industrial/Flex Properties* Year Ended December 31, 2004 $7.13 2005 $10.42 2003 $11.41 $ 7.65 $ 0.85 $ 1.44 $9.35 $0.90 $1.01 $10.48 $ 0.81 $ 1.91 * Excludes properties sold or classified as held for sale. The $3.29 increase in tenant improvement costs per square foot of space leased for office buildings in 2005 was primarily due to leases executed at Maryland Trade Centers I & II and 1776 G Street in 2005, allowing for $2.1 and $1.2 million, respectively, in tenant improvements. The retail and industrial tenant improvement costs are substantially lower than office and medical office improvement costs due to the tenant improvements required in these property types being substantially less extensive. Excluding properties sold or classified as held for sale, approximately 65% of our office tenants renewed their leases with us in 2005, compared to 50% in 2004 and 68% in 2003. Renewing tenants generally require minimal tenant improvements. In addition, lower tenant improvement costs are one of the many benefits of our focus on leasing to smaller office tenants. Smaller office suites have limited configuration alternatives. Therefore, we are often able to lease an existing suite with limited tenant improvements. Other Capital Improvements Other capital improvements are those not included in the above categories. These are also referred to as recurring capital improvements. Over time these costs will be re-incurred to maintain a property’s income and value. In our residential properties, these include new appliances, flooring, cabinets and bathroom fixtures. These improvements, which are made as needed upon vacancy of an apartment, totaled $0.9 million in 2005 and averaged $1,084 per apartment for the 39% of apartments turned over relative to our total portfolio of apartment units. In addition, during 2005, we incurred repair and maintenance expenses of $7.3 million that were not capitalized, to maintain the quality of our buildings. FORWaRD-LOOKINg StateMeNtS This Annual Report contains forward-looking statements which involve risks and uncertainties. Such forward-looking statements include the following statements with respect to the greater Washington real estate markets: (a) job growth in 2005 is a positive sign for continued economic growth in the region; (b) continued spending by the Federal Government, government contracting firms and professional services firms is expected to further drive regional economic growth; (c) increased office leasing activity is expected to have a positive impact on occupancy with moderate rental rate growth going forward; (d) retail leasing space may continue to be positively affected by the Metro area’s overall population growth and high levels of discretionary income; (e) the office sector vacancy rate is projected to decline over the next two years; (f) multifamily sector occupancy will be impacted by the number of units taken off line for renovation; (g) the Washington Metro area market continues to be a strong retail market and we expect to continue to increase rents substantially; and (h) industrial sector rents are projected to increase in the first half of 2006, as vacancy rates improve. Such forward-looking statements also include the following statements with respect to WRIT: (a) our intention to invest in properties that we believe will increase in income and value; (b) our belief that external sources of capital will continue to be available and that additional sources of capital will be Washington Real Estate Investment Trust and Subsidiaries 59 available from the sale of shares or notes; and (c) our belief that we have the liquidity and capital resources necessary to meet our known obligations and to make additional property acquisitions and capital improvements when appropriate to enhance long-term growth. Forward-looking statements also include other statements in this report preceded by, followed by or that include the words “believe,” “expect,” “intend,” “anticipate,” “potential,” “project,” “will” and other similar expressions. We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for the foregoing statements. The following important factors, in addition to those discussed elsewhere in this Annual Report, could affect our future results and could cause those results to differ materially from those expressed in the forward-looking statements: (a) the economic health of our tenants; (b) the economic health of the greater Washington/Baltimore region, or other markets we may enter, including the effects of changes in Federal government spending; (c) the supply of competing properties; (d) inflation; (e) consumer confidence; (f) unemployment rates; (g) consumer tastes and preferences; (h) stock price and interest rate fluctuations; (i) our future capital requirements; (j) compliance with applicable laws, including those concerning the environment and access by persons with disabilities; (k) governmental or regulatory actions and initiatives; (l) changes in general economic and business conditions; (m) terrorist attacks or actions; (n) acts of war; (o) weather conditions; (p) the effects of changes in capital available to the technology and biotechnology sectors of the economy; and (q) other factors discussed under the caption “Risk Factors.” We undertake no obligation to update our forward-looking statements or risk factors to reflect new information, future events, or otherwise. RatIOS OF eaRNINgS tO FIXeD CHaRgeS aND DeBt SeRVICe COVeRage The following table sets forth our ratios of earnings to fixed charges and debt service coverage for the periods shown: Earnings to fixed charges Year Ended December 31, 2004 2.13x 2005 2.01x 2003 2.33x Debt service coverage 3.05x 3.29x 3.53x We computed the ratio of earnings to fixed charges by dividing earnings by fixed charges. For this purpose, earnings consist of income from continuing operations plus fixed charges, less capitalized interest. Fixed charges consist of interest expense, including amortized costs of debt issuance, plus interest costs capitalized. We computed the debt service coverage ratio by dividing EBITDA (which is earnings before interest income and expense, taxes, depreciation, amortization and gain on sale of real estate) by interest expense and principal amortization. Funds from Operations Funds from Operations (“FFO”) is a widely used measure of operating performance for real estate companies. We provide FFO as a supplemental measure to net income calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Although FFO is a widely used measure of operating performance for REITs, FFO does not represent net income calculated in accordance with GAAP. As such, it should not be considered an alternative to net income as an indication of our operating performance. In addition, FFO does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to cash flow from operating activities, determined in accordance with GAAP as a measure of our liquidity. The National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) defines FFO (April 2002 White Paper) as net income (computed in accordance with GAAP) excluding gains (or losses) 60 Washington Real Estate Investment Trust and Subsidiaries from sales of property plus real estate depreciation and amortization. We consider FFO to be a standard supplemental measure for REITs because it facilitates an understanding of the operating performance of our properties without giving effect to real estate depreciation and amortization, which historically assumes that the value of real estate assets diminishes predictably over time. Since real estate values have instead historically risen or fallen with market conditions, we believe that FFO more accurately provides investors an indication of our ability to incur and service debt, make capital expenditures and fund other needs. Our FFO may not be comparable to FFO reported by other REITs. These other REITs may not define the term in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently. The following table provides the calculation of our FFO and a reconciliation of FFO to net income for the years presented (in thousands): Net income Adjustments Depreciation and amortization Gain on property disposed Discontinued operations depreciation and amortization FFO as defined by NAREIT 2005 $77,638 47,161 (37,515) 71 $87,355 2004 $45,564 39,309 (1,029) 1,784 $85,628 2003 $44,887 33,490 — 2,265 $80,642 Washington Real Estate Investment Trust and Subsidiaries 61 IteM 7a. QUaLItatIVe aND QUaNtItatIVe DISCLOSUReS aBOUt MaRKet RISK The principal material financial market risk to which we are exposed is interest rate risk. Our exposure to interest rate risk relates primarily to refinancing long-term fixed rate obligations, the opportunity cost of fixed rate obligations in a falling interest rate environment and our variable rate lines of credit. We primarily enter into debt obligations to support general corporate purposes including acquisition of real estate properties, capital improvements and working capital needs. In the past we have used interest rate hedge agreements to hedge against rising interest rates in anticipation of imminent refinancing or new debt issuance. The table below presents principal, interest and related weighted-average fair value interest rates by year of maturity, with respect to debt outstanding on December 31, 2005. (In thousands) Unsecured fixed rate debt Principal 2006 2007 2008 2009 2010 Thereafter Total Fair Value $50,000 — $60,000 — — $410,000 $520,000 $523,768 Interest payments $30,264 $26,639 $24,569 $22,500 $22,500 $129,401 $255,873 Interest rate on debt maturities Unsecured variable rate debt Principal Variable interest rate on debt maturities(a) Mortgages Principal amortization (30-year schedule) Interest payments Weighted-average interest rate on 7.49% — 6.74% — — 5.57% 5.89% — — — $24,000 — 4.97% — — — — — $24,000 $ 24,000 — 4.97% $8,678 $9,850 $9,991 $9,004 $2,232 $52,338 $8,883 $7,884 $2,438 $5,107 $93,940 $169,617 $171,478 $9,923 $50,651 principal amortization 5.76% 6.46% 5.22% 7.06% 5.23% 5.27% 5.92% (a) Variable interest rates based on LIBOR in effect on our borrowings outstanding at December 31, 2005. 62 Washington Real Estate Investment Trust and Subsidiaries IteM 8. FINaNCIaL StateMeNtS aND SUPPLeMeNtaRY Data The financial statements and supplementary data appearing on pages 75 to 112 are incorporated herein by reference. IteM 9. CHaNgeS IN aND DISagReeMeNtS WItH aCCOUNtaNtS ON aCCOUNtINg aND FINaNCIaL DISCLOSURe None. IteM 9a. CONtROLS aND PROCeDUReS We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer and Senior Vice President of Accounting, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Senior Vice President of Accounting, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2005. Based on the foregoing, our Chief Executive Officer, Chief Financial Officer and Senior Vice President of Accounting concluded that the Trust’s disclosure controls and procedures were effective. Changes in Internal Control Over Financial Reporting During the three months ended December 31, 2005, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control for financial reporting. IteM 9B. OtHeR INFORMatION None. Washington Real Estate Investment Trust and Subsidiaries 63 paRT III Certain information required by Part III is omitted from this report in that we will file a definitive proxy statement pursuant to Regulation 14A with respect to our 2006 Annual Meeting (the “Proxy Statement”) no later than 120 days after the end of the fiscal year covered by this report, and certain information included therein is incorporated herein by reference. Only those sections of the Proxy Statement which specifically address the items set forth herein are incorporated by reference. Such incorporation does not include the Performance Graph included in the Proxy Statement. In addition, we have adopted a Code of Ethics which can be reviewed and printed from our website www.writ.com. IteM 10. DIReCtORS aND eXeCUtIVe OFFICeRS OF tHe RegIStRaNt The information required by this Item is hereby incorporated herein by reference to the Proxy Statement. IteM 11. eXeCUtIVe COMPeNSatION The information required by this Item is hereby incorporated herein by reference to the Proxy Statement. IteM 12. SeCURItY OWNeRSHIP OF CeRtaIN BeNeFICIaL OWNeRS aND MaNageMeNt aND ReLateD StOCKHOLDeR MatteRS The information required under this Item by Item 403 of Regulation S-K is hereby incorporated herein by reference to the Proxy Statement. equity Compensation Plan Information Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) Weighted-average exercise price of outstanding options, warrants and rights (b) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c) 466,779 64,000 530,779 $23.93 25.76 $24.15 1,313,000 66,000* 1,379,000 Plan category Equity compensation plans approved by security holders Equity compensation plans not approved by security holders Total * We maintain a Share Grant Plan for officers and trustees. The aggregate number of shares which can be made the subject of awards under this Share Grant Plan, together with the aggregate number of shares issued either directly or in connection with the exercise of a stock option under any other plan maintained by the Trust, may not exceed three percent (3%) of the number of then-outstanding shares in any one calendar year and may not exceed, in the aggregate, during any five (5) year period, ten percent (10%) of the number of then- outstanding shares. As of December 31, 2005, 228,164 shares have been granted under this plan. We maintained a stock option plan for trustees which provided for the annual granting of 2,000 non-qualified stock options to trustees the last of which were granted in 2004. As of December 31, 2005, 84,000 options had been granted. See Note 7 to the consolidated financial statements for a description of the Share Grant Plan. 64 Washington Real Estate Investment Trust and Subsidiaries IteM 13. CeRtaIN ReLatIONSHIPS aND ReLateD tRaNSaCtIONS The information required by this Item is hereby incorporated herein by reference to the Proxy Statement. IteM 14. PRINCIPaL aCCOUNtaNt FeeS aND SeRVICeS The information required by this Item is hereby incorporated by reference to the material in the Proxy Statement under the caption “Independent Registered Public Accounting Firm.” Washington Real Estate Investment Trust and Subsidiaries 65 paRT IV IteM 15. eXHIBItS aND FINaNCIaL StateMeNt SCHeDULeS (A). The following documents are filed as part of this Report: 1. Financial Statements Management’s Report on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2005 and 2004 Consolidated Statements of Income for the Years Ended December 31, 2005, 2004 and 2003 Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2005, 2004 and 2003 Consolidated Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003 Notes to Consolidated Financial Statements 2. Financial Statement Schedules Page 75 76 77 78 79 80 81 83 Schedule III—Summary of Real Estate Investments and Accumulated Depreciation 108 3. exhibits: 3. Declaration of Trust and Bylaws (a) Declaration of Trust. Incorporated herein by reference to Exhibit 3 to the Trust’s registration statement on Form 8-B dated July 10, 1996. (b) Bylaws. Incorporated herein by reference to Exhibit 4 to the Trust’s registration statement on Form 8-B dated July 10, 1996. (c) Amendment to Declaration of Trust dated September 21, 1998. Incorporated herein by reference to Exhibit 3 to the Trust’s Form 10-Q dated November 13, 1998. (d) Articles of Amendment to Declaration of Trust dated June 24, 1999. Incorporated herein by reference to Exhibit 4c to Amendment No. 1 to the Trust’s Form S-3 registration statement filed with the Securities and Exchange Commission as of July 14, 1999. (e) Amendment to Bylaws dated February 21, 2002. Incorporated herein by reference to Exhibit 3(e) to the Trust’s Form 10-K dated April 1, 2002. 4. Instruments Defining Rights of Security Holders (a) [Intentionally omitted] (b) Amended and restated credit agreement dated July 25, 1999, among Washington Real Estate Investment Trust, as borrower, SunTrust Bank (successor by merger to Crestar Bank), as lender, First Union National Bank (successor by merger to Signet Bank), as lender, and SunTrust Bank, as agent.(1) (c) Indenture dated as of August 1, 1996, between Washington Real Estate Investment Trust and The First National Bank of Chicago.(2) 66 Washington Real Estate Investment Trust and Subsidiaries (d) Officers’ Certificate Establishing Terms of the Notes, dated August 8, 1996(2) (e) [Intentionally omitted] (f) Form of 2006 Notes(2) (g) Form of MOPPRS Notes(3) (h) Form of 30-year Notes(3) (i) Remarketing Agreement(3) (j) Form of 2004 fixed-rate notes(4) (k) [Intentionally omitted] (l) Credit agreement dated July 23, 2002, between Washington Real Estate Investment Trust, as borrower, Bank One, as lender, and Bank One, as agent(7) (m) Amendment to amended and restated credit agreement dated July 25, 2002, among Washington Real Estate Investment Trust, as borrower, SunTrust Bank, successor to Crestar Bank, as Agent, and SunTrust Bank (SunTrust), successor to Crestar Bank, and Wachovia Bank, National Association (Wachovia), successor to First Union National Bank (the Credit Agreement)(7) (n) Officer’s Certificate Establishing Terms of the Notes, dated March 12, 2003.(8) (o) Form of 2013 Notes.(8) (p) Officers’ Certificate Establishing Terms of the Notes, dated December 8, 2003.(9) (q) Form of 2014 Notes.(9) (r) [Intentionally omitted] (s) Amended and Restated Credit Agreement, Dated as of July 21, 2004, among Washington Real Estate Investment Trust, as borrower and Bank One, NA, and Wells Fargo Bank, National Association, as lenders and Bank One, NA, as agent and Banc One Capital Markets, Inc., as lead arranger and sole book runner.(10) (t) Form of 5.05% Senior Notes due May 1, 2012(11) (u) Form of 5.35% Senior Notes due May 1, 2015, dated April 26, 2005(11) (v) Officers Certificate establishing the terms of the Notes, dated April 20, 2005(11) (w) Credit agreement dated July 25, 2005, between Washington Real Estate Investment Trust as borrower and SunTrust Bank as lender.(12) (x) Form of 5.35% Senior Notes due May 1, 2015, dated October 6, 2005(13) (y) Officers Certificate establishing the terms of the Notes, dated October 3, 2005(13) We are a party to a number of other instruments defining the rights of holders of long-term debt. No such instrument authorizes an amount of securities in excess of 10% of the total assets of the Trust and its Subsidiaries on a consolidated basis. On request, we agree to furnish a copy of each such instrument to the Commission. 10. Management Contracts, Plans and Arrangements (a) Employment Agreement dated May 11, 1994, with Edmund B. Cronin, Jr.(5) (b) 1991 Incentive Stock Option Plan, as amended.(5) (c) Nonqualified Stock Option Agreement dated December 14, 1994, with Edmund B. Cronin, Jr.(5) (d) Nonqualified Stock Option Agreement dated December 19, 1995, with Edmund B. Cronin, Jr. Incorporated herein by reference to Exhibit 10(e) to the 1995 Form 10-K filed March 29, 1996. (e) Share Grant Plan(6) (f) Share Option Plan for Trustees(6) (g) Deferred Compensation Plan for Executives dated January 1, 2000, incorporated herein by reference to Exhibit 10(g) to the 2000 Form 10-K filed March 19, 2001. Washington Real Estate Investment Trust and Subsidiaries 67 (h) Split-Dollar Agreement dated April 1, 2000, incorporated herein by reference to Exhibit 10(h) to the 2000 Form 10-K filed March 19, 2001. (i) 2001 Stock Option Plan incorporated herein by reference to Exhibit A to 2001 Proxy Statement dated March 29, 2001. (j) Share Purchase Plan.(7) (k) Supplemental Executive Retirement Plan.(7) (l) Description of Washington Real Estate Investment Trust Short-term and Long-term Incentive Plan incorporated herein by reference to Exhibit 10(l) to the 2005 Form 10-K filed March 16, 2005. (m) Description of Washington Real Estate Investment Trust Revised Trustee Compensation Plan incorporated herein by reference to Exhibit 10(m) to the 2005 Form 10-K filed March 16, 2005. (n) Employment Agreement dated October 3, 2005, with Christopher P. Mundy.(14) (o) Change in Control Agreement dated October 3, 2005, with Christopher P. Mundy.(15) (p) Supplemental Executive Retirement Plan (q) Change in Control Agreement dated May 22, 2003, with Thomas L. Regnell (r) Change in Control Agreement dated June 13, 2005, with David A. DiNardo (s) Change in Control Agreement dated May 22, 2003, with George F. McKenzie (t) Change in Control Agreement dated May 22, 2003, with Laura M. Franklin (u) Change in Control Agreement dated May 22, 2003, with Kenneth C. Reed (v) Change in Control Agreement dated May 22, 2003, with Sara L. Grootwassink (w) Change in Control Agreement dated January 1, 2006, with James B. Cederdahl 12. Computation of Ratio of Earnings to Fixed Charges 21. Subsidiaries of Registrant In 1995, WRIT formed a subsidiary partnership, WRIT Limited Partnership, a Maryland limited partnership in which it owns 100% of the partnership interest. In 1998, WRIT formed a subsidiary limited liability company, WRIT-NVIP, L.L.C., a Virginia limited liability company in which it owns 93% of the membership interest. The 7% minority ownership interest is discussed further in Note 2 to the financial statements. In 2003, WRIT formed a subsidiary limited liability company, WRIT Prosperity Holdings, L.L.C., a Delaware limited liability company in which WRIT owns 100% of the membership interest. In 2003, WRIT formed subsidiary limited liability companies WRIT 8501-8503, L.L.C. and WRIT 8505, L.L.C., both Delaware limited liability companies in which WRIT owns 100% of the membership interest. In 2004, WRIT formed a subsidiary limited liability company, Shady Grove Medical Village II, L.L.C., a Delaware limited liability company in which WRIT owns 100% of the membership interest. In 2004, WRIT formed subsidiary limited liability companies WRIT Dulles Holdings, L.L.C., WRIT Dulles I, L.L.C. and WRIT Dulles II, L.L.C., all Delaware limited liability companies in which WRIT owns 100% of the membership interest. 23. Consents (a) Consent of Independent Registered Public Accounting Firm 68 Washington Real Estate Investment Trust and Subsidiaries 31. Rule 13a-14(a)/15(d)-14(a) Certifications (a) Certification—Chief Executive Officer (b) Certification—Senior Vice President—Accounting and Administration (c) Certification—Chief Financial Officer 32. Section 1350 Certifications (a) Written Statement of Chief Executive Officer and Financial Officers (1) Incorporated herein by reference to the Exhibits of the same designation to the Trust’s Form 10-K filed March 24, 2000. (2) Incorporated herein by reference to the Exhibit of the same designation to the Trust’s Form 8-K filed August 13, 1996. (3) Incorporated herein by reference to the Exhibit of the same designation to the Trust’s Form 8-K filed February 25, 1998. (4) Incorporated herein by reference to Exhibit 4 to the Trust’s Form 10-Q filed November 14, 2000. (5) Incorporated herein by reference to the Exhibit of the same designation to Amendment No. 2 to the Trust’s Registration Statement on Form S-3 filed July 17, 1995. (6) Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to the Trust’s Registration Statement on Form S-8 filed on March 17, 1998. (7) Incorporated herein by reference to the Exhibits of the same designation to the Trust’s Form 10-Q filed November 14, 2002. (8) Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to the Trust’s Form 8-K filed March 17, 2003. (9) Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to the Trust’s Form 8-K filed December 11, 2003. (10) Incorporated herein by reference to Exhibit 4 to the Trust’s Form 10-Q filed August 6, 2004. (11) Incorporated herein by reference to Exhibits 4.1, 4.2 and 4.3 to the Trust’s Form 8-K filed April 26, 2005. (12) Incorporated herein by reference to Exhibit 4 to the Trust’s Form 10-Q filed August 5, 2005. (13) Incorporated herein by reference to Exhibit 4.1 and 4.2 to the Trust’s Form 8-K filed October 6, 2005. (14) Incorporated herein by reference to Exhibit 10 to the Trust’s Form 10-Q filed November 9, 2005. (15) Incorporated herein by reference to Exhibit 10 to the Trust’s Form 8-K filed October 7, 2005. Washington Real Estate Investment Trust and Subsidiaries 69 SIgNatUReS Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 16, 2006 Washington Real estate Investment trust By: /s/ Edmund B. Cronin, Jr. Edmund B. Cronin, Jr. President, Chief Executive Officer and Chairman Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature /s/ Edmund B. Cronin, Jr. Edmund B. Cronin, Jr. /s/ John M. Derrick, Jr. John M. Derrick, Jr. /s/ John P. McDaniel John P. McDaniel /s/ Charles T. Nason Charles T. Nason /s/ David M. Osnos David M. Osnos /s/ Robert W. Pivik Robert W. Pivik /s/ Susan J. Williams Susan J. Williams /s/ Laura M. Franklin Laura M. Franklin /s/ Sara L. Grootwassink Sara L. Grootwassink Title Trustee Trustee Trustee Trustee Trustee Trustee Trustee Senior Vice President Accounting and Administration and Corporate Secretary Date March 16, 2006 March 16, 2006 March 16, 2006 March 16, 2006 March 16, 2006 March 16, 2006 March 16, 2006 March 16, 2006 Chief Financial Officer March 16, 2006 70 Washington Real Estate Investment Trust and Subsidiaries eXHIBIt 31(a) I, Edmund B. Cronin, Jr., certify that: 1. I have reviewed this annual report on Form 10-K of Washington Real Estate Investment Trust; 2. 3. 4. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. b. c. d. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonable likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: March 16, 2006 /s/ Edmund B. Cronin, Jr. Edmund B. Cronin, Jr. Chief Executive Officer Washington Real Estate Investment Trust and Subsidiaries 71 eXHIBIt 31(b) I, Laura M. Franklin, certify that: 1. I have reviewed this annual report on Form 10-K of Washington Real Estate Investment Trust; 2. 3. 4. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: a. b. c. d. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonable likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: March 16, 2006 /s/ Laura M. Franklin Laura M. Franklin Senior Vice President Accounting, Administration and Corporate Secretary 72 Washington Real Estate Investment Trust and Subsidiaries eXHIBIt 31(c) I, Sara L. Grootwassink, certify that: 1. I have reviewed this annual report on Form 10-K of Washington Real Estate Investment Trust; 2. 3. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: a. b. c. d. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonable likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. DATE: March 16, 2006 /s/ Sara L. Grootwassink Sara L. Grootwassink Chief Financial Officer Washington Real Estate Investment Trust and Subsidiaries 73 eXHIBIt 32 Written Statement of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 The undersigned, the Chairman of the Board, President and Chief Executive Officer, the Senior Vice President Accounting, Administration and Corporate Secretary, and the Chief Financial Officer of Washington Real Estate Investment Trust (“WRIT”), each hereby certifies on the date hereof, that: (a) the Annual Report on Form 10-K for the year ended December 31, 2005 filed on the date hereof with the Securities and Exchange Commission (the “Report”) fully complies with the requirements of Section 13 (a) or 15(d) of the Securities Exchange Act of 1934; and (b) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of WRIT. Dated: March 16, 2006 Dated: March 16, 2006 Dated: March 16, 2006 /s/ Edmund B. Cronin, Jr. Edmund B. Cronin, Jr. Chief Executive Officer /s/ Laura M. Franklin Laura M. Franklin Senior Vice President Accounting, Administration and Corporate Secretary /s/ Sara L. Grootwassink Sara L. Grootwassink Chief Financial Officer 74 Washington Real Estate Investment Trust and Subsidiaries MaNageMeNt’S RePORt ON INteRNaL CONtROL OVeR FINaNCIaL RePORtINg Management of Washington Real Estate Investment Trust (the “Trust”) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal controls over financial reporting. The Trust’s internal control system over financial reporting is a process designed under the supervision of the Trust’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions. In connection with the preparation of the Trust’s annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Trust’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Management’s assessment included an evaluation of the design of the Trust’s internal control over financial reporting and testing of the operational effectiveness of those controls. Based on this assessment, management has concluded that as of December 31, 2005, the Trust’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Ernst & Young LLP, the independent registered public accounting firm that audited the Trust’s consolidated financial statements included in this report, has issued an attestation report on management’s assessment of internal control over financial reporting, a copy of which appears on the next page of this annual report. Washington Real Estate Investment Trust and Subsidiaries 75 RePORt OF INDePeNDeNt RegISteReD PUBLIC aCCOUNtINg FIRM ON INteRNaL CONtROL OVeR FINaNCIaL RePORtINg to the trustees and Shareholders of Washington Real estate Investment trust We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Washington Real Estate Investment Trust and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Washington Real Estate Investment Trust and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that Washington Real Estate Investment Trust and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Washington Real Estate Investment Trust and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Washington Real Estate Investment Trust and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005, of Washington Real Estate Investment Trust and Subsidiaries, and our report dated March 8, 2006, expressed an unqualified opinion thereon. //s/ Ernst & Young LLP McLean, Virginia March 8, 2006 76 Washington Real Estate Investment Trust and Subsidiaries RePORt OF INDePeNDeNt RegISteReD PUBLIC aCCOUNtINg FIRM to the trustees and Shareholders of Washington Real estate Investment trust We have audited the accompanying consolidated balance sheets of Washington Real Estate Investment Trust and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Washington Real Estate Investment Trust and Subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Washington Real Estate Investment Trust and Subsidiaries’ internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 8, 2006, expressed an unqualified opinion thereon. //s/ Ernst & Young LLP McLean, Virginia March 8, 2006 Washington Real Estate Investment Trust and Subsidiaries 77 CONSOLIDateD BaLaNCe SHeetS As of December 31, 2005 and 2004 2005 2004 (In thousands) assets Land Income producing property Accumulated depreciation and amortization Net income producing property Development in progress Total investments in real estate, net Investment in real estate held for sale, net Cash and cash equivalents Restricted cash Rents and other receivables, net of allowance for doubtful accounts of $2,916 and $2,636, respectively Prepaid expenses and other assets Other assets related to properties held for sale Total assets Liabilities Accounts payable and other liabilities Advance rents Tenant security deposits Other liabilities related to properties held for sale Mortgage notes payable Lines of credit Notes payable Total liabilities Minority interest Shareholders’ equity Shares of beneficial interest; $.01 par value; 100,000 shares authorized: 42,139 and 42,000 shares issued and outstanding, respectively Additional paid in capital Distributions in excess of net income Less: Deferred compensation on restricted shares Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying notes to the financial statements. $ 226,217 1,024,702 1,250,919 (240,153) 1,010,766 58,241 1,069,007 — 4,938 1,764 25,258 40,318 — $ 204,831 895,553 1,100,384 (200,375) 900,009 12,280 912,289 36,986 5,065 962 21,402 34,969 720 $1,141,285 $1,012,393 $ 32,728 $ 22,586 5,572 7,393 — 169,617 24,000 520,000 759,310 1,670 421 407,972 (25,228) (2,860) 380,305 5,108 5,784 848 173,429 117,000 320,000 644,755 1,629 420 405,029 (35,544) (3,896) 366,009 $1,141,285 $1,012,393 78 Washington Real Estate Investment Trust and Subsidiaries CONSOLIDateD StateMeNtS OF INCOMe For the years ended December 31, 2005, 2004, and 2003 2005 2004 2003 (In thousands, except per share data) Revenue Real estate rental revenue Expenses Utilities Real estate taxes Repairs and maintenance Property administration Property management Operating services and common area maintenance Other real estate expenses Depreciation and amortization General and administrative expenses Real estate operating income Other income (expense) Interest expense Other income Other income from property settlement $190,046 $171,646 $153,576 11,153 15,958 7,255 5,472 5,678 9,967 2,633 47,161 8,005 113,282 76,764 9,375 14,062 6,668 4,965 5,153 8,834 2,271 39,309 6,194 96,831 74,815 7,677 11,884 5,848 4,223 4,685 8,153 2,157 33,490 5,275 83,392 70,184 (37,743) (34,500) (30,040) 918 504 326 — 414 — (36,321) (34,174) (29,626) Income from continuing operations 40,443 40,641 40,558 Discontinued operations: Income from operations of properties sold or held for sale Gain on disposal Net income Basic net income per share Continuing operations Discontinued operations including gain on disposal Net income per share Diluted net income per share Continuing operations Discontinued operations including gain on disposal Net income per share Weighted average shares outstanding—basic Weighted average shares outstanding—diluted 184 37,011 3,894 1,029 4,329 — $ 77,638 $ 45,564 $ 44,887 $ 0.96 0.89 $ 1.85 $ 0.96 0.88 $ 1.84 42,069 42,203 $ 0.98 0.11 $ 1.09 $ 0.97 0.12 $ 1.09 41,642 41,863 $ 1.03 0.11 $ 1.14 $ 1.02 0.11 $ 1.13 39,399 39,600 $ 1.47 Dividends paid per share $ 1.60 $ 1.55 See accompanying notes to the financial statements. Washington Real Estate Investment Trust and Subsidiaries 79 CONSOLIDateD StateMeNtS OF CHaNgeS IN SHaReHOLDeRS’ eQUItY Shares of Beneficial Interest at Deferred Par Value Compensation Shares Additional Paid in Capital Distributions in Excess of Net Income Shareholders’ Equity 39,168 392 (458) 328,797 For the years ended December 31, 2005, 2004 and 2003 (In thousands) Balance, December 31, 2002 Net income Dividends Share offering Share options exercised Share grants, net of share grant amortization — — 2,201 181 57 Balance, December 31, 2003 41,607 Net income Dividends Share options exercised Share grants, net of share grant amortization — — 302 91 Balance, December 31, 2004 42,000 Net income Dividends Share options exercised Share grants, net of share grant amortization, net of forfeitures — — 136 3 Balance, December 31, 2005 42,139 See accompanying notes to the financial statements. — — 22 2 — 416 — — 3 1 $420 — — 1 — $421 — — — — — — 62,802 3,236 (1,400) (1,858) 1,627 396,462 — — — (2,038) $(3,896) — — — — — 5,662 2,905 — — 2,845 (2,554) 44,887 (58,605) — — — (16,272) 45,564 (64,836) — — 326,177 44,887 (58,605) 62,824 3,238 227 378,748 45,564 (64,836) 5,665 868 77,638 (67,322) — — 77,638 (67,322) 2,846 1,134 1,036 98 $(2,860) $407,972 $(25,228) $380,305 $405,029 $(35,544) $366,009 80 Washington Real Estate Investment Trust and Subsidiaries CONSOLIDateD StateMeNtS OF CaSH FLOWS For the years ended December 31, 2005, 2004 and 2003 2005 2004 2003 (In thousands) Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Gain on sale of real estate Depreciation and amortization Provision for losses on accounts receivable Amortization of share grants Changes in other assets Changes in other liabilities Net cash provided by operating activities Cash flows from investing activities Real estate acquisitions, net* Capital improvements to real estate Net cash received for sale of real estate Non-real estate capital improvements Net cash used in investing activities Cash flows from financing activities Net proceeds from share offering Line of credit (repayments)/borrowings, net Notes payable repayments Dividends paid Principal payments—mortgage notes payable Net proceeds from debt offering Net proceeds from exercise of share options Net cash provided by financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year $ 77,638 $ 45,564 $ 44,887 (37,011) 47,233 872 1,134 (6,735) 4,391 87,522 (123,358) (48,603) 73,879 (437) (98,519) — (93,000) — (67,322) (28,820) 197,166 2,846 10,870 (127) 5,065 (1,029) 41,093 964 868 (9,404) 1,867 79,923 (55,135) (33,237) 8,071 (101) (80,402) — 117,000 (55,000) (64,836) (2,041) — 5,665 788 309 4,756 — 35,755 1,835 227 (8,448) 1,723 75,979 (120,000) (27,391) — (132) (147,523) 62,824 (50,750) (50,000) (58,605) (1,333) 158,178 3,238 63,552 (7,992) 12,748 Cash and cash equivalents at end of year $ 4,938 $ 5,065 $ 4,756 Supplemental disclosure of cash flow information: Cash paid for interest $ 36,662 $ 32,157 $ 28,889 * Supplemental discussion of non-cash investing and financing activities: On March 23, 2005, we purchased Frederick Crossing Shopping Center for $44.8 million. We assumed a mortgage in the amount of $24.3 million, fair valued at $25.0 million, and funded the balance ($20.5 million) utilizing $1.0 million in credit facility borrowings and $19.5 million of the $31.3 million in cash escrowed from the sale of Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike in February 2005. The $24.3 million of assumed mortgage is not included in the $20.9 million shown as real estate acquisitions for the year ended December 31, 2005, as the assumption of the mortgage was a non-cash acquisition cost. On April 9, 2005, we purchased the DBP Coleman Building for $8.8 million, which was funded in part ($8.3 million) from cash escrowed from the aforementioned sale of Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike. Washington Real Estate Investment Trust and Subsidiaries 81 On August 12, 2004, we purchased Shady Grove Medical Village II for $18.5 million. We assumed a mortgage in the amount of $10.1 million, fair valued at $11.2 million, and paid the balance in cash utilizing a borrowing under Credit Facility No. 1. On December 22, 2004, we purchased Dulles Business Park for $46.0 million. We assumed two mortgages in the total amount of $19.5 million, fair valued at $22.0 million, and borrowed $28.0 million under Credit Facility No. 1 to fund the acquisition. The $29.6 million of total assumed mortgages is not included in the $55.1 million shown as 2004 acquisitions, as the assumption of these mortgages was a non-cash acquisition cost. On January 24, 2003, we purchased Fullerton Industrial Center for $10.6 million. We assumed a mortgage in the amount of $6.6 million, fair valued at $6.8 million, and paid the balance in cash. On October 9, 2003, we purchased Prosperity Medical Center for $78.0 million. We assumed two mortgages in the total amount of $49.8 million (fair valued at $49.8 million), borrowed $27.0 million under Credit Facility No. 3 and paid the balance in cash. The $120.0 million shown as 2003 real estate acquisitions does not include the $56.4 million in total assumed mortgages for Fullerton Industrial and Prosperity Medical Center, as the assumption of these mortgages was a non-cash acquisition cost. See accompanying notes to the financial statements. 82 Washington Real Estate Investment Trust and Subsidiaries NOteS tO CONSOLIDateD FINaNCIaL StateMeNtS for the years ended December 31, 2005, 2004 and 2003 1. Nature of Business: Washington Real Estate Investment Trust (“WRIT,” the “company” or the “Trust”), a Maryland Real Estate Investment Trust, is a self-administered, self-managed equity real estate investment trust, successor to a trust organized in 1960. Our business consists of the ownership of income-producing real estate properties in the greater Washington/ Baltimore region. We own a diversified portfolio of office buildings, medical office buildings, industrial/flex properties, multifamily buildings and retail centers. Federal Income Taxes We qualify as a Real Estate Investment Trust (REIT) under Sections 856–860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute 90% of our ordinary taxable income to our shareholders. When selling properties, we have the option of (i) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (ii) paying out capital gains to the shareholders with no tax to the company or (iii) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. All of the gains on the sale of properties disposed in 2005 were reinvested in replacement properties. The gain on the property sold during 2004 was paid out to the shareholders. No provision for income taxes was necessary in 2005, 2004 or 2003. The following is a breakdown of the taxable percentage of our dividends for 2005, 2004 and 2003, respectively: 2005 2004 2003 Ordinary Income 81% 86% 97% Return of Capital 14% 10% 3% Unrecaptured Section 1250 Gain 5% 2% 0% Capital Gain 0% 2% 0% 2. accounting Policies: Basis of Presentation The accompanying consolidated financial statements include the accounts of the Trust and its majority owned subsidiaries, after eliminating all intercompany transactions. New Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB opinion No. 25 (APB No. 25), “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Statement No. 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and eliminates the intrinsic value method of accounting in Washington Real Estate Investment Trust and Subsidiaries 83 APB No. 25, which was permitted under SFAS No. 123, as originally issued. The Company will be required to apply the provisions of this statement as of January 1, 2006. Since we used the fair-value-based method of accounting under the original provisions of SFAS No. 123 in pro forma disclosure, we are required to adopt the provisions of the new standard using either the modified-prospective- transition or the modified-retrospective-transition method. Under both methods, for awards granted, settled or modified subsequent to adopting the standard and for awards granted prior to the date of adoption for which the requisite service has not been completed as of the adoption date, compensation cost must be recognized in the financial statements. Under the modified retrospective method, financial statements for prior periods are restated for this change and under the modified prospective method only statements subsequent to adoption will include this compensation cost. The modified prospective method also requires a cumulative adjustment in the first period of adoption to conform to the new standard. The Company plans to adopt SFAS No. 123R using the modified- prospective-transition method. The Company anticipates that adoption of SFAS No. 123R will not have a material impact on its results of operations and its financial position. Revenue Recognition Residential properties (our multifamily segment) are leased under operating leases with terms of generally one year or less, and commercial properties (our office, medical office, retail and industrial segments) are leased under operating leases with average terms of three to seven years. We recognize rental income and rental abatements from our residential and commercial leases when earned on a straight-line basis in accordance with SFAS No. 13 “Accounting for Leases.” Recognition of rental income commences when control of the facility has been given to the tenant. We record a provision for losses on accounts receivable equal to the estimated uncollectible amounts. This estimate is based on our historical experience and a review of the current status of the company’s receivables. Percentage rents, which represent additional rents based on gross tenant sales, are recognized when tenants’ sales exceed specified thresholds. In accordance with SFAS No. 66, “Accounting for Sales of Real Estate,” sales are recognized at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to the buyer and we have no significant continuing involvement. We recognize cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements. Minority Interest We entered into an operating agreement with a member of the entity that previously owned Northern Virginia Industrial Park in conjunction with the acquisition of this property in May 1998. This resulted in a minority ownership interest in this property based upon defined company ownership units at the date of purchase. The operating agreement was amended and restated in 2002 resulting in a reduced minority ownership percentage interest. We account for this activity by allocating the minority owner’s percentage ownership interest of the net income of the property to minority interest included in our general and administrative expenses, thereby reducing net income. Minority interest expense was $172,000, $154,800 and $167,400 for the years ended December 31, 2005, 2004 and 2003 respectively. Quarterly distributions are made to the minority owner equal to the quarterly dividend per share for each ownership unit. 84 Washington Real Estate Investment Trust and Subsidiaries Deferred Financing Costs Costs associated with the issuance of mortgages, notes payable and fees associated with the lines of credit are capitalized and amortized using the effective interest rate method, or the straight-line method which approximates the effective interest rate method over the term of the related debt. As of December 31, 2005 and 2004 deferred financing costs of $14.5 million and $11.3 million, respectively, net of accumulated amortization of $5.8 million and $4.7 million were included in Prepaid Expenses and Other Assets on the balance sheets. The amortization is included in interest expense in the accompanying statements of income. The amortization of debt costs included in interest expense totaled $1.4 million, $1.3 million and $1.3 million for the years ended December 31, 2005, 2004 and 2003, respectively. Deferred Leasing Costs Costs associated with the successful negotiation of leases, both external commissions and internal direct costs, are capitalized and amortized on a straight-line basis over the terms of the respective leases. If an applicable lease terminates prior to the expiration of its initial lease term, the carrying amount of the costs are written-off to expense. As of December 31, 2005 and 2004 deferred leasing costs of $15.1 million and $11.5 million, respectively, net of accumulated amortization of $4.9 million and $3.6 million, were included in Prepaid Expenses and Other Assets on the balance sheets. The amortization of deferred leasing costs included in expense for properties classified as continuing operations totaled $2.0 million, $1.5 million and $1.5 million for the years ended December 31, 2005, 2004 and 2003, respectively. Real Estate and Depreciation Buildings are depreciated on a straight-line basis over estimated useful lives ranging from 28 to 50 years. All capital improvement expenditures associated with replacements, improvements, or major repairs to real property that extend its useful life are capitalized and depreciated using the straight-line method over their estimated useful lives ranging from 3 to 30 years. In addition, we capitalize tenant leasehold improvements when certain criteria are met, including when we supervise construction and will own the improvements. All tenant improvements are amortized over the shorter of the useful life of the improvements or the term of the related tenant lease. Real estate depreciation expense from continuing operations for the years ended December 31, 2005, 2004 and 2003, was $41.8 million, $34.4 million and $29.6 million, respectively. Maintenance and repair costs are charged to expense as incurred. We capitalize interest costs incurred on borrowing obligations while qualifying assets are being readied for their intended use in accordance with SFAS No. 34, “Capitalization of Interest Cost.” Total interest expense capitalized to real estate assets related to development and major renovation activities was $1,127,300, $703,400 and $247,600, for the years ended December 31, 2005, 2004 and 2003, respectively. Interest capitalized is amortized over the useful life of the related underlying assets upon those assets being placed into service. We recognize impairment losses on long-lived assets used in operations when indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. If such carrying amount is in excess of the estimated cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to the estimated fair market value. There were no property impairments recognized during the three-year period ended December 31, 2005. Washington Real Estate Investment Trust and Subsidiaries 85 We allocate the purchase price of acquired properties to the related physical assets and in-place leases based on their fair values, in accordance with SFAS No. 141, “Business Combinations.” The fair values of acquired buildings are determined on an “as-if-vacant” basis considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. The “as-if-vacant” fair value is allocated to land, building and tenant improvements based on property tax assessments and other relevant information obtained in connection with the acquisition of the property. The fair value of in-place leases consists of the following components—(1) the estimated cost to us to replace the leases, including foregone rents during the period of finding a new tenant, foregone recovery of tenant pass- throughs, tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as “Tenant Origination Cost”); (2) estimated leasing commissions associated with obtaining a new tenant (referred to as “Leasing Commissions”); (3) the above/at/below market cash flow of the leases, determined by comparing the projected cash flows of the leases in place to projected cash flows of comparable market-rate leases (referred to as “Net Lease Intangible”); and (4) the value, if any, of customer relationships, determined based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the tenant (referred to as “Customer Relationship Value”). The amounts used to calculate Tenant Origination Cost, Leasing Commissions, and Net Lease Intangible are discounted using an interest rate which reflects the risks associated with the leases acquired. Tenant Origination Costs are included in Real Estate Assets on our balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. Leasing Commissions are classified as Other Assets and are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. Net Lease Intangible Assets are classified as Other Assets and are amortized on a straight-line basis as a decrease to Real Estate Rental Revenue over the remaining term of the underlying leases. Net Lease Intangible Liabilities are classified as Other Liabilities and are amortized on a straight-line basis as an increase to Real Estate Rental Revenue over the remaining term of the underlying leases. Should a tenant terminate its lease, the unamortized portion of the Tenant Origination Cost, Leasing Commissions, and Net Lease Intangible associated with that lease are written off to depreciation expense, amortization expense, and rental revenue, respectively. Balances, net of accumulated depreciation or amortization, as appropriate, of the components of the fair value of in- place leases at December 31, 2005 and 2004, are as follows (in millions): December 31, Gross Carrying Value $12.3 $ 7.4 $ 6.8 $ 8.9 2005 Accumulated Amortization $3.8 $2.2 $1.7 $1.8 Net $8.5 $5.2 $5.1 $7.1 Gross Carrying Value $8.2 $5.2 $5.5 $4.1 2004 Accumulated Amortization $1.9 $1.1 $0.7 $0.7 Net $6.3 $4.1 $4.8 $3.4 Tenant Origination Costs Leasing Commissions Net Lease Intangible Assets Net Lease Intangible Liabilities Amortization of these components combined was $3.0 million, $2.1 million and $0.9 million for the years ended December 31, 2005, 2004 and 2003, respectively. No value had been assigned to Customer Relationship Value at December 31, 2005, or December 31, 2004. 86 Washington Real Estate Investment Trust and Subsidiaries Discontinued Operations We classify properties as held for sale when they meet the necessary criteria specified by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” These include: senior management commits to and actively embarks upon a plan to sell the assets, the sale is expected to be completed within one year under terms usual and customary for such sales and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Depreciation on these properties is discontinued, but operating revenues, operating expenses and interest expense continue to be recognized until the date of sale. Under SFAS No. 144, revenues and expenses of properties that are either sold or classified as held for sale are presented as discontinued operations for all periods presented in the Statements of Income. Cash and Cash Equivalents Cash and cash equivalents include investments readily convertible to known amounts of cash with original maturities of 90 days or less. Restricted Cash Restricted cash at December 31, 2005, and December 31, 2004, consisted of $1.8 million and $1.0 million, respectively, in funds escrowed for tenant security deposits, real estate tax, insurance and mortgage escrows and escrow deposits required by lenders on certain of our properties to be used for future building renovations or tenant improvements. Stock Based Compensation We maintain Share Grant Plans and Incentive Stock Option Plans as described in Note 7, Share Options and Grants, which include qualified and non-qualified options and deferred shares for eligible employees. Shares are granted to officers and trustees under the Share Grant Plans. Officer share grants vest over five years in annual installments commencing one year after the date of grant. Trustee share grants are fully vested immediately upon date of share grant and are restricted from transferability for the period of the Trustee’s service. Compensation expense is recognized for share grants over the vesting period equal to the fair market value of the shares on the date of issuance. Compensation expense for the trustee grants is fully recognized upon issuance based upon the fair market value of the shares on the date of grant. The unvested portion of officer share grants is recognized as deferred compensation. Unvested shares are forfeited upon an employee’s termination while unvested shares for employees eligible for retirement fully vest upon retirement. For shares granted to employees who are eligible for retirement or will become eligible for retirement during the vesting period, compensation cost is recognized over the explicit service period with acceleration of expense upon the date of actual retirement for these employees. The Company will continue this practice for awards granted prior to the adoption of SFAS No. 123(R) and for shares granted after the adoption of SFAS No. 123(R) the Company will recognize compensation expense through the date that the employee is no longer required to provide service to earn the award (e.g., the date the employee is eligible to retire). The Company will recognize $1.0 million in compensation cost in the future for awards amortized over the explicit service period. Stock options were historically issued annually to officers, trustees and non-officer key employees under the Incentive Stock Option Plans. They were last issued to officers in 2002, to non-officer key employees in 2003 and to trustees in 2004. The options vest over a 2-year period in annual installments commencing one year after the date of grant, Washington Real Estate Investment Trust and Subsidiaries 87 except for trustee options which vested immediately upon the date of grant. Stock options are accounted for in accordance with APB No. 25, whereby if options are priced at fair market value or above at the date of grant and if other requirements are met then the plans are considered fixed and no compensation expense is recognized. Accordingly, we have recognized no compensation cost for stock options. Had we determined compensation cost for the Plans consistent with SFAS No. 123, “Accounting for Stock-Based Compensation,” our net income and earnings per share would have been reduced to the following pro-forma amounts (in thousands, except per share data): Pro-forma Information Net income, as reported Add: Stock-based employee compensation 2005 $77,638 For the Years Ended December 31, 2004 $45,564 2003 $44,887 expense included in reported net income 1,134 868 227 Deduct: Total stock-based employee compensation expense determined under fair value method Pro-forma net income Earnings per share: Basic—as reported Basic—pro-forma Diluted—as reported Diluted—pro-forma Earnings per Common Share (1,210) $77,562 (1,218) $45,214 $ 1.85 $ 1.84 $ 1.84 $ 1.84 $ 1.09 $ 1.09 $ 1.09 $ 1.08 (935) $44,179 $ 1.14 $ 1.12 $ 1.13 $ 1.12 We calculate basic and diluted earnings per share in accordance with SFAS No. 128, “Earnings per Share.” “Basic earnings per share” is computed as net income divided by the weighted-average common shares outstanding. “Diluted earnings per share” is computed using the treasury stock method, which is net income divided by the total weighted-average common shares outstanding plus the effect of dilutive common equivalent shares outstanding for the period. Using this method, dilutive common equivalent shares reflect the assumed issuance of additional common shares pursuant to certain of our share based compensation plans that could potentially reduce or “dilute” earnings per share. Use of Estimates in the Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. 88 Washington Real Estate Investment Trust and Subsidiaries 3. Real estate Investments: Our real estate investment portfolio, at cost, consists of properties located in Maryland, Washington, D.C. and Virginia as follows (in thousands): Office Buildings Medical Office Buildings Retail Centers Multifamily Industrial/Flex Properties December 31, 2005 $ 548,110 2004 $ 486,691 142,067 200,395 153,549 265,039 141,510 145,757 131,617 207,089 $1,309,160 $1,112,664 The amounts above reflect properties classified as continuing operations, which means they are to be held and used in rental operations or are currently in development. We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and where market conditions for sale are favorable. The proceeds from the sales may be redeployed into other properties, used to fund development operations or to support other corporate needs, or distributed to our shareholders. Properties are considered held for sale when they meet the criteria specified by SFAS No. 144 (see Note 2—Discontinued Operations). Depreciation on these properties is discontinued at that time, but operating revenues, other operating expenses and interest continue to be recognized until the date of sale. We had no properties classified as held for sale at December 31, 2005, and four held for sale at December 31, 2004, as follows (in thousands): Office Buildings Industrial Buildings Total Less accumulated depreciation December 31, 2005 2004 $ 45,573 4,211 49,784 (12,798) $ 36,986 Our results of operations are dependent on the overall economic health of our markets, tenants and the specific segments in which we own properties. These segments include commercial office, medial office, retail, multifamily and industrial. All sectors are affected by external economic factors, such as inflation, consumer confidence, unemployment rates, etc. as well as changing tenant and consumer requirements. Because the properties are located primarily in the Washington/Baltimore region, the Company is subject to a concentration of credit risk related to these properties. As of December 31, 2005, no single property or tenant accounted for more than 10% of total real estate assets or total revenues. Washington Real Estate Investment Trust and Subsidiaries 89 Properties we acquired during the years ending December 31, 2005, 2004 and 2003 are as follows: Acquisition Date March 23, 2005 April 8, 2005 July 29, 2005 Property Frederick Crossing Coleman Building Albemarle Point December 2, 2005 Dulles Station March 10, 2004 August 12, 2004 8880 Gorman Road Shady Grove Medical Village II October 12, 2004 8301 Arlington Boulevard December 22, 2004 Dulles Business Park January 24, 2003 Fullerton Industrial Center May 29, 2003 August 7, 2003 October 9, 2003 October 9, 2003 October 9, 2003 718 E. Jefferson Street 1776 G Street Prosperity Medical Center I Prosperity Medical Center II Prosperity Medical Center III Type Retail Industrial Office/Industrial Development Total 2005 Industrial Medical Office Medical Office Industrial Total 2004 Industrial Retail Office Medical Office Medical Office Medical Office Total 2003 Rentable Square Feet 295,000 60,000 296,000 n/a Contract Purchase Price (in thousands) $ 44,800 8,800 66,800 24,700 651,000 $145,100 141,000 66,000 50,000 265,000 522,000 137,000 5,000 262,000 92,000 88,000 75,000 $ 11,500 18,500 8,000 46,000 $ 84,000 $ 10,550 1,120 84,750 27,990 27,010 23,000 659,000 $174,420 We accounted for these acquisitions using the purchase method of accounting. As discussed in Note 2, we allocate the purchase price to the related physical assets (land, building and tenant improvements) and in-place leases (tenant origination costs, leasing commissions, and net lease intangible assets/liabilities) based on their fair values in accordance with SFAS No. 141, “Business Combinations.” The results of operations of the acquired properties are included in the income statement as of their respective acquisition date. The fair value of in-place leases recorded as a result of the above acquisitions follows (in millions): Tenant origination costs Leasing commissions Net lease intangible assets Net least intangible liabilities Fair Value of In-Place Leases 2003 2004 2005 $4.7 $2.8 $4.2 $2.2 $1.3 $4.8 $1.3 $2.9 $0.8 $2.6 $0.8 $3.0 The weighted-average life in months for the components above ranged from 58 months to 120 months for 2005 acquisitions and from 62 months to 102 months for 2004 acquisitions. The difference in total 2005 contract purchase price of properties acquired per the above chart of $145.1 million and the acquisition cost per the Statement of Cash Flows of $123.4 million is the $24.3 million mortgage assumed on the acquisition of Frederick Crossing, offset by $1.7 million in predevelopment costs (not included in the contract price) paid at closing for Dulles Station and closing costs on all acquisitions. 90 Washington Real Estate Investment Trust and Subsidiaries The difference in total 2004 contract purchase price of properties acquired per the above chart of $84.0 million and the acquisition cost per the Statement of Cash Flows of $55.1 million is the $29.6 million in mortgages assumed on the acquisitions of Shady Grove Medical Village II and Dulles Business Park, net of closing costs. The difference in total 2003 contract purchase price of properties acquired per the above chart of $174.4 million and the acquisition cost per the Statement of Cash Flows of $120.0 million is the $56.4 million in mortgages assumed on the acquisitions of Fullerton Industrial Center and Prosperity Medical Center, net of closing costs. The following unaudited pro-forma combined condensed statements of operations set forth the consolidated results of operations for the years ended December 31, 2005 and 2004, as if the above described acquisitions had occurred at the beginning of the period of acquisition and the same period in the year prior to the acquisition. The unaudited pro-forma information does not purport to be indicative of the results that actually would have occurred if the acquisitions had been in effect for the years ended December 31, 2005, and December 31, 2004. The unaudited data presented is in thousands, except per share data. Real estate revenues Year ended December 31, 2005 $194,957 2004 $190,343 Income from continuing operations $ 40,480 $ 41,804 Net income Diluted earnings per share $ 77,675 $ 46,727 $ 1.84 $ 1.12 We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and where market conditions for sale are favorable. The proceeds from the sales may be reinvested into other properties, used to fund development operations or to support other corporate needs, or are distributed to our shareholders. Properties we sold during the three years ending December 31, 2005, are as follows: Disposition Date February 1, 2005 February 1, 2005 February 1, 2005 Property 7700 Leesburg Pike Tycon Plaza II Tycon Plaza III September 8, 2005 Pepsi Distribution Center Type Office Office Office Industrial Total Rentable Square Feet 147,000 127,000 137,000 69,000 480,000 Contract Purchase Price (in thousands) $20,150 19,400 27,950 6,000 $73,500 November 15, 2004 8230 Boone Boulevard Office 58,000 $10,000 The office properties sold on February 1, 2005, classified as discontinued operations effective November 2004, were sold to a single buyer for a $67.5 million contract sales price. WRIT recognized a gain on disposal of $32.1 million, in accordance with SFAS No. 66, “Accounting for Sales of Real Estate.” $31.3 million of the proceeds from the disposition was escrowed in a tax-free property exchange account and subsequently used to fund a portion of the purchase price of Frederick Crossing Shopping Center on March 23, 2005, and the Coleman Building on April 8, 2005. $31.0 million of the proceeds was used to pay down $31.0 million outstanding under Credit Facility No. 2. In September 2005 the industrial property was sold for $6.0 million for a gain of $3.0 million. Proceeds of $5.8 million Washington Real Estate Investment Trust and Subsidiaries 91 were escrowed in a tax-free exchange account and were used to partially fund the purchase of Dulles Station in December 2005. Discontinued operations for 2005 consist of the properties sold in February and September 2005. For 2004, discontinued operations include those same properties and 8230 Boone Boulevard, which was sold on November 15, 2004. There was a gain of $1.9 million recognized in April 2005 that had been previously deferred from the sale of Boone Boulevard. On November 15, 2004, we sold 8230 Boone Boulevard for a sale price of $10.0 million. A portion of the proceeds was in the form of a subordinated $1.8 million 10% note receivable from the seller, which was scheduled to mature in November 2005. We recognized a gain on disposal of $1.0 million and offset the $1.8 million note from the buyer with a deferred gain liability in the same amount, in accordance with Statement of Financial Accounting Standards (SFAS) No. 66, “Accounting for Sales of Real Estate.” SFAS 66 limits gain recognition when the seller’s note is subject to future subordination to the amount by which the buyer’s cash payments at settlement exceed the seller’s cost of the property sold. We distributed the gain from the 2004 disposition of 8230 Boone Boulevard to the shareholders. Also in November 2004 we concluded that 7700 Leesburg, Tycon Plaza II, Tycon Plaza III and certain development rights and approvals related to Tycon Plaza III met the criteria specified by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” necessary to classify these properties as held for sale. Senior management had committed to and actively embarked upon a plan to sell the assets, and the sale was expected to be completed within one year under terms usual and customary for such sales, with no indication that the plan would be significantly altered or abandoned. Depreciation on these properties was discontinued at that time, but operating revenues and other operating expenses continued to be recognized until the date of sale. Under SFAS No. 144, revenues and expenses of properties that are classified as held for sale or sold are presented as discontinued operations for all periods presented in the Statements of Income. Operating results of the properties classified as discontinued operations are summarized as follows (in thousands): Revenues Property expenses Depreciation and amortization Operating Income For the Year Ending December 31, 2004 $ 8,894 (3,216) (1,784) $ 3,894 2005 $ 656 (401) (71) $ 184 Operating income by property is summarized below (in thousands): Property 8230 Boone Boulevard 7700 Leesburg Tycon Plaza II Tycon Plaza III Pepsi Distribution Center Segment Office Office Office Office Industrial Operating Income For the Year Ending December 31, 2004 $ 204 903 1,340 1,223 224 $3,894 2005 $ 0 89 30 111 (46) $184 2003 $ 9,829 (3,235) (2,265) $ 4,329 2003 $ 144 1,245 1,652 1,054 234 $4,329 92 Washington Real Estate Investment Trust and Subsidiaries 4. Mortgage Notes Payable: December 31, 2005 2004 On November 30, 1998, we assumed a $9.2 million mortgage note payable and a $12.4 million mortgage note payable as partial consideration for our acquisition of Woodburn Medical Park I and II. Both mortgages bore interest at 7.69% per annum. Principal and interest were payable monthly until September 15, 2005, at which time all unpaid principal and interest were paid in full. $— $ 18,658 On September 20, 1999, we assumed an $8.7 million mortgage note payable as partial consideration for our acquisition of the Avondale Apartments. The mortgage bore interest at 7.88% per annum. Principal and interest were payable monthly until November 1, 2005. This mortgage was paid off prior to maturity on August 15, 2005. On September 27, 1999, we executed a $50.0 million mortgage note payable secured by Munson Hill Towers, Country Club Towers, Roosevelt Towers, Park Adams Apartments and The Ashby of McLean. The mortgage bears interest at 7.14% per annum, and interest only is payable — 7,677 monthly until October 1, 2009, at which time all unpaid principal and interest are payable in full. 50,000 50,000 On November 1, 2001, we assumed an $8.5 million mortgage note payable, with an estimated fair value* of $9.3 million, as partial consideration for our acquisition of Sullyfield Commerce Center. The mortgage bears interest at 9.00% per annum and includes a significant prepayment penalty. Principal and interest are payable monthly until February 1, 2007, at which time all unpaid principal and interest are payable in full. 8,144 8,487 On January 24, 2003, we assumed a $6.6 million mortgage note payable, with an estimated fair value* of $6.8 million, as partial consideration for our acquisition of Fullerton Industrial Center. The mortgage bears interest at 6.77% per annum. Principal and interest are payable monthly until September 1, 2006, at which time all unpaid principal and interest are payable in full. 6,292 6,491 On October 9, 2003, we assumed a $36.1 million mortgage note payable and a $13.7 million mortgage note payable as partial consideration for our acquisition of Prosperity Medical Center. The mortgages bear interest at 5.36% per annum and 5.34% per annum, respectively. Principal and interest are payable monthly until May 1, 2013, at which time all unpaid principal and interest are payable in full. 48,196 48,911 On August 12, 2004, we assumed a $10.1 million mortgage note payable with an estimated fair value* of $11.2 million as partial consideration for our acquisition of Shady Grove Medical Village II. The mortgage bears interest at 6.98% per annum. Principal and interest are payable monthly until December 1, 2011, at which time all unpaid principal and interest are payable in full. 10,855 11,149 On December 22, 2004, we assumed a $15.6 million mortgage note payable with an estimated fair value of $17.8 million and a $3.9 million mortgage note payable with an estimated fair value* of $4.2 million as partial consideration for our acquisition of Dulles Business Park. The mortgages bear interest at 7.09% per annum and 5.94% per annum, respectively. Principal and interest are payable monthly until August 10, 2012, at which time all unpaid principal and interest are payable in full. 21,443 22,056 On March 23, 2005, we assumed a $24.3 million mortgage note payable with an estimated fair value* of $25.0 million as partial consideration for our acquisition of Frederick Crossing. The mortgage bears interest at 5.95% per annum. Principal and interest are payable monthly until January 1, 2013, at which time all unpaid principal and interest are payable in full. 24,687 — $169,617 $173,429 * The fair value of the mortgage notes payable was estimated upon acquisition based upon dealer quotes for instruments with similar terms and maturities. There is no notation when the fair value is the same as the carrying value. Washington Real Estate Investment Trust and Subsidiaries 93 Total carrying amount of the above mortgaged properties was $289.4 million and $282.0 million at December 31, 2005 and 2004, respectively. Scheduled principal payments during the five years subsequent to December 31, 2005, and thereafter are as follows (in thousands): 2006 2007 2008 2009 2010 Thereafter Principal Payments $ 8,678 9,991 2,233 52,338 2,438 93,939 $169,617 5. Unsecured Lines of Credit Payable and Short-term Note Payable: As of December 31, 2005, we maintained an $85.0 million unsecured line of credit maturing in July 2007 (“Credit Facility No. 1”) and a $70.0 million line of credit maturing in July 2008 (“Credit Facility No. 2”). Credit Facility No. 1 We had $0.0 outstanding as of December 31, 2005, related to Credit Facility No. 1, with $0.9 million in letters of credit issued and $84.1 million unused and available for subsequent acquisitions or capital improvements. At December 31, 2004, $67.0 million was outstanding under this facility, all of which was paid in full using a portion of the proceeds from the April 2005 issuance of $50.0 million of seven-year 5.05% unsecured notes and $50.0 million of ten-year 5.35% unsecured notes (see Note 6—Notes Payable). Borrowings were used to repay mortgage debt in August and September 2005 of $7.5 million and $18.0 million, respectively, and an additional $5.0 million in September to fund capital improvements was repaid in October 2005 using a portion of the proceeds from the October 2005 issuance of an additional $100.0 million of our 5.35% senior unsecured notes maturing in May 2015. Advances under this agreement bear interest at LIBOR plus a spread based on the credit rating on our publicly issued debt. All outstanding advances are due and payable upon maturity in July 2007. Interest-only payments are due and payable generally on a monthly basis. For the years ended December 31, 2005, 2004 and 2003, we recognized interest expense (excluding unused commitment and facility fees) of $783,000, $455,000, and $251,000, respectively, on Credit Facility No. 1, representing an average interest rate of 3.30%, 2.36%, and 1.90% per annum, respectively. From July 2002 through July 20, 2004, Credit Facility No. 1 had a maximum available commitment of $25.0 million and required us to pay the lender unused line of credit fees, which averaged 0.326% in 2004 and 0.279% in 2003. These fees were payable quarterly. For the years ended December 31, 2004 and 2003, we incurred unused commitment fees of $29,500 and $40,200, respectively. On July 21, 2004, we closed on a new $50.0 million line of credit with Bank One, NA (now J.P. Morgan) and Wells Fargo Bank, National Association, replacing the former $25.0 million facility. On November 10, 2004, we amended the Credit Agreement to increase the maximum available commitment from $50.0 million to $85.0 million. Currently, Credit Facility No. 1 requires us to pay the lender a facility fee on the total commitment ranging from 0.15% to 0.25% per annum according to a sliding scale based on the credit rating on our publicly issued debt. These fees are payable quarterly. For the years ended December 31, 2005 and 2004, we incurred facility fees of $131,200 and $41,200, respectively. 94 Washington Real Estate Investment Trust and Subsidiaries Credit Facility No. 2 We had $24.0 million outstanding as of December 31, 2005, related to Credit Facility No. 2, with an additional $1.1 million in letters of credit issued and $44.9 million unused and available for subsequent acquisitions or capital improvements. Of the $24.0 million outstanding at December 31, 2005, $21.0 million was borrowed in December 2005 to fund the acquisition of Dulles Station and $3.0 million was borrowed to fund certain capital improvements to real estate. At December 31, 2004, $50.0 million was outstanding under this facility. In February 2005, we repaid $31.0 million of the $50.0 million outstanding at December 31, 2004, using a portion of the $67.5 million proceeds from the disposition of 7700 Leesburg, Tycon Plaza II and Tycon Plaza III. In April 2005, we repaid the remaining outstanding balance at December 31, 2004, under Credit Facility No. 2 using a portion of the proceeds from the April 2005 issuance of $50.0 million of seven-year, 5.05% unsecured notes and $50.0 million of ten-year, 5.35% unsecured notes (see Note 6—Notes Payable). In July 2005, we borrowed $63.0 million under this facility to fund our purchase of Albemarle Point, all of which we repaid in October 2005 using a portion of the proceeds from the October 2005 issuance of an additional $100.0 million of our 5.35% senior unsecured notes maturing in May 2015. Advances under this agreement bear interest at LIBOR plus a spread. An advance may also be converted into a term loan based upon a Treasury rate plus a spread. All outstanding advances are due and payable upon maturity in July 2008. Interest-only payments are due and payable generally on a monthly basis. For the years ended December 31, 2005, 2004 and 2003, we recognized interest expense (excluding unused commitment and facility fees) of $898,000, $192,000 and $442,000, respectively, on Credit Facility No. 2, representing an average interest rate of 3.88%, 2.93% and 1.91% per annum, respectively. Before its renewal in July 2005, Credit Facility No. 2 required us to pay the lender unused line of credit fees ranging from 0.15% to 0.25% per annum according to a sliding scale based on the credit rating on our publicly issued debt. The fee was paid quarterly in arrears. For the years ended December 31, 2005, 2004 and 2003, we incurred $38,400, $89,000 and $54,000, respectively, in unused commitment fees on this facility. On July 25, 2005, we renewed Credit Facility No. 2, extending its maturity date to July 25, 2008, and increasing the commitment to $70.0 million. This renewal and extension included a carve-out for letters of credit in the amount of $14.0 million. Credit Facility No. 2 requires us to pay the lender an annual facility fee on the total commitment ranging from 0.15% to 0.25% per annum according to a sliding scale based on the credit rating on our publicly issued debt. These fees are payable quarterly. For the year ended December 31, 2005, we incurred facility fees of $46,700. Credit Facility No. 3 On August 7, 2003, we executed a $60.0 million unsecured term note, the proceeds of which were utilized as partial payment for the acquisition of 1776 G Street. With the acquisition of Prosperity Medical Center on October 9, 2003, we increased this facility to $90.0 million and drew $27.0 million on the extension to fund a portion of the purchase price. We subsequently repaid these borrowings using proceeds from the issuance of $100.0 million of 5.25% unsecured notes in December 2003. Subsequent to 2003, we had no additional borrowings under this facility, which we allowed to expire without renewal in February 2004. For the year ended December 31, 2003, we recognized interest expense of $457,000 on Credit Facility No. 3, representing an average interest rate of 1.82% per annum. Borrowings under this facility bore interest at LIBOR plus a spread based on the credit rating on our publicly issued debt. Interest-only payments were due on a monthly basis. Washington Real Estate Investment Trust and Subsidiaries 95 Credit Facilities No. 1 and No. 2 contain certain financial and non-financial covenants, all of which we have met as of December 31, 2005. Information related to revolving credit facilities is as follows (in thousands)(1): Total revolving credit facilities at December 31 Borrowings outstanding at December 31 Weighted average daily borrowings during the year Maximum daily borrowings during the year Weighted average interest rate during the year Weighted average interest rate at December 31 (1) Excludes Credit Facility No. 3, which was not a revolving facility. 6. Notes Payable: 2005 $155,000 24,000 46,229 $117,000 3.58% 4.97% 2004 $135,000 117,000 26,338 $117,000 2.43% 3.07% 2003 $75,000 — 35,378 $72,500 1.91% — On August 13, 1996, we sold $50.0 million of 7.125% 7-year unsecured notes due August 13, 2003, and $50.0 million of 7.25% unsecured 10-year notes due August 13, 2006. The 7-year notes were sold at 99.107% of par, and the 10-year notes were sold at 98.166% of par. Net proceeds to the Trust after deducting underwriting expenses were $97.6 million. The 7-year notes, which we paid off at maturity in August 2003 with an advance under Credit Facility No. 2, bore an effective interest rate of 7.46%. The 10-year notes due in August 2006 bear an effective interest rate of 7.49%. On February 20, 1998, we sold $50.0 million of 7.25% unsecured notes due February 25, 2028 at 98.653% to yield approximately 7.36%. We also sold $60.0 million in unsecured Mandatory Par Put Remarketed Securities (“MOPPRS”) at an effective borrowing rate through the remarketing date (February 2008) of approximately 6.74%. Our costs of the borrowings and related closed hedge settlements of approximately $7.2 million are amortized over the lives of the notes using the effective interest method. These notes do not require any principal payment and are due in full at maturity. On November 6, 2000, we sold $55.0 million of 7.78% unsecured notes due November 2004. The notes bear an effective interest rate of 7.89%. Our total proceeds, net of underwriting fees, were $54.8 million. We used the proceeds of these notes to repay advances on our lines of credit. We paid off the note on November 15, 2004, with a $50.0 million advance under Credit Facility No. 2 and a $7.0 million advance under Credit Facility No. 1. On March 17, 2003, we sold $60.0 million of 5.125% unsecured notes due March 2013. The notes bear an effective interest rate of 5.23%. Our total proceeds, net of underwriting fees, were $59.1 million. We used portions of the proceeds of these notes to repay advances on our lines of credit and to fund general corporate purposes. On December 11, 2003, we sold $100.0 million of 5.25% unsecured notes due January 2014. The notes bear an effective interest rate of 5.34%. Our total proceeds, net of underwriting fees, were $99.3 million. We used portions of the proceeds of these notes to repay advances on our lines of credit. On April 26, 2005, we sold $50.0 million of 5.05% senior unsecured notes due May 1, 2012, and $50.0 million of 5.35% senior unsecured notes due May 1, 2015, at effective yields of 5.064% and 5.359% respectively. The net proceeds from the sale of the notes of $99.1 million were used to repay borrowings under our lines of credit totaling $90.5 million and the remainder was used for general corporate purposes. In October 2005, we sold an additional 96 Washington Real Estate Investment Trust and Subsidiaries $100.0 million of notes of the series of 5.35% senior unsecured notes due May 1, 2015, at an effective yield of 5.49%. $93.5 million of the $98.1 million net proceeds from the sale of these notes was used to repay borrowings under our lines of credit and to fund general corporate purposes. Interest on these notes is payable semi-annually. These notes contain certain financial and non-financial covenants, all of which we have met as of December 31, 2005. The covenants under one of the line of credit agreements require us to insure our properties against loss or damage in the amount of the replacement cost of the improvements at the properties. The covenants for the notes require us to keep all of our insurable properties insured against loss or damage at least equal to their then full insurable value. We have an insurance policy which has no terrorism exclusion; however, our financial condition and results of operations are subject to the risks associated with acts of terrorism and the potential for uninsured losses as the result of any such acts. Effective November 26, 2002, under this existing coverage, any losses caused by certified acts of terrorism would be partially reimbursed by the United States under a formula established by federal law. Under this formula the United States pays 90% of covered terrorism losses exceeding the statutorily established deductible paid by the insurance provider, and insurers pay 10% until aggregate insured losses from all insurers reach $100 billion in a calendar year. If the aggregate amount of insured losses under the Act exceeds $100 billion during the applicable period for all insured and insurers combined, then each insurance provider will not be liable for payment of any amount which exceeds the aggregate amount of $100 billion. This legislation, originally scheduled to expire on December 31, 2005, was extended through December 31, 2007, with the enactment of the Terrorism Risk Insurance Extension Act of 2005. With the extension, the Federal share of compensation for insured losses decreases to 85% in 2007. Scheduled maturity dates of securities during the five years subsequent to December 31, 2005, and thereafter are as follows: (in thousands) $ 50,000 — 60,000 — — 410,000 $ 520,000 2006 2007 2008 2009 2010 Thereafter 7. Share Options and grants: Options We have historically maintained Incentive Stock Option Plans (the “Plans”), which included qualified and non- qualified options. In 2003 the Board approved a change in the composition of officer share options and share grant awards such that annual incentive compensation is awarded as the same percentage of cash compensation as in prior years except it is in the form of share grants only. The last option awards to Officers were in 2003 and to Trustees in 2004. Effective 2005, Officers and Trustees received annual share grant awards only. We adopted the Washington Real Estate Investment Trust 2001 Stock Option Plan (“New Stock Option Plan”) to replace the 1991 Stock Option Plan (“Stock Option Plan”) that expired on June 25, 2001. Under the Plans, options, Washington Real Estate Investment Trust and Subsidiaries 97 which were issued at market price on the date of grant, vested 50% after year one and 50% after year two and expire ten years following the date of grant. We adopted the Washington Real Estate Investment Trust Stock Option Plan for Trustees in March 1998. Options granted to trustees were fully vested on the grant date. Activity under the Plans is summarized below: Outstanding at January 1 Granted Exercised Expired/Forfeited Outstanding at December 31 Exercisable at December 31 2005 2004 2003 Shares 667,000 — (136,000) — 531,000 531,000 Wtd Avg Ex Price 23.49 — 20.91 — 24.15 24.15 Shares 977,000 12,000 (302,000) (20,000) 667,000 652,000 Wtd Avg Ex Price 21.99 33.09 18.70 28.14 23.49 23.34 Shares 1,107,000 57,000 (181,000) (6,000) 977,000 834,000 Wtd Avg Ex Price $20.94 29.49 17.83 25.36 21.99 21.16 The 531,000 options outstanding at December 31, 2005, all of which are exercisable, have exercise prices between $14.47 and $33.09, with a weighted-average exercise price of $24.15 and a weighted-average remaining contractual life of 6.1 years. Of the 531,000 options outstanding at December 31, 2005, 185,000 options have an exercise price between $14.47 and $21.34, with a weighted-average exercise price of $20.61 and a weighted- average remaining contractual life of 4.8 years. The remaining 346,000 options outstanding have an exercise price between $24.84 and $33.09, with a weighted-average exercise price of $26.04, and a weighted-average remaining contractual life of 6.8 years. The weighted-average fair value of options granted and related assumptions are summarized below: Weighted-average fair value of options Granted Weighted-average assumptions: Expected lives (years) Risk free interest rate Expected volatility Expected dividend yield 2005 2004 $ 2.79 5 3.53% 15.30% 4.75% 2003 $ 2.04 5 3.18% 14.40% 4.97% The assumptions used in the calculations of weighted-average fair value of options granted are as prescribed under accounting principles generally accepted in the United States. Such assumptions may not be the same as those used by the financial community and others in determining the fair value of such options. The option values are based upon a Black Scholes model calculation. Share Grants We maintain a Share Grant Plan for Officers and Trustees. At the approval of the Board, the Share Grant Plan was changed in 2003 so that officers received an award of shares with a market value of a percentage of the individual’s cash compensation depending on level of officer. In November 2004, the Board of Trustees approved an amended short-term and long-term incentive plan for officers and executives. The first cash benefits under the amended short-term plan were paid in late 2005, and the first share grants under the amended long-term plan will be made in 2006. The short-term incentive 98 Washington Real Estate Investment Trust and Subsidiaries compensation plan provides for the annual payment of cash bonuses based upon WRIT’s achievement of its annual targets for funds from operations (FFO) per share (a non-GAAP financial measure) and EBITDA as defined by the revised plan (earnings before interest, taxes, depreciation and amortization). Each target will be determined in November of the preceding year by management and approved by the Board of Trustees. The long-term incentive plan provides for the annual grant of restricted WRIT shares based on WRIT’s total shareholder return compared to a benchmark or index appropriate to the industry. Shares granted to officers under the Share Grant Plan vest 20% per year over five years and are restricted from transfer for five years from the date of grant. Prior to 2004, each Trustee received an annual grant of 400 unrestricted shares under the trustee compensation plan. In November 2004, the Board of Trustees approved revisions to the trustee compensation plan, under which the first cash and share grant benefits were paid in 2005. Under this plan, annual long-term incentive compensation for trustees is changed from options for 2,000 shares plus 400 restricted shares to $30,000 in restricted shares. These restricted shares vest immediately and are restricted from sale for the period of the Trustees’ service. Additionally, the amounts of certain director fees and retainers were amended. During 2005, 2004 and 2003, we issued 17,044, 87,066 and 56,678 share grants, respectively, to our executives and trustees. Of the restricted shares awarded in 2005, 11,182 were awarded by the Trust pursuant to the Employment Agreement of the Executive Vice President and Chief Investment Officer in October 2005. The Employment Agreement provides for an additional installment of share grants with a market value of $150,000 on May 31, 2006, assuming the CIO is promoted to Chief Operating Officer on or before that date. The CIO shares granted in October 2005 (and, if granted, in May 2006) will vest 50% upon his fourth anniversary of employment and the remaining 50% upon his fifth anniversary. For the first five years of the CIO’s employment, his long-term incentive payout will be based on WRIT’s total shareholder return compared to a benchmark or index appropriate to the industry for the nearest whole number of years in which he has been employed (e.g., in year one, a one-year average; in year two, a two-year average, etc.). The 87,066 restricted shares awarded in 2004 include a special award of 59,859 shares to officers in recognition of the Trust’s performance for 2003 and 4,066 shares to non-officer key employees. The total share grants vested at December 31, 2005, 2004 and 2003, were 124,175, 87,467 and 65,528, respectively. The total share grants unvested at December 31, 2005, 2004 and 2003, were 103,989, 137,684 and 68,491, respectively. The total compensation expense recognized in income for stock-based compensation awards for December 31, 2005, 2004 and 2003, was $1.2 million, $0.9 million and $0.2 million, respectively. Share grants awarded in 2005 were valued at $31.10 per share based on their market value on the date of grant. Washington Real Estate Investment Trust and Subsidiaries 99 Earnings per Share The following table sets forth the computation of basic and diluted earnings per share (dollars in thousands; except per share data): Numerator for basic and diluted per share calculations: Income from continuing operations Discontinued operations including gain on disposal Net income Denominator for basic and diluted per share calculations: 2005 2004 2003 $40,443 37,195 $77,638 $40,641 4,923 $45,564 $40,558 4,329 $44,887 Denominator for basic per share amounts—weighted-average shares 42,069 41,642 39,399 Effect of dilutive securities: Employee stock options Denominator for diluted per share amounts Income from continuing operations per share Basic Diluted Discontinued operations including gain on disposal Basic Diluted Net income per share Basic Diluted 8. Other Benefit Plans 134 42,203 221 41,863 201 39,600 $ 0.96 $ 0.96 $ 0.89 $ 0.88 $ 1.85 $ 1.84 $ 0.98 $ 0.97 $ 0.11 $ 0.12 $ 1.09 $ 1.09 $ 1.03 $ 1.02 $ 0.11 $ 0.11 $ 1.14 $ 1.13 We have a Retirement Savings Plan (the “401K Plan”), which permits all eligible employees to defer a portion of their compensation in accordance with the Internal Revenue Code. Under the 401K Plan, the company may make discretionary contributions on behalf of eligible employees. For the years ended December 31, 2005, 2004 and 2003, the company made contributions to the 401K plan of $0.3 million each year. We adopted a split-dollar life insurance plan for executive officers (the Chief Financial Officer, Executive Vice President of Real Estate and Senior Vice President Accounting and Administration) and other company officers, excluding the Chief Executive Officer (“CEO”), in 2000. The purpose of the plan is to provide these officers with financial security in exchange for a career commitment. It is intended that we will recover our costs from the life insurance policies at death prior to retirement, termination prior to retirement or retirement at age 65. It is intended that the officers can use the cash values of the policy in excess of the Trust’s interest, which is equal to the cash value and death benefit of each policy to the extent of the sum of premium payments we have made. Subsequent to July 2002 we discontinued premium advances under this plan for the benefit of executive officers. For the years ended December 31, 2005, 2004 and 2003, the company paid premiums of $0.2 million, $0.4 million and $0, respectively. We expect to terminate the split-dollar agreements in February 2006 upon the purchase of additional life insurance for the officers. We intend to transfer ownership of the policies back to WRIT. At December 31, 2005 and 2004, the cash surrender value was approximately $1.2 million, which is less than the premiums paid since the plan’s inception. 100 Washington Real Estate Investment Trust and Subsidiaries We have adopted a non-qualified deferred compensation plan for the officers and members of the Board of Trustees. The plan allows for a deferral of a percentage of annual cash compensation and trustee fees. The plan is unfunded, and payments are to be made out of the general assets of the Trust. The deferred compensation liability was $1.6 million, $1.3 million and $0.9 million at December 31, 2005, 2004 and 2003, respectively. We established a Supplemental Executive Retirement Plan (“SERP”) effective July 1, 2002, for the benefit of the CEO. In November 2005, the Board of Trustees approved the establishment of a SERP for the benefit of the executive officers, including the Chief Investment Officer appointed in October 2005, and other company officers. Under these plans, upon a participant’s termination of employment from the Trust for any reason other than death, discharge for cause or total and permanent disability, the participant will be entitled to receive an annual benefit equal to his or her accrued benefit times his or her vested interest. We account for these plans in accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions,” whereby we accrue benefit cost in an amount that will result in an accrued balance at the end of each participant’s employment which is not less than the present value of the estimated benefit payments to be made. For the three years ended December 31, 2005, 2004 and 2003, we recognized current service costs of $565,000, $355,000 and $309,000, respectively. 9. Fair Value of Financial Instruments: SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of the fair value of financial instruments. Whenever possible, the estimated fair value has been determined using quoted market information as of December 31, 2005. The estimated market values have not been updated since December 31, 2005; therefore, current estimates of fair value may differ significantly from the amounts presented. Below is a summary of significant methodologies used in estimating fair values and a schedule of fair values at December 31, 2005. Cash and cash equivalents Includes cash and commercial paper with remaining maturities of less than 90 days, which are valued at the carrying value. Mortgage notes payable Mortgage notes payable consist of instruments in which certain of our real estate assets are used for collateral. The fair value of the mortgage notes payable is estimated based upon dealer quotes for instruments with similar terms and maturities. Lines of credit payable Lines of credit payable consist of bank facilities which we use for various purposes including working capital, acquisition funding or capital improvements. The lines of credit advances are priced at a specified rate plus a spread. The carrying value of the lines of credit payable is estimated to be market value since the interest rate adjusts with the market. Washington Real Estate Investment Trust and Subsidiaries 101 Notes payable The fair value of these securities is estimated based on dealer quotes for securities with similar terms and characteristics. 2005 2004 (in thousands) Cash and cash equivalents Mortgage notes payable Lines of credit payable Notes payable Carrying Value $ 6,702 $169,617 $ 24,000 $520,000 Fair Value $ 6,702 $171,478 $ 24,000 $523,768 Carrying Value $ 6,027 $173,429 $117,000 $320,000 Fair Value $ 6,027 $179,585 $117,000 $335,353 10. Rentals under Operating Leases: Non-cancelable commercial operating leases provide for minimum rental income from continuing operations during each of the next five years and thereafter as follows (in millions): 2006 2007 2008 2009 2010 Thereafter Rental Income $141.0 127.9 112.4 92.8 71.4 181.5 $727.0 Apartment leases are not included as they are generally for one year. Most of these commercial leases increase in future years based on agreed-upon percentages or changes in the Consumer Price Index. Percentage rents from retail centers, based on a percentage of tenants’ gross sales, were $0.1 million, $0.3 million and $0.5 million in 2005, 2004 and 2003, respectively. Real estate tax, operating expense and common area maintenance reimbursement income from continuing operations was $15.5 million, $12.0 million and $9.9 million for the years ended December 31, 2005, 2004 and 2003, respectively. 11. Commitments and Contingencies: Development Commitments At December 31, 2005 and 2004, we had various contracts outstanding with third parties in connection with our ongoing development projects. Total accumulated spending, including land costs, for development projects at December 31, 2005, and December 31, 2004, was $56.7 million and $12.8 million, respectively. Remaining contractual commitments for development projects at December 31, 2005 were $85.6 million. Litigation We are involved from time to time in various legal proceedings, lawsuits, examinations by various tax authorities and claims that have arisen in the ordinary course of business. Management believes that the resolution of such matters will not have a material adverse effect on our financial condition or results of operations. 102 Washington Real Estate Investment Trust and Subsidiaries Other At December 31, 2005, we were contingently liable under an $885,000 unused letter of credit related to our assumption of mortgage debt on Dulles Business Park to ensure the funding of certain tenant improvements and leasing commissions over the term of the debt. We were also contingently liable under unused letters of credit totaling $1,053,000 related to our development projects at Rosslyn Towers, Foxchase Shopping Center and South Washington Street, to ensure the complete installation of public improvements in accordance with the projects’ related site plans. 12. Segment Information: We have five reportable segments: office buildings, medical office buildings, retail centers, multifamily properties and industrial/flex centers. Office buildings provide office space for various types of businesses and professions. Medical office buildings provide offices and facilities for a variety of medical services. Retail centers are typically neighborhood grocery store- or drug store-anchored retail centers. Multifamily properties provide rental housing for families throughout the Washington metropolitan area. Industrial/flex centers are used for flex-office, warehousing, services and distribution type facilities. Real estate revenue as a percentage of the total for each of the five reportable operating segments is as follows: Office Buildings Medical Office Buildings Retail Centers Multifamily Properties Industrial/Flex Centers Year Ended December 31, 2004 45% 2005 40% 2003 46% 10% 17% 16% 17% 8% 16% 17% 14% 5% 17% 18% 14% Real estate assets as a percentage of the total for each of the five reportable operating segments are as follows: Office Buildings Medical Office Buildings Retail Centers Multifamily Properties Industrial/Flex Centers December 31, 2005 42% 11% 15% 12% 20% 2004 44% 12% 13% 12% 19% The accounting policies of each of the segments are the same as those described in Note 2. We evaluate performance based upon operating income from the combined properties in each segment. Our reportable operating segments are consolidations of similar properties. Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing segments’ performance. Net operating income is a key measurement of our segment profit and loss. Net operating income is defined as segment revenues less direct segment operating expenses. Included in our segment reporting for 2005, 2004 and 2003 is the new medical office segment. This portfolio of buildings was previously reported as part of the office segment and has now become a significant element of our diversified total portfolio. Segment reporting has been restated for prior periods to conform to this presentation. Washington Real Estate Investment Trust and Subsidiaries 103 The following table presents revenues and net operating income for the years ended December 31, 2005, 2004 and 2003, from these segments, and reconciles net operating income of reportable segments to operating income as reported (in thousands): Real estate rental revenue Office Buildings $ 76,976 Medical Office $ 18,024 Retail Centers $ 31,907 Multi- family $ 30,529 2005 Industrial/ Flex Corporate Properties and Other $ 32,610 — $ Consoli- dated $ 190,046 Real estate expenses 26,277 4,650 6,878 12,816 7,495 — 58,116 Net Operating Income $ 50,699 $ 13,374 $ 25,029 $ 17,713 $ 25,115 $ — $ 131,930 Depreciation and amortization Interest expense General and administrative Other income Income from discontinued operations Gain on property disposal Net income (47,161) (37,743) (8,005) 1,422 184 37,011 $ 77,638 Capital expenditures $ 14,625 $ 609 $ 9,743 $ 20,982 $ 2,644 $ 437 $ 49,040 Total assets $457,398 $133,274 $182,098 $108,632 $237,808 $22,075 $1,141,285 Real estate rental revenue Office Buildings $ 77,070 Medical Office $ 15,050 Retail Centers $ 27,243 Multi- family $28,858 2004 Industrial/ Flex Corporate Properties and Other $ 23,425 — $ Consoli- dated $ 171,646 Real estate expenses 24,835 3,686 5,899 11,637 5,271 — 51,328 Net Operating Income $ 52,235 $ 11,364 $ 21,344 $17,221 $ 18,154 $ — $ 120,318 Depreciation and amortization Interest expense General and administrative Other income Income from discontinued operations Gain on property disposal Net income (39,309) (34,500) (6,194) 326 3,894 1,029 $ 45,564 Capital expenditures $ 14,707 $ 375 $ 5,644 $10,008 $ 2,503 $ 101 $ 33,338 Total assets $447,439 $137,136 $127,915 $91,870 $187,295 $20,738 $1,012,393 104 Washington Real Estate Investment Trust and Subsidiaries 2003 Office Buildings $ 70,307 Medical Office $ 7,031 Retail Centers $ 26,474 Multi- family $28,266 Industrial/ Flex Properties $ 21,498 Real estate rental revenue Corporate Consoli- and Other $ dated $153,576 — Real estate expenses 21,191 1,628 5,921 10,860 5,027 — 44,627 Net Operating Income $ 49,116 $ 5,403 $ 20,553 $17,406 $ 16,471 $ — $108,949 Depreciation and amortization Interest expense General and administrative Other income Income from discontinued operations Gain on property disposal Net income (33,490) (30,040) (5,275) 414 4,329 — $ 44,887 Capital expenditures $ 16,835 $ 4 $ 2,055 $ 7,199 $ 1,298 $ 132 $ 27,523 Total assets $458,775 $112,333 $127,884 $83,445 $128,844 $16,808 $928,089 Washington Real Estate Investment Trust and Subsidiaries 105 13. Selected Quarterly Financial Data (in thousands, unaudited): The following table summarizes our financial data by quarter for 2005 and 2004: 2005: Real estate rental revenue(2) Income from continuing operations(2) Net income Income from continuing operations per share(2) Basic Diluted Net income per share(3) Basic Diluted 2004: Real estate rental revenue(2) Income from continuing operations(2) Net income Income from continuing operations per share(2) Basic Diluted Net income per share(3) Basic Diluted First Second Third Fourth Quarter(1) $45,282 9,848 42,234 $ 0.24 $ 0.23 $ 1.01 $ 1.01 $42,159 10,403 11,302 $ 0.25 $ 0.25 $ 0.27 $ 0.27 $46,567 9,004 10,875 $ 0.21 $ 0.21 $ 0.26 $ 0.26 $42,517 10,086 11,082 $ 0.24 $ 0.24 $ 0.27 $ 0.26 $48,939 10,523 13,461 $ 0.25 $ 0.25 $ 0.32 $ 0.32 $43,246 9,764 10,797 $ 0.23 $ 0.23 $ 0.26 $ 0.26 $49,258 11,068 11,068 $ 0.26 $ 0.26 $ 0.26 $ 0.26 $43,724 10,388 12,383 $ 0.25 $ 0.25 $ 0.30 $ 0.30 (1) With regard to per share calculations, the sum of the quarterly results may not equal full year results due to rounding. (2) These amounts differ from amounts previously reported due to the disposal of the Pepsi Distribution Center in September 2005 as discussed in Note 3—Real Estate Investments. (3) Includes gain on the sale of real estate of $0.77 per share, basic and $0.76 per share, diluted in the first quarter of 2005, $.04 per share in the second quarter of 2005, $0.07 per share in the third quarter of 2005 and $0.02 per share in the fourth quarter of 2004. 106 Washington Real Estate Investment Trust and Subsidiaries 14. Subsequent event On February 14, 2006 WRIT purchased The Hampton Properties, a five-building, 303,000 square foot industrial portfolio located in Capitol Heights, Maryland for $23.1 million. We drew $23.1 million on our line of credit to complete the transaction. The properties are 74% leased. Washington Real Estate Investment Trust and Subsidiaries 107 SCHeDULe III SUMMaRY OF ReaL eState INVeStMeNtS aND aCCUMULateD DePReCIatION Properties Office Buildings 1901 Pennsylvania Avenue 51 Monroe Street 515 King Street The Lexington Building The Saratoga Building Brandywine Center 6110 Executive Boulevard 1220 19th Street Maryland Trade Center I Maryland Trade Center II 1600 Wilson Boulevard 7900 Westpark Drive 600 Jefferson Plaza 1700 Research Boulevard Parklawn Plaza Wayne Plaza Courthouse Square One Central Plaza Atrium Building 1776 G Street Albemarle Point Dulles Station(f) Medical Office Woodburn Medical Park I Woodburn Medical Park II 8501 Arlington Boulevard(a) 8503 Arlington Boulevard(a) 8505 Arlington Boulevard(a) Shady Grove Medical II(a) 8301 Arlington Boulevard Retail Centers Takoma Park Westminster Concord Centre Wheaton Park Bradlee Chevy Chase Metro Plaza Montgomery Village Center Shoppes of Foxchase Frederick County Square 800 S. Washington Street(f) Centre at Hagerstown Frederick Crossing(a) Location Land Initial Cost(b) Buildings and Improvements Washington, DC Maryland Virginia Maryland Maryland Maryland Maryland Washington, DC Maryland Maryland Virginia Virginia Maryland Maryland Maryland Maryland Virginia Maryland Maryland Washington, DC Virginia Virginia Virginia Virginia Virginia Virginia Virginia Maryland Virginia Maryland Maryland Virginia Maryland Virginia Washington, DC Maryland Virginia Maryland Virginia Maryland Virginia $ 892,000 840,000 4,102,000 1,180,000 1,464,000 718,000 4,621,000 7,803,000 3,330,000 2,826,000 6,661,000 12,049,000 2,296,000 1,847,000 714,000 1,564,000 0 5,480,000 3,182,000 31,500,000 1,326,000 26,584,000 $120,979,000 $ 2,563,000 2,632,000 2,071,000 1,598,000 2,819,000 1,995,000 1,251,000 $ 14,929,000 $ 415,000 519,000 413,000 796,000 4,152,000 1,549,000 11,625,000 5,838,000 6,561,000 3,173,000 13,029,000 12,759,000 $ 60,829,000 $ 3,481,000 10,869,000 3,931,000 1,262,000 1,554,000 735,000 11,926,000 11,366,000 12,747,000 9,486,000 16,742,000 71,825,000 12,188,000 11,105,000 4,053,000 6,243,000 17,096,000 39,107,000 11,281,000 54,327,000 18,211,000 0 $329,535,000 $ 12,460,000 17,574,000 26,317,000 25,850,000 19,680,000 16,601,000 6,589,000 $125,071,000 $ 1,084,000 1,775,000 850,000 857,000 5,383,000 4,304,000 9,105,000 2,979,000 6,830,000 5,489,000 25,415,000 34,763,000 $ 98,834,000 Net Improvements (Retirements) since Acquisition $ 12,795,000 16,747,000 2,156,000 1,280,000 2,190,000 1,448,000 6,430,000 3,033,000 7,396,000 3,653,000 4,394,000 16,199,000 1,356,000 2,551,000 655,000 3,011,000 1,664,000 7,659,000 1,884,000 533,000 1,000 560,000 $ 97,595,000 $ 913,000 752,000 154,000 1,000 66,000 0 182,000 $ 2,068,000 $ 94,000 8,581,000 3,145,000 3,711,000 6,999,000 3,744,000 1,371,000 3,480,000 2,063,000 5,688,000 470,000 1,333,000 $ 40,679,000 Buildings and December 31, Year of Date of Net Rentable Square Feet(e) Depreci- ation Land Improvements Total(c) 2005 Construction Acquisition Units Life(d) Accumulated Depreciation at 100,073,000 23,381,000 1972/’86/‘99 November 1997 $120,979,000 $ 427,130,000 $ 548,109,000 $111,718,000 3,021,000 $ 892,000 $ 16,276,000 $ 17,168,000 $ 9,147,000 27,616,000 28,456,000 14,793,000 840,000 4,102,000 1,180,000 1,464,000 718,000 4,621,000 7,803,000 3,330,000 2,826,000 6,661,000 12,049,000 2,296,000 1,847,000 714,000 1,564,000 0 5,480,000 3,182,000 31,500,000 1,326,000 26,584,000 6,087,000 2,542,000 3,744,000 2,183,000 18,356,000 14,399,000 20,143,000 13,139,000 21,136,000 88,024,000 13,544,000 13,656,000 4,708,000 9,254,000 18,760,000 46,766,000 13,165,000 54,860,000 18,212,000 560,000 10,189,000 3,722,000 5,208,000 2,901,000 22,977,000 22,202,000 23,473,000 15,965,000 27,797,000 15,840,000 15,503,000 5,422,000 10,818,000 18,760,000 52,246,000 16,347,000 86,360,000 19,538,000 27,144,000 2,271,000 1,102,000 1,590,000 735,000 7,843,000 4,892,000 6,808,000 4,291,000 6,001,000 3,383,000 2,829,000 1,083,000 1,798,000 3,588,000 7,960,000 1,801,000 6,090,000 332,000 0 $ 2,563,000 $ 13,373,000 $ 15,936,000 $3,300,000 2,632,000 2,071,000 1,598,000 2,819,000 1,995,000 1,251,000 18,326,000 26,471,000 25,851,000 19,746,000 16,601,000 6,771,000 20,958,000 28,542,000 27,449,000 22,565,000 18,596,000 8,022,000 4,373,000 2,151,000 2,084,000 1,601,000 860,000 312,000 $ 14,929,000 $ 127,139,000 $ 142,068,000 $ 14,681,000 $ 415,000 $ 1,178,000 $ 1,593,000 $ 978,000 10,356,000 10,875,000 519,000 413,000 796,000 4,152,000 1,549,000 11,625,000 5,838,000 6,561,000 3,604,000 13,029,000 12,759,000 3,995,000 4,568,000 12,382,000 8,048,000 10,476,000 6,459,000 8,893,000 10,746,000 25,885,000 36,096,000 4,408,000 5,364,000 16,534,000 9,597,000 22,101,000 12,297,000 15,454,000 14,350,000 38,914,000 2,985,000 2,275,000 2,064,000 6,252,000 3,509,000 3,075,000 1,196,000 3,370,000 1960 1975 1966 1970 1977 1969 1971 1976 1981 1984 1973 1985 1982 1986 1970 1979 1974 1980 1979 2001 n/a 1984 1988 2000 2001 2002 1999 1965 1962 1969 1960 1967 1955 1975 1969 1960 1973 May 1977 August 1979 July 1992 November 1993 November 1993 November 1993 January 1995 November 1995 May 1996 May 1996 October 1997 May 1999 May 1999 November 1999 May 2000 October 2000 April 2001 July 2002 August 2003 July 2005 December 2005 November 1998 November 1998 October 2003 October 2003 October 2003 August 2004 October 2004 July 1963 September 1972 December 1973 September 1977 December 1984 September 1985 December 1992 June 1994 August 1995 June 1998 June 2002 97,000 208,000 78,000 46,000 59,000 35,000 199,000 102,000 190,000 158,000 166,000 521,000 115,000 103,000 40,000 91,000 113,000 267,000 81,000 262,000 90,000 0 71,000 96,000 92,000 88,000 75,000 66,000 50,000 538,000 51,000 146,000 76,000 72,000 168,000 50,000 198,000 128,000 227,000 45,000 334,000 295,000 $ 61,260,000 $ 139,082,000 $ 200,342,000 $ 31,172,000 1,790,000 48,855,000 1,055,000 1999–2003 March 2005 1,143,000 1951/’55/’59/’90 3,270,000 2000 28 Years 41 Years 50 Years 50 Years 50 Years 50 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years n/a 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 50 Years 37 Years 33 Years 50 Years 40 Years 50 Years 50 Years 50 Years 30 Years 30 Years 30 Years 30 Years 108 Washington Real Estate Investment Trust and Subsidiaries SCHeDULe III SUMMaRY OF ReaL eState INVeStMeNtS aND aCCUMULateD DePReCIatION 1901 Pennsylvania Avenue Washington, DC $ 892,000 Location Land Buildings and Improvements Net Improvements (Retirements) since Acquisition $ 3,481,000 10,869,000 $ 12,795,000 16,747,000 Properties Office Buildings 51 Monroe Street 515 King Street The Lexington Building The Saratoga Building Brandywine Center 6110 Executive Boulevard 1220 19th Street Maryland Trade Center I Maryland Trade Center II 1600 Wilson Boulevard 7900 Westpark Drive 600 Jefferson Plaza 1700 Research Boulevard Parklawn Plaza Wayne Plaza Courthouse Square One Central Plaza Atrium Building 1776 G Street Albemarle Point Dulles Station(f) Medical Office Woodburn Medical Park I Woodburn Medical Park II 8501 Arlington Boulevard(a) 8503 Arlington Boulevard(a) 8505 Arlington Boulevard(a) Shady Grove Medical II(a) 8301 Arlington Boulevard Retail Centers Takoma Park Westminster Concord Centre Wheaton Park Bradlee Chevy Chase Metro Plaza Montgomery Village Center Shoppes of Foxchase Frederick County Square 800 S. Washington Street(f) Centre at Hagerstown Frederick Crossing(a) Washington, DC Washington, DC Maryland Virginia Maryland Maryland Maryland Maryland Maryland Maryland Virginia Virginia Maryland Maryland Maryland Maryland Virginia Maryland Maryland Virginia Virginia Virginia Virginia Virginia Virginia Virginia Maryland Virginia Maryland Maryland Virginia Maryland Virginia Maryland Virginia Maryland Virginia Maryland Virginia Washington, DC 840,000 4,102,000 1,180,000 1,464,000 718,000 4,621,000 7,803,000 3,330,000 2,826,000 6,661,000 12,049,000 2,296,000 1,847,000 714,000 1,564,000 0 5,480,000 3,182,000 31,500,000 1,326,000 26,584,000 2,632,000 2,071,000 1,598,000 2,819,000 1,995,000 1,251,000 519,000 413,000 796,000 4,152,000 1,549,000 11,625,000 5,838,000 6,561,000 3,173,000 13,029,000 12,759,000 3,931,000 1,262,000 1,554,000 735,000 11,926,000 11,366,000 12,747,000 9,486,000 16,742,000 71,825,000 12,188,000 11,105,000 4,053,000 6,243,000 17,096,000 39,107,000 11,281,000 54,327,000 18,211,000 0 17,574,000 26,317,000 25,850,000 19,680,000 16,601,000 6,589,000 1,775,000 850,000 857,000 5,383,000 4,304,000 9,105,000 2,979,000 6,830,000 5,489,000 25,415,000 34,763,000 16,199,000 2,156,000 1,280,000 2,190,000 1,448,000 6,430,000 3,033,000 7,396,000 3,653,000 4,394,000 1,356,000 2,551,000 655,000 3,011,000 1,664,000 7,659,000 1,884,000 533,000 1,000 560,000 752,000 154,000 1,000 66,000 0 182,000 8,581,000 3,145,000 3,711,000 6,999,000 3,744,000 1,371,000 3,480,000 2,063,000 5,688,000 470,000 1,333,000 $ 2,563,000 $ 12,460,000 $ 913,000 $ 415,000 $ 1,084,000 $ 94,000 $ 60,829,000 $ 98,834,000 $ 40,679,000 Gross Amounts at Which Carried at December 31, 2005 Buildings and Improvements Total(c) Land Accumulated Depreciation at December 31, 2005 Year of Construction Date of Acquisition Net Rentable Square Feet(e) Depreci- ation Units Life(d) $ 892,000 $ 16,276,000 $ 17,168,000 $ 9,147,000 14,793,000 2,271,000 1,102,000 1,590,000 735,000 7,843,000 4,892,000 6,808,000 4,291,000 6,001,000 27,616,000 6,087,000 2,542,000 3,744,000 2,183,000 18,356,000 14,399,000 20,143,000 13,139,000 21,136,000 88,024,000 13,544,000 13,656,000 4,708,000 9,254,000 18,760,000 46,766,000 13,165,000 54,860,000 18,212,000 560,000 28,456,000 10,189,000 3,722,000 5,208,000 2,901,000 22,977,000 22,202,000 23,473,000 15,965,000 27,797,000 100,073,000 15,840,000 15,503,000 5,422,000 10,818,000 18,760,000 52,246,000 16,347,000 86,360,000 19,538,000 27,144,000 1960 1975 1966 1970 1977 1969 1971 1976 1981 1984 1973 May 1977 August 1979 July 1992 November 1993 November 1993 November 1993 January 1995 November 1995 May 1996 May 1996 October 1997 23,381,000 1972/’86/‘99 November 1997 May 1999 May 1999 November 1999 May 2000 October 2000 April 2001 July 2002 August 2003 July 2005 December 2005 3,383,000 2,829,000 1,083,000 1,798,000 3,588,000 7,960,000 1,801,000 6,090,000 332,000 0 1985 1982 1986 1970 1979 1974 1980 1979 2001 n/a 97,000 208,000 78,000 46,000 59,000 35,000 199,000 102,000 190,000 158,000 166,000 521,000 115,000 103,000 40,000 91,000 113,000 267,000 81,000 262,000 90,000 0 840,000 4,102,000 1,180,000 1,464,000 718,000 4,621,000 7,803,000 3,330,000 2,826,000 6,661,000 12,049,000 2,296,000 1,847,000 714,000 1,564,000 0 5,480,000 3,182,000 31,500,000 1,326,000 26,584,000 $120,979,000 $329,535,000 $ 97,595,000 $120,979,000 $ 427,130,000 $ 548,109,000 $111,718,000 3,021,000 $ 14,929,000 $125,071,000 $ 2,068,000 $ 14,929,000 $ 127,139,000 $ 142,068,000 $ 14,681,000 $ 2,563,000 $ 13,373,000 $ 15,936,000 20,958,000 28,542,000 27,449,000 22,565,000 18,596,000 8,022,000 18,326,000 26,471,000 25,851,000 19,746,000 16,601,000 6,771,000 2,632,000 2,071,000 1,598,000 2,819,000 1,995,000 1,251,000 $3,300,000 4,373,000 2,151,000 2,084,000 1,601,000 860,000 312,000 1984 1988 2000 2001 2002 1999 1965 November 1998 November 1998 October 2003 October 2003 October 2003 August 2004 October 2004 $ 415,000 $ 1,178,000 $ 1,593,000 $ 978,000 2,985,000 2,275,000 2,064,000 6,252,000 3,509,000 3,075,000 1,196,000 3,370,000 1,143,000 1951/’55/’59/’90 3,270,000 10,875,000 4,408,000 5,364,000 16,534,000 9,597,000 22,101,000 12,297,000 15,454,000 14,350,000 38,914,000 10,356,000 3,995,000 4,568,000 12,382,000 8,048,000 10,476,000 6,459,000 8,893,000 10,746,000 25,885,000 519,000 413,000 796,000 4,152,000 1,549,000 11,625,000 5,838,000 6,561,000 3,604,000 13,029,000 1962 1969 1960 1967 1955 1975 1969 1960 1973 2000 July 1963 September 1972 December 1973 September 1977 December 1984 September 1985 December 1992 June 1994 August 1995 June 1998 June 2002 71,000 96,000 92,000 88,000 75,000 66,000 50,000 538,000 51,000 146,000 76,000 72,000 168,000 50,000 198,000 128,000 227,000 45,000 334,000 12,759,000 1,055,000 $ 61,260,000 $ 139,082,000 $ 200,342,000 $ 31,172,000 36,096,000 48,855,000 1999–2003 March 2005 295,000 1,790,000 28 Years 41 Years 50 Years 50 Years 50 Years 50 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years n/a 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 50 Years 37 Years 33 Years 50 Years 40 Years 50 Years 50 Years 50 Years 30 Years 30 Years 30 Years 30 Years Washington Real Estate Investment Trust and Subsidiaries 109 SCHeDULe III SUMMaRY OF ReaL eState INVeStMeNtS aND aCCUMULateD DePReCIatION (CONtINUeD) Properties Multifamily Properties 3801 Connecticut Avenue Roosevelt Towers(a) Country Club Towers(a) Park Adams(a) Munson Hill Towers(a) The Ashby at McLean(a) Walker House Apartments Bethesda Hill Apartments Avondale Rosslyn Towers(f) Industrial Properties Fullerton Business Center Charleston Business Center Tech 100 Industrial Park Crossroads Distribution Center The Alban Business Center The Earhart Building Ammendale Technology Park I Ammendale Technology Park II Pickett Industrial Park Northern Virginia Industrial Park 8900 Telegraph Road Dulles South IV Sully Square Amvax Sullyfield Center(a) Fullerton Industrial(a) 8880 Gorman Road Dulles Business Park(a) Albemarle Point Total Location Land Initial Cost(b) Buildings and Improvements Washington, DC Virginia Virginia Virginia Virginia Virginia Maryland Maryland Maryland Virginia Virginia Maryland Maryland Maryland Virginia Virginia Maryland Maryland Virginia Virginia Virginia Virginia Virginia Virginia Virginia Virginia Maryland Virginia Virginia $ 420,000 336,000 299,000 287,000 322,000 4,356,000 2,851,000 3,900,000 3,460,000 2,861,000 $ 19,092,000 $ 950,000 2,045,000 2,086,000 894,000 878,000 916,000 1,335,000 862,000 3,300,000 4,971,000 372,000 913,000 1,052,000 246,000 2,803,000 2,465,000 1,771,000 6,085,000 6,159,000 $ 40,103,000 $255,932,000 $ 2,678,000 1,996,000 2,562,000 1,654,000 3,337,000 17,102,000 7,946,000 13,412,000 9,244,000 917,000 $ 60,848,000 $ 3,317,000 2,091,000 4,744,000 1,946,000 3,298,000 4,129,000 6,466,000 4,996,000 4,920,000 25,670,000 1,489,000 5,997,000 6,506,000 1,987,000 19,711,000 8,397,000 9,230,000 50,504,000 40,154,000 $205,552,000 $819,840,000 Net Improvements (Retirements) since Acquisition $ 5,826,000 5,704,000 5,593,000 6,157,000 11,616,000 9,917,000 4,598,000 4,229,000 2,758,000 17,263,000 $ 73,661,000 $ 958,000 717,000 928,000 808,000 411,000 1,404,000 1,489,000 1,111,000 1,020,000 8,690,000 153,000 223,000 234,000 -4,000 674,000 201,000 89,000 278,000 1,000 $ 19,385,000 $233,388,000 NOTES: (a) At December 31, 2005, our properties were encumbered by non-recourse mortgage amounts as follows: $13,700,000 on The Ashby, $7,755,000 on Country Club Towers, $10,560,000 on Munson Hill Towers, $9,625,000 on Park Adams, $8,360,000 on Roosevelt Towers, $8,144,000 on Sullyfield Center, $6,292,000 on Fullerton Industrial Center, $10,855,000 on Shady Grove Medical Village II, $24,687,000 on Frederick Crossing, $48,196,000 on Prosperity Medical Center and $21,443,000 on Dulles Business Park. (b) The purchase cost of real estate investments has been divided between land and buildings and improvements on the basis of management’s determination of the relative fair values. (c) At December 31, 2005, total land, buildings and improvements are carried at $1,372,726,000 for federal income tax purposes. (d) The useful life shown is for the main structure. Buildings and improvements are depreciated over various useful lives ranging from 3 to 50 years. (e) Residential properties are presented in gross square feet. (f) As of December 31, 2005, we had under development a residential and retail project with 224 apartment units and 5,900 square feet of retail space in Arlington, Virginia (Rosslyn Towers), a mixed-use project with 75 residential units and 2,600 square feet of retail space in Alexandria, Virginia (South Washington Street), and a 5.27 acre development site located along the Dulles Toll Road which is to be developed in two phases to include approximately 540,000 square feet of office and retail space (Dulles Station). 110 Washington Real Estate Investment Trust and Subsidiaries $ 21,005,000 $ 132,596,000 $ 153,601,000 $ 45,943,000 $ 950,000 $ 4,275,000 $ 5,225,000 $ 1,970,000 Buildings and December 31, Year of Date of Net Rentable Square Feet(e) Depreci- ation Land Improvements Total(c) 2005 Construction Acquisition Units Life(d) $ 420,000 $ 8,504,000 $ 8,924,000 $ 5,948,000 Accumulated Depreciation at 3,807,000 4,922,000 4,178,000 6,945,000 7,832,000 4,007,000 5,271,000 3,027,000 6,000 786,000 2,301,000 864,000 1,347,000 1,878,000 2,902,000 1,916,000 1,761,000 9,825,000 500,000 1,482,000 1,532,000 414,000 2,855,000 862,000 626,000 8,036,000 8,454,000 8,098,000 15,275,000 31,375,000 15,395,000 21,541,000 15,462,000 21,041,000 4,853,000 7,758,000 3,648,000 4,587,000 6,449,000 9,290,000 6,969,000 9,240,000 2,014,000 7,133,000 7,792,000 2,229,000 23,188,000 11,063,000 11,090,000 56,867,000 46,314,000 1951 1964 1965 1959 1963 1982 1971 1986 1987 1957 1980 1973 1990 1987 1987 1985 1986 1973 1985 1988 1986 1986 1985 January 1963 May 1965 July 1969 January 1969 January 1970 August 1996 March 1996 November 1997 September 1999 February 2001 September 1985 November 1993 May 1995 December 1995 December 1996 February 1997 February 1997 October 1997 May 1998 September 1998 January 1999 April 1999 September 1999 November 2001 January 2003 March 2004 — — — 1,729,000 2,095 177,000 168,000 159,000 172,000 259,000 244,000 154,000 226,000 170,000 104,000 85,000 167,000 85,000 87,000 93,000 167,000 108,000 246,000 788,000 32,000 83,000 95,000 31,000 245,000 137,000 141,000 325,000 206,000 307 30 Years 190 40 Years 227 35 Years 200 35 Years 279 33 Years 250 30 Years 212 30 Years 194 30 Years 236 30 Years 50 Years 50 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 1981/’82 October 1996 1980/’82 2000 2,084,000 1999/’04/’05 Dec/Apr ‘04/’05 734,000 2001/’03/’05 July 2005 336,000 299,000 287,000 322,000 4,356,000 2,851,000 3,900,000 3,460,000 4,774,000 2,045,000 2,086,000 894,000 878,000 916,000 1,335,000 862,000 3,300,000 4,971,000 372,000 913,000 1,052,000 246,000 2,803,000 2,465,000 1,771,000 6,085,000 6,158,000 7,700,000 8,155,000 7,811,000 14,953,000 27,019,000 12,544,000 17,641,000 12,002,000 16,267,000 2,808,000 5,672,000 2,754,000 3,709,000 5,533,000 7,955,000 6,107,000 5,940,000 1,642,000 6,220,000 6,740,000 1,983,000 20,385,000 8,598,000 9,319,000 50,782,000 40,156,000 34,360,000 39,331,000 1968/’91 $ 40,102,000 $ 224.938.000 $ 265,040,000 $ 36,639,000 $258,275,000 $1,050,885,000 $1,309,160,000 $240,153,000 3,225,000 — 10,303,000 2,095 SCHeDULe III SUMMaRY OF ReaL eState INVeStMeNtS aND aCCUMULateD DePReCIatION (CONtINUeD) Location Land Buildings and Improvements Washington, DC $ 420,000 $ 2,678,000 $ 5,826,000 Properties Multifamily Properties 3801 Connecticut Avenue Roosevelt Towers(a) Country Club Towers(a) Park Adams(a) Munson Hill Towers(a) The Ashby at McLean(a) Walker House Apartments Bethesda Hill Apartments Avondale Rosslyn Towers(f) Industrial Properties Fullerton Business Center Charleston Business Center Tech 100 Industrial Park Crossroads Distribution Center The Alban Business Center The Earhart Building Ammendale Technology Park I Ammendale Technology Park II Pickett Industrial Park Northern Virginia Industrial Park 8900 Telegraph Road Dulles South IV Sully Square Amvax Sullyfield Center(a) Fullerton Industrial(a) 8880 Gorman Road Dulles Business Park(a) Albemarle Point Total Virginia Virginia Virginia Virginia Virginia Maryland Maryland Maryland Virginia Virginia Maryland Maryland Maryland Virginia Virginia Maryland Maryland Virginia Virginia Virginia Virginia Virginia Virginia Virginia Virginia Maryland Virginia Virginia $ 950,000 $ 3,317,000 $ 958,000 Net Improvements (Retirements) since Acquisition 5,704,000 5,593,000 6,157,000 11,616,000 9,917,000 4,598,000 4,229,000 2,758,000 17,263,000 $ 73,661,000 717,000 928,000 808,000 411,000 1,404,000 1,489,000 1,111,000 1,020,000 8,690,000 153,000 223,000 234,000 -4,000 674,000 201,000 89,000 278,000 1,000 336,000 299,000 287,000 322,000 4,356,000 2,851,000 3,900,000 3,460,000 2,861,000 2,045,000 2,086,000 894,000 878,000 916,000 1,335,000 862,000 3,300,000 4,971,000 372,000 913,000 1,052,000 246,000 2,803,000 2,465,000 1,771,000 6,085,000 6,159,000 1,996,000 2,562,000 1,654,000 3,337,000 17,102,000 7,946,000 13,412,000 9,244,000 917,000 2,091,000 4,744,000 1,946,000 3,298,000 4,129,000 6,466,000 4,996,000 4,920,000 25,670,000 1,489,000 5,997,000 6,506,000 1,987,000 19,711,000 8,397,000 9,230,000 50,504,000 40,154,000 $ 40,103,000 $255,932,000 $205,552,000 $819,840,000 $ 19,385,000 $233,388,000 Gross Amounts at Which Carried at December 31, 2005 Buildings and Improvements Total(c) Land Accumulated Depreciation at December 31, 2005 Year of Construction Date of Acquisition Net Rentable Square Feet(e) Depreci- ation Units Life(d) $ 420,000 $ 8,504,000 $ 8,924,000 $ 5,948,000 3,807,000 4,922,000 4,178,000 6,945,000 7,832,000 4,007,000 5,271,000 3,027,000 6,000 8,036,000 8,454,000 8,098,000 15,275,000 31,375,000 15,395,000 21,541,000 15,462,000 21,041,000 7,700,000 8,155,000 7,811,000 14,953,000 27,019,000 12,544,000 17,641,000 12,002,000 16,267,000 336,000 299,000 287,000 322,000 4,356,000 2,851,000 3,900,000 3,460,000 4,774,000 1951 1964 1965 1959 1963 1982 1971 1986 1987 1957 January 1963 May 1965 July 1969 January 1969 January 1970 August 1996 March 1996 November 1997 September 1999 February 2001 177,000 168,000 159,000 172,000 259,000 244,000 154,000 226,000 170,000 — 307 30 Years 190 40 Years 227 35 Years 200 35 Years 279 33 Years 250 30 Years 212 30 Years 194 30 Years 236 30 Years — — $ 19,092,000 $ 60,848,000 $ 21,005,000 $ 132,596,000 $ 153,601,000 $ 45,943,000 1,729,000 2,095 $ 950,000 $ 4,275,000 $ 5,225,000 $ 1,970,000 786,000 2,301,000 864,000 1,347,000 1,878,000 2,902,000 1,916,000 1,761,000 9,825,000 500,000 1,482,000 1,532,000 414,000 2,855,000 862,000 626,000 4,853,000 7,758,000 3,648,000 4,587,000 6,449,000 9,290,000 6,969,000 9,240,000 39,331,000 2,014,000 7,133,000 7,792,000 2,229,000 23,188,000 11,063,000 11,090,000 56,867,000 46,314,000 2,808,000 5,672,000 2,754,000 3,709,000 5,533,000 7,955,000 6,107,000 5,940,000 34,360,000 1,642,000 6,220,000 6,740,000 1,983,000 20,385,000 8,598,000 9,319,000 50,782,000 40,156,000 1980 1973 1990 1987 1981/’82 1987 1985 1986 1973 1968/’91 1985 1988 1986 1986 1985 1980/’82 2000 September 1985 November 1993 May 1995 December 1995 October 1996 December 1996 February 1997 February 1997 October 1997 May 1998 September 1998 January 1999 April 1999 September 1999 November 2001 January 2003 March 2004 2,084,000 1999/’04/’05 Dec/Apr ‘04/’05 July 2005 2,045,000 2,086,000 894,000 878,000 916,000 1,335,000 862,000 3,300,000 4,971,000 372,000 913,000 1,052,000 246,000 2,803,000 2,465,000 1,771,000 6,085,000 6,158,000 734,000 2001/’03/’05 $ 40,102,000 $ 224.938.000 $ 265,040,000 $ 36,639,000 104,000 85,000 167,000 85,000 87,000 93,000 167,000 108,000 246,000 788,000 32,000 83,000 95,000 31,000 245,000 137,000 141,000 325,000 206,000 3,225,000 50 Years 50 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years 30 Years — $258,275,000 $1,050,885,000 $1,309,160,000 $240,153,000 10,303,000 2,095 Washington Real Estate Investment Trust and Subsidiaries 111 SUMMaRY OF ReaL eState INVeStMeNtS aND aCCUMULateD DePReCIatION The following is a reconciliation of real estate assets and accumulated depreciation for the years ended December 31, 2005, 2004 and 2003: (In thousands) Real Estate Assets Balance, beginning of period Additions—property acquisitions* —improvements* Deductions—write-off of disposed assets Deductions—property sales Balance, end of period Accumulated Depreciation Balance, beginning of period Additions—depreciation Deductions—write-off of disposed assets Deductions—property sales Balance, end of period 2005 2004 2003 $1,162,448 $1,052,866 $ 850,805 149,696 50,858 (4,099) (49,743) 85,047 33,439 (182) (8,722) 176,156 27,391 (1,486) — $1,309,160 $1,162,448 $1,052,866 $ 213,173 $ 177,640 $ 146,912 43,876 (4,099) (12,797) 37,387 (182) (1,672) 32,214 (1,486) — $ 240,153 $ 213,173 $ 177,640 * Includes non-cash accruals for capital items and assumed mortgage. 112 Washington Real Estate Investment Trust and Subsidiaries corporate information Corporate Headquarters Washington Real Estate Investment Trust 6110 Executive Boulevard, Suite 800 Rockville, Maryland 20852-3927 301.984.9400 800.565.9748 fax 301.984.9610 www.writ.com Counsel Arent Fox PLLC 1050 Connecticut Avenue, N.W. Washington, D.C. 20036-5339 Independent Registered Public Accounting Firm Ernst & Young LLP 8484 Westpark Drive McLean, Virginia 22102 Transfer Agent Computershare Trust Company, N.A. P.O. Box 43069 Providence, Rhode Island 02940-3069 Annual Meeting WRIT will hold its annual meeting of stockholders on May 26, 2006, at 11:00 a.m. at the Bethesda North Marriott Hotel & Conference Center, 5701 Marinelli Road, North Bethesda, Maryland. WRIT Direct WRIT’s dividend reinvestment and direct stock purchase plan permits cash investment of up to $25,000 per month, plus dividends, and is IRA eligible. Stock Information WRIT is traded on the New York Stock Exchange. The symbol listed in the newspaper is WRIT. The trading symbol is WRE. Member National Association of Real Estate Investment Trusts® 1875 Eye Street, N.W., Suite 600 Washington, D.C. 20006-5413 Annual CEO Certification WRIT submitted the CEO Certification required by the NYSE under Section 303A. 12(a) without qualifications. trustees and officers Trustees Edmund B. Cronin, Jr. Chairman, President and Chief Executive Officer; Director, John J. Kirlin Companies; Pepco Holdings Inc.; Chairman, Georgetown University Hospital John M. Derrick, Jr. Retired Chairman, President and Chief Executive Officer, Pepco Holdings Inc. John P. McDaniel Chief Executive Officer, MedStar Health; Director, Thrivent Financial for Lutherans Charles T. Nason Retired Chairman, President and Chief Executive Officer, The Acacia Group; Director, MedStar Health; Vice Chairman, Washington & Jefferson College David M. Osnos Attorney, Arent Fox PLLC; Director, EastGroup Properties; VSE Corporation Robert W. Pivik Retired Partner, Deloitte & Touche LLP Susan J. Williams President and Chief Executive Officer, Williams Aron & Associates Officers Edmund B. Cronin, Jr. Chairman, President and Chief Executive Officer James B. Cederdahl Managing Director, Property Management David A. DiNardo Managing Director, Leasing Laura M. Franklin Senior Vice President, Accounting, Administration and Corporate Secretary Sara L. Grootwassink Chief Financial Officer George F. McKenzie Executive Vice President, Real Estate Christopher P. Mundy Executive Vice President, Chief Investment Officer Thomas L. Regnell Managing Director, Acquisitions $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $ 500,000 1971 returns $10,000 invested in WRIT since December 31, 1971, with dividends reinvested, would be worth $2,490,392 as of December 31, 2005. WRIT Total Return WRIT Price Return 2005 Total Return Price Return WRIT NAREIT Equity S&P 500 WRIT NASDAQ DJIA WRIT Washington Real Estate Investment Trust 6110 Executive Boulevard, Suite 800, Rockville, Maryland 20852-3927 301.984.9400 800.565.9748 Fax 301.984.9610 www.writ.com